I have been a tax advisor for almost 50 years. During my career I have seen numerous tax changes and patterns of those changes.
Two recurring, unannounced patterns fall under most radar screens, but are worth mentioning as we’ll be seeing them for the next year or so.
The first is how the two political parties work in lockstep to raise our taxes.
When Republicans are in power, they lower tax rates but expand the tax base by increasing the amount of taxable income. In other words, they pay for lower rates by removing deductions or expediting income taxation.
When the Democrats regain power, they will restore tax rates without changing the way taxable income is calculated.
The second is that tax hikes are supposedly aimed at the rich, often defined as the top 10%. Various studies have found different income thresholds for 90th percentile income, but most show that households earning $ 120,000 to $ 125,000 are in the top 10%.
According to IRS statistics, households earning between $ 100,000 and $ 1.1 million pay the highest percentage of their income in taxes. Households earning more than this amount typically earn income that is taxable or otherwise protected with Capital Gains Rates.
It is not surprising, then, that many middle-class households will bear the brunt of these increases when tax increases target the top 10% while the extremely rich somehow manage to avoid paying additional taxes.
The Joe Biden administration has some interesting proposals trying to target the mega-rich, but I’m concerned about two provisions that promise to appeal to middle-class households, including many residents of the Santa Clarita Valley.
The first concerns the estate tax. Currently, when a person dies, the tax base of their assets is adjusted from what the deceased paid for those assets (“tax base”) to their fair value at the time of death. If the heirs sell these assets, they will only be taxed on the post-mortem increase in value.
President Biden has proposed eliminating this adjustment through a regime where the heirs would follow in the deceased’s footsteps by inheriting the deceased’s tax base. Biden is not the first to ask for this. Politicians as diverse as Edward Kennedy and Paul Ryan have made similar proposals.
However, on March 30, a number of Democratic Senators introduced the “Reasonable Taxes and Equity Incentives Act of 2021,” which far surpasses the Biden proposals.
According to her proposal, people who die for income tax reasons would be treated as if they had sold their intangible assets, including stocks, bonds, family businesses and collectibles.
Although the first million dollars in profits would be tax-free, many family businesses are worth more than that amount.
Imagine someone dying with an estate that consists of a $ 2 million stock portfolio. Let’s say they acquired these assets many years ago at a cost of $ 400,000.
The after death sale would result in capital gains of $ 1.6 million.
Although the first million would not be taxed, the remainder would be taxed at 23%. This would add an additional tax of nearly $ 140,000 to the deceased’s final income tax return.
While $ 2 million sounds like a large estate to various sources, an estimated 6% of American households have a net worth of $ 2 million. That $ 2 million is well below the current $ 11.7 million estate tax threshold and well below the Biden proposed $ 3.6 million estate tax threshold. This is a new type of death tax that is broader and is in addition to inheritance tax.
The other issue that will receive considerable rhetoric is the reinstatement of the state and local tax deduction (SALT), which the government really cannot afford to implement. Both House Speaker Nancy Pelosi and MP Mike Garcia have expressed a desire to restore the trigger.
Historically, when a trigger is lifted it never returns, but due to political dexterity we can see a mirage claiming to be the SALT trigger. In the 1990s, Ohio Democratic MP Donald Pease tabled a proposal that limited the use of single prints. The so-called “Pease Limitation” reduced the individual deductions above a certain level by 3% of the income.
The pease restriction was lifted in 2017, but the Biden tax proposals aim to reintroduce it.
Increased SALT deductions would be subject to the pease restriction and would not be fully deductible for many taxpayers.
The pease restriction is a good example of how tax law has become more complicated for political reasons. Congress didn’t want to be seen as an increase in tax rates, so they added a complex calculation to increase the amount of taxable income.
I plan to write future columns explaining other tax proposals as they arise.
Jim de Bree, a resident of Valencia, is a CPA on half board and a student of tax policy.