The US: Biden vs. Trump: How would a change in the Oval Office impact my tax affairs?
As we move into November and continue to adjust to the ‘new normal’, you could be forgiven for forgetting that millions of Americans are currently casting their votes early, for one of the most divisive US elections in recent years. In the early morning of November 4th, we should expect to know whether Donald Trump will be re-elected for his second and final term in office, or if Joe Biden will be inaugurated in January 2021 as the 46th President of the United States.
Whilst the stark differences between the two candidates has been clear to see throughout the entirety of this election campaign, with a light being shone on their personal differences rather than their party’s, here we consider the differences in their tax policy and what reforms a Biden administration may bring.
The state of play
Trump signed into law the Tax Cuts & Jobs Act 2017 (TCJA) following his inauguration, which brought about major changes to how individuals are taxed from 2018 until 2025. We have touched on some of the key changes below.
The TCJA reduced five of the seven rates of income tax for individuals. This includes the top rate which has been reduced from 39.6% to 37% whilst the threshold at which this kicks in has increased from $470,700 to $600,000 (for Married Filing Joint filers). A clear win for high earners.
Personal exemptions have been suspended, but standard deductions for all filers have essentially been doubled. However, if you are a high net worth (HNW) individual, you are more likely to itemise your deductions rather than claim the standard. Under the TCJA, a number of itemised deductions have been capped or suspended, so whilst you are subject to a lower rate of income tax, the total deductions you can claim may now be less. Two of the main changes are the capping of state and local tax deductions for both single and joint filers at $10,000, whilst the amount of loan principal you can deduct mortgage interest against has been reduced from $1 million to $750,000.
Before 2018, under the Pease Limitations, the itemised deductions you could claim were reduced by 3% of the amount by which your adjusted gross income (AGI) exceeded certain thresholds. In 2017 this threshold for single taxpayers was $261,500. The TCJA did away with the Pease Limitations, so itemised deductions are no longer limited based on AGI.
A significant change under the TCJA was the increase in the estate tax exclusion from $5,450,000 to $11,400,000 for each individual. The exemption for 2020 is now $11.58m per individual. This is the highest the exclusion has ever been and also means that the majority of Americans are unlikely to pay any estate tax at all. In 2019 for example, only 0.07% of Americans who died will have to pay any estate tax. This increased exclusion runs until 2026, at which point it will revert back to the lower exclusion.
Prior to the TCJA, US corporation tax was at a relatively high level, with companies paying tax at a rate of 25% if their taxable income ranged from $50,001 – $70,000. This eventually reached a maximum rate of 35% for companies with taxable income over $10 million. Personal Service Companies (PSC) always paid a flat rate of 35%, regardless of taxable income levels. However, from 2018 the TCJA established a flat rate of 21% – including PSCs – which represented a significant drop in tax for any company that generated taxable income above $50,000. As a businessman himself, there is no doubt this change appealed to Trump personally (in case he should ever be in a position to pay more tax in the US than China), as well as US businesses.
Biden’s plan to Top Trumps
Joe Biden has clearly set out what tax reforms he intends to make should he be elected into Office, a number of which would directly repeal parts of the TCJA.
Biden is proposing to roll back the income tax reductions introduced in the TCJA for those who earn above $400,000. This could be done by reverting the rates for taxable income above this threshold, back to pre-TCJA levels. He has made it clear that if you earn less than $400,000, you would not be impacted by these changes. What this means is that, if you are taxed at the top rate, you would have an income tax increase of 2.6%.
To further counteract the rules implemented by the TCJA, Biden wants to cap itemised deductions at 28% of their value for those with income over $400,000. Rather than being capped as soon as you reach the threshold, it is likely this limitation will be phased in between a range, for example between $400,000 – $500,000. This change would potentially limit the deductions you can claim by over 70%, which would result in a significant increase in income tax for high earners.
With the estate tax exemption currently as high as it has ever been, it is inevitable that Biden will look to bring this back down to at least the level in 2017. The proposals are not clear on what this figure will be; however, we can be confident that the exclusion will not exceed the previous amount of $5.5 million per individual and could be as low as $3.5 million.
In another proposed change aimed at high earners, Biden would look to tax capital gains and dividends at the same rate as ordinary income if you earn over $1 million in the year. This would mean for capital gains and qualifying dividends, your maximum tax rate would increase from 20% to 39.6% (assuming they revert to the pre-TCJA income tax rates), essentially doubling the tax you pay.
Finally, Biden is proposing the introduction of a flat rate of corporation tax at 28%, a 7% increase on the changes brought in by Trump at the end of 2017. There is also a clear shift to a greener future, with Biden looking to provide tax credits to those working on renewable energy whilst eliminating the preferences offered to companies focused on fossil fuels.
What can I do now?
If Biden is elected, we would expect any reforms to come in no earlier than January 2021. However, given the ongoing pandemic and the unpredictable future ahead of us, these changes could be pushed back as far as 2022 should further tax breaks and reliefs be required to protect jobs and ensure the wellbeing of people in the US. We would still recommend undertaking advanced tax planning to ensure that if any of the above may impact you, you have taken the necessary steps to manage your tax position.
These discussions can cover:
- Estate planning:
Making gifts out of your estate now in order to take advantage of the $11.4 million exemption. Any gifts out of your estate that exceed the exclusion can be subject to tax in the US up to a rate of 40%, so it seems a no brainer to make use of it now, should the exemption potentially be reduced by nearly $8 million.
- Crystallise chargeable gains:
If you know you are going to realise a sizeable gain at some point in the future, it may be worth realising this sooner rather than later, to ensure you only pay tax at 20%, rather than Biden’s proposed rate of 39.6% (plus net investment income tax!).