With Ohio’s primary election postponed until June 2nd, and with a much narrower field of candidates, maybe it’s time to take a closer look at one of the more important topics of the election, and one that is quite frankly many times overlooked – what is each candidate’s tax plan? While all the candidates promise to do what is best for us, federal tax policy may ultimately be the item that impacts our pocketbooks the most. Everyone knows the old adage “in this world nothing can be said to be certain, except death and taxes.” That includes you COVID-19! Assuming the current tax environment is the status quo for President Trump, here is a closer look at where the challenging candidates stand on some of the key major tax issues:
Tax Rates – Individual and Corporate
Let’s start with individual income tax rates. Under the Tax Cuts and Jobs Act of 2017 (TCJA), top rates for individuals in most brackets were cut 1 to 4%, with the top bracket decreasing from 39.6% to 37%. Candidates Biden and Sanders both suggest raising individual rates – Biden would effectively support repealing the rate cuts from the TCJA, bumping all brackets up and topping out at 39.6% again. Sanders’ plan is a mixed bag – on the one hand it proposes the status quo for those with joint income below $500,000, which would appear to provide lower rates on these taxpayers than Biden’s plan, except when you consider Bernie’s proposed 4% surtax on all taxable income over $250,000 for a married couple. For those with income above $500,000, the brackets increase dramatically, beginning at 40% ($500,000 to $1M), 45% ($1M to $4M), 50% ($4M to $20M) and topping out at 52% (above $20M). And don’t forget the 4% surtax on top of all that. Both Biden and Sanders would also push for a new 28% limit on the reduction of income tax liability from itemized deductions. Sanders is also touting an increase to the current 3.8% net investment tax, hiking it up to a flat 10%.
On the corporate side, Biden proposes a 28% rate and Sanders a 35% rate, and both have other little tweaks as well, including eliminating certain incentive credits and deductions.
The highest capital gains rate is currently 20%, with lower rates applicable to those in the lower tax brackets. This structure has been in place for nearly a decade and has survived both Republican and Democrat administrations and Congress. Both Biden and Sanders are proposing changes. Sanders favors taxing capital gains at ordinary income rates for taxpayers with income in excess of $250,000. Biden has the same idea, but the ordinary income rates would only kick in for taxpayers with income in excess of $1 million.
Current law imposes 12.4% tax (social security/”FICA”) on wages up to the “wage base” of $137,500, and an additional 2.9% Medicare tax on all wages (no limiting wage base). Both taxes are split between the employee and the employer, with the employee’s portion withheld from the employee’s paycheck.
Both Biden and Sanders have proposed a repeal of the payroll taxes on wages above the wage base of $137,500, but below $250,000 (Sanders) and $400,000 (Biden). This means those with individual wages between the wage base and the upper limit would have no payroll taxes on wages within this range, creating what has been termed a “donut hole.” This is an interesting proposal because the benefit hits only the upper middle class. First, it would not touch the payroll tax currently paid by those earning less than the wage base – providing no relief to low-income (generally those below $50,000) and middle-class taxpayers (generally those $50,000 to $100,000). For the upper middle-class taxpayer earning wages between $137,500 and $250,000/$400,000, the donut hole provision would effectively keep the wage base in place on the social security side and provide a 1.45% cut on Medicare taxes imposed above the wage base. The result is a maximum benefit of approximately $1,600 (Sanders) or $3,800 (Biden) for the full donut hole. Above the donut hole, taxpayers and their employers would again be subject to the 12.4% social security and the 2.9% Medicare tax on all wages in excess of the donut hole’s upper limit.
In addition, Sanders would levy another 7.5% payroll tax on employers who have gross payroll over $2 million (levied on excess over $2M) – this is part of the funding mechanism for “Medicare for All.” Presumably, similar concepts would be applied with respect to self-employment tax as well, which has a similar rate structure to social security/Medicare.
To boil this down, if your wages are less than the annual wage base of $137,000, there will be no change. If you are in the “donut hole” of each plan, your overall employment tax burden will decrease ever so slightly, and if you are in excess of the donut hole limitation, you will have a substantial increase to your payroll tax burden.
Estate and Gift Tax
Some of the biggest proposed changes by the candidates come in the area of estate and gift tax. Biden proposes to eliminate the long-standing “step up in basis” on a taxpayer’s death. Under current law, when a taxpayer dies and passes assets on to heirs, the tax basis of those assets is “stepped up” to the current fair market value. This allows the heirs to then sell the asset and not incur any income tax on the sale, presuming the sale is at the current fair market value. Eliminating the step up will create a tax burden on the heirs, and Biden further proposes that the tax is paid upon inheritance or transfer, not when the heir ultimately sells the asset. This would be very disruptive to the current system and would impose tax on many transfers in which there are no liquid funds available to pay the tax. It will also require taxpayers to more carefully track adjusted tax bases of their assets during life so that heirs will be able to establish basis upon inheritance. The IRS takes the view that if you cannot establish basis that you have a zero basis.
Sanders also proposes an elimination of the basis step up and would increase the estate tax rates from the current rate of 40% to a progressive structure with 45% ($3.5M to $10M), 50% ($10M to $50M), 55% ($50M to $1B) and 77% (over $1B). The individual estate tax exemption would decrease from the current $11.58M to $3.5M per individual.
Biden’s tax plan would put an end to like-kind exchanges under § 1031, a provision that has long helped real estate investors sell properties and defer capital gains if replacement properties are purchased. All of the gain associated with the sold property is carried over into the new property and deferred until future sale. Recall that Biden is also proposing to do away with preferential capital gain rates for taxpayers with over $1M of income, which along with the elimination of 1031 exchanges would significantly increase the tax burden for some folks who are exiting one real estate investment and simultaneously entering a new one.
Sanders has a couple other taxes up his sleeve, or at least confiscation mechanisms, that directly impact high net worth individuals and certain businesses. The “Tax on Extreme Wealth” would apply progressive rates from 1% to 8% to anyone with a net worth over $32M, with the top rate kicking in at a net worth over $10B. Sanders’ website states the purpose of this tax is to “substantially break up the concentration of wealth and power of this small privileged class.” Interesting statement from someone making a living on Capitol Hill. This proposed tax would hit every year until it knocked the taxpayer below the $32M threshold of net worth. While this would be an incredible boon to the appraisers around the country as they valued assets every year, it would be burdensome in reporting and audit, not to mention encouraging high net worth individuals to expatriate.
If the wealth tax is not extreme enough, Sanders is also proposing mandatory shifts in the ownership of corporations with at least $100M in annual revenue, forcing the corporation to divest 2% of its stock each year to its employees until the corporation is at least 20% employee owned. The plan would also dictate the makeup of corporate boards, guarantee a right of first refusal for employees to purchase the corporation on any future sale, mandate diversity on corporate boards (gender, race, ethnicity, religion, disability, or sexual), and even examine prior mergers to determine if such transactions should be undone. This is all on Sanders’ website – you can’t make this stuff up.
The Tax Voter
There are a lot of issues that garner more press than the candidate’s position on tax policy, but not many that hit us as individuals as hard as raising income and payroll taxes, imposing higher taxes on individuals and businesses, and substantially raising the tax burden on the transfer of assets at death. For the tax voters out there, I hope this background on some of the major issues has been helpful as you consider your vote in not on the primary but also the general election in 2020.
For more information, contact Chad Hansen, Chair of Coolidge’s Tax Department.
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