It looks like the United States of America is going to get a new President in January. New Presidents bring change, and sometimes that change trickles down into the tax code. Today, we are going to look at some of President-elect Joe Biden’s tax proposals. It is important to remember, though, that just because he wants these things to happen doesn’t necessarily mean that they will. In most cases, he has to get Congress on board with his ideas to move them forward, which can prove quite challenging.
The major way that Biden wants to help low- and middle-income Americans is through tax credits. Tax credits directly lower your tax bill and some are even refundable, meaning you can receive a payment if the credit exceeds your tax bill. These are the tax credits that he is targeting:
Premium Tax Credit
You may know the Premium Tax Credit by the name of Obamacare Subsidy. These are the income-based tax credits given to people who purchase their health insurance on the Affordable Care Act Marketplace. To be eligible, you must make between 100% and 400% of the federal poverty level. Biden would like to expand these tax credits to people with higher incomes and even those with workplace health coverage.
Child Tax Credit
The Child Tax Credit is a partially refundable credit given to people with qualifying children under age 17. President Trump doubled the amount of the credit from $1,000 per child to $2,000 per child with the Tax Cuts & Jobs Act. Biden would like to increase it even further, to $3,000 per child and throw in an extra $600 for children under 6. He would also like to make it fully refundable, instead of just partially as it is now.
Child & Dependent Care Tax Credit
The Child & Dependent Care Tax Credit helps to reimburse some of the dependent care expenses that taxpayers incur. It only covers a percentage of expenses, ranging from 20% to 35% based on income. The expenses used to calculate the credit are currently capped at $3,000 for an individual dependent or $6,000 for two or more. Biden would like to increase those limits to $8,000 for an individual dependent and $16,000 for two or more. He also wants to increase the top percentage from 35% to 50%.
First Time Homebuyers’ Tax Credit
The First Time Homebuyers’ Tax Credit was created in response to the bursting of the housing bubble and the Great Recession and was offered from 2008 to 2010. It provided federal funds in the form of a tax credit to help people make their first home purchase. Biden would like to revive and increase the credit. He has proposed making the credit worth up to $15,000, which is a significant increase from the original levels.
Renter’s Tax Credit
Biden would like to create a brand new tax credit for renters with the goal of keeping rent and utility payments at 30% of monthly income. The tax credit would be refundable.
Earned Income Tax Credit
One change that would greatly benefit senior citizens relates to the Earned Income Tax Credit. It is a credit offered to lower-income workers to help offset the cost of the payroll taxes that they pay. Currently, only people between the ages of 24 and 65 are eligible if they do not have qualifying dependents. Biden’s proposal would open eligibility up to workers age 65 and older.
Another major change that Biden has proposed affects the tax benefits of contributing to a retirement plan. Right now, if you make a contribution to a retirement plan that isn’t a Roth, you receive a tax deduction for the contribution amount. It is subtracted from your income before you calculate your taxes due. The fact that you essentially don’t pay taxes on the money you put into those accounts (you pay the taxes upon withdrawal) is the reason they are referred to as pre-tax accounts.
Biden’s proposal would exchange the tax deduction for a tax credit. It would be a matching tax credit at a flat rate of 26% in the form of a retirement contribution. Instead of the taxpayer getting the money directly, it would be deposited into their retirement account.
Comparing Current Law & Biden’s Proposal
Let’s illustrate the difference with an example. If you contribute $1,000 to a traditional IRA today, then when you file your tax return you can subtract that $1,000 from your taxable income. That would be a $120 tax savings if you are in the 12% tax bracket and a $370 tax savings if you are in the 37% tax bracket. Under Biden’s plan, it would work differently. Instead of lowering your taxable income and therefore your tax bill, the government would make a contribution to your retirement account for you of $260 (26%).
There are two major differences between the two plans. First, the tax benefit goes directly into your retirement savings under Biden’s plan. You don’t actually get the money today. Technically you could access the money, but withdrawals from retirement plans before age 59 ½ are subject to a 10% penalty on top of regular income taxes. Second, those in lower-income tax brackets receive a greater benefit. The person in the 12% tax bracket now gets $260 instead of just saving $120 and the person in the 37% tax bracket now gets only $260 instead of saving $370 as before.
Overall, Biden’s tax proposals are designed to alleviate the burden of lower-income taxpayers and shift it to higher-income earners. His proposed tax increases all impact people who earn $400,000 or more.
The first is a change in the tax brackets. He would like to raise the current top federal income tax bracket to the pre-Tax Cuts & Jobs Act level of 39.6% for those earning over $400,000. It is important to note, though, that this is a change that is set to happen eventually anyway. The tax bracket changes from the Tax Cuts & Jobs Act are set to sunset, or expire, at the end of 2025.
Another change aimed at that income range regards Social Security taxes. Right now, Social Security taxes are only paid on wages up to $137,700 (the cap adjusts annually with inflation). Any income above that amount is not subject to the Social Security tax of 6.2% for employees and 12.4% for self-employed individuals. Biden has proposed keeping the original cap in place but reintroducing the tax on income over $400,000. That way, only income between $137,700 and $400,000 would escape Social Security taxation.
Other changes aimed at those who earn more than $400,000 are limiting itemized deductions and phasing out the qualified small business income deduction.
There is one last tax increase that affects only those earning $1 million or more. He would like to eliminate the preferential tax rates for long-term capital gains and qualified dividends for those taxpayers. Instead, he would have them pay ordinary income taxes of 39.6% on those earnings.
Transfer & Capital Gains Taxes
Biden has also proposed some changes that would affect those passing on assets or receiving an inheritance. The IRS gives a limit to the amount of assets you can give away either during your life or at death, and anything above that limit is taxed. Right now the limits are very high, but Biden would like to lower them to where they were in 2009. This will only affect those who have several million dollars to pass on and their heirs.
Another proposed change related to inheritances will have a much broader reach. Under current tax law, when you inherit an investment, you don’t have to pay any taxes on the gains that the investment earned during the original owner’s lifetime. It is called a step-up in tax basis and basically means that the tax liability for the earnings dies with the original owner. The heir only has to pay taxes on growth since the original owner’s death. Biden would like to eliminate that provision and collect taxes on all earnings, both prior to and after the original owner’s passing.
What This Means For You
Though Biden has a lot of ideas for changing the tax code, you must remember that they are just proposals. There is no guarantee that any of these changes will become law. Also, legislation takes time, so even if they do become law, it won’t be in January 2021.
It is important to understand the proposals and changes that could be on the horizon, but you should make your financial decisions based on the reality of today. It is helpful to plan for the what-ifs, but much more important to have a solid plan for what-is.
Do you have a well-thought-out financial plan? If not, we can help. We can develop a comprehensive financial plan for you so that you can build a solid financial foundation today that will prepare you for any changes that may come down the road. Schedule an introductory call or check out our website to learn more.
About Guide Financial Planning
Guide Financial Planning is led by founder Ben Wacek, who is a Christian fee-only Certified Financial Planner™ and Certified Kingdom Advisor®. He has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective using Biblical principles. Based in Minneapolis, MN, he works with clients both locally and virtually throughout the country and abroad. You can follow the links to learn more about Guide Financial Planning and our team and the services we offer.