President Joe Biden has proposed raising taxes on wealthy Americans earning over $400,000 per year to fund childcare, education, paid leave, and other reforms. He plans to achieve this goal by raising the top income and capital gains tax rates, eliminating tax loopholes, changing estate taxation, and focusing audits on the wealthy.
According to the White House, the American Families Plan is expected to raise $1.5 trillion over ten years by taxing high earners. In a speech detailing his program, Biden said, “I think you should be able to become a billionaire or a millionaire. But you must pay your fair share.”
Research published by the Institute on Taxation and Economic Policy revealed that the wealthiest 1% of taxpayers with an average income of $2.2 million would bear the brunt of the tax hike. According to the analysis, two-thirds of this group would see their taxes rise by an average of $159,000 each year.
Naturally, the measure will face opposition in Congress. In addition, the House Ways and Means Committee is actively writing their own tax bill proposal for consideration. Biden’s proposal will likely change along the way, and passage is not certain. Below are some of the most notable proposed changes to the tax law being discussed.
The New Top Tax Rate
Under Biden’s plan, the top income tax rate of 39.6% would apply only to 1% of Americans. According to Garrett Watson, a senior policy researcher at the Tax Foundation, households with more than $540,000 in income are among the highest 1% of taxpayers.
However, the exact income at which the 39.6% rate would apply to single taxpayers and joint filers remains unknown. According to Watson, these rates would most likely correlate with the present top rate of 37%.
It would be applicable to single filers earning more than $523,600 and married couples earning more than $628,300. The Tax Foundation estimates that this part of Biden’s proposal would raise $110 billion over ten years.
Double Capital Gains Rates
The American Families Plan would also alter how the wealthy pay tax on investment returns. For starters, Biden’s proposal would boost the top tax rate on long-term capital gains from 20% to 39.6%, the same rate that applies to their wages.
The policy applies to taxpayers who sell stocks, bonds, and other assets kept in taxable accounts for a profit and have an annual income of more than $1 million. This group constitutes the top 0.3% of Americans.
In comparison to lower earners, the wealthy receive a substantially bigger portion of their annual income from investments. According to a Tax Foundation estimate, investments account for more than 40% of income for taxpayers earning at least $1 million each year. The other streams make up lesser parts of the total.
On the other hand, Americans earning less than $50,000 a year receive only about 5% of their income from investments. For this group, their wages account for more than 80% of total income.
Gains in Capital at Death
At the moment, an asset’s appreciation is not taxed in the event of the owner’s death. Instead, the asset is given a step-up in basis and is passed on to successors at current market value, wiping out the capital gain. The asset could then be sold without paying capital gains tax to the heirs.
Biden’s plan will alter how rich estates are taxed on appreciated assets when the owner dies. It is the second main component of his capital gains tax overhaul, and the president aims to eliminate the step-up in basis after death for gains exceeding $1 million.
Unrealized gains would be subject to capital gains tax at the time of the owner’s death. For the wealthiest households, this figure might go as high as 43.4%. Single individual estates may incur a 40% federal estate tax on assets worth more than $11.7 million. For married couples, the limit is $23.4 million.
Talking about Biden’s tax plan, Gordon Mermin, a principal research associate at the Urban-Brookings Tax Policy Center, said, “This is not the estate tax. It is just taxing those gains that were never taxed.”
At death, wealthy estates would be allowed to omit $1 million of gains from tax in the event of death. For couples, the threshold would be $2 million. This exception would be allowed in conjunction with the current tax break for real estate that has risen in value. Single taxpayers can omit up to $250,000 in capital gains, while married couples can omit up to $500,000.
Let’s imagine a wealthy couple spent $5 million on a mansion that will be worth $10 million when they die. The estate can omit half the initial amount in such a case, but the remaining $2.5 million will be taxed. The exclusion is high enough to aim at higher earners.
According to the White House, family-owned businesses and farms would likewise be exempt from paying taxes when the business or farm is passed down to heirs who continue to run it.
Experts say it is unclear how Biden’s proposal to tax unrealized profits at death will interact with the federal estate tax. For instance, can taxes paid on unrealized gains be deducted from the total estate size? Operationally, there are a lot of uncertainties about how this might work.
Increased IRS Audits
The White House would also give the IRS more resources to improve tax audits of households earning more than $400,000. According to IRS figures provided by the White House, audit rates for taxpayers earning over $1 million per year decreased by 80% between 2011 and 2018, raising $700 billion over a decade.
Contact Windes for Tax Preparation & Filing
As a leading accounting firm, Windes can help you understand potential tax reforms and how they may affect your estate or business. We will continue to monitor progress in Washington and provide updates on the tax bill being developed by Congress to provide proactive advice to our clients in order to assist them in making the best decisions possible. Connect with us today for individual tax preparation or any other tax and finance concerns.