The transition to a new administration has created uncertainty about tax law.
“Changes are anticipated, with uncertainty about what to expect and when,” says Matt McKinnon, tax director at Brady Ware. “Everyone is concerned about how those changes will affect the general public, families with kids, the middle class and businesses.”
Smart Business spoke with McKinnon about tax law changes expected under the Biden Administration and how they will impact businesses and individuals.
How soon could changes be enacted?
The Tax Cuts & Jobs Act in 2017 took 11 months from introduction to law, which is pretty remarkable considering it was the largest piece of tax reform since 1986. With a Democratic president and Democrats effectively controlling Congress, it’s likely something gets passed in 2021, taking effect in early 2022.
What changes are proposed for businesses?
Under the Jobs Act, the corporate tax rate, which had been at 35 percent, dropped to 21 percent. With the proposed changes, corporations would pay a flat rate of 28 percent. However, for those paying no or negative federal tax, there would be a minimum tax rate of 15 percent of book income if that is more than $100 million.
For pass-through entities such as S Corps and LLCs that are taxed as partnerships, the entity itself does not pay taxes. Instead, that income passes through to the partners, who bear an individual tax burden. Generally, these individuals can now deduct 20 percent of qualified business income, so they pay taxes at the individual rate of 37 percent on 80 percent of their business income. With a proposed increase in the individual rate back to 39.6 percent, and a phasing out of the qualified business income deduction for those earning more than $400,000, these individuals face a significant tax increase.
What changes are anticipated for individual taxpayers?
The individual maximum tax rate will likely return to 39.6 percent from 37 percent for those making more than $400,000. We also anticipate a substantial increase in the capital gains tax rate, from the preferential rate of 20 percent to a top rate of 39.6 percent for those with more than $1 million in income.
On a favorable note, there is a proposed one-year enhancement of the Child Tax Credit, from $2,000 to $3,000 per child between the ages of 6 and 17, and $3,600 for those under age 6. Currently, if your credit exceeds your tax burden, that additional money is lost; under the Biden proposal, that tax credit would be fully refundable.
What other changes can individuals expect?
A proposed change in itemized deductions would eliminate the $10,000 cap for state, local and property taxes to allow for full deductibility, capped at 28 percent of value once an individual’s income tops $400,000. In addition:
- Currently, once income hits $142,800, the Social Security component of FICA is eliminated. Under the proposal, that returns once income tops $400,000.
- The proposal eliminates up to $50,000 in federal student loan debt, tax-free.
- The estate tax exemption for 2021 is $11.7 million. Estates in excess of that are taxed at 40 percent. The assets receive a stepped-up basis and transfer to heirs at fair market value. Under the proposed change, the exemption drops to $3.5 million; amounts over would be taxed at 45 percent, and the stepped-up basis rule would be eliminated.
How can taxpayers navigate the complexity of tax laws?
The uncertainty and flux makes it difficult to do financial planning, because what the landscape looks like today may change tomorrow. A tax professional can help you identify issues and make the best choices. In addition, business owners should create a cohesive team of advisers — a lender, attorney, CPA, financial adviser — working together to avoid creating tax issues, allowing you to be proactive instead of reactive.
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