House Democrats have proposed legislation that could end Trump’s tax cuts for the wealthy and corporations. If passed, it could lead to some of the biggest tax increases in decades. But while these tax changes are intended to fulfill President Joe Biden’s promises to tackle inequality, they are on a smaller scale in an effort to win over moderate Democrats. The new plan offers a lift at the top capital gains tax rate from 20% to 25%, instead of nearly doubling it to 39.6% as Biden originally proposed. And the corporate tax rate will only rise to 26.5% instead of 28%. Let’s find out how these tax changes may affect you. A financial advisor may be able to help you with tax planning. SmartAsset’s Free Advisor Matching Tool can put you in touch with financial advisors in your area.
What was originally proposed?
President Biden initially presented various tax proposals that included increasing the top tax rate on capital gains from 20% to 39.6%. With the high earners Medicare surtax from 3.8%, the top rate will become 43.4%. According to his original plan, both short term and long term capital gains will be taxed in the same way, with the highest income tax bracket including a rate of 39.6%.
Biden also proposed eliminating a loophole that allows capital gains to be passed along as part of an estate to avoid taxation. The president suggested the IRS do a better job of auditing high earners to make sure they pay their fair share. The tax increases are also intended to help fund increased IRS oversight.
What does the current proposal look like?
House Democrats just released an updated version of the tax overhaul Biden outlined in April. While there are certainly consistent themes, some of the numbers are returned. The move likely stems from the fact that Democrats don’t want to alienate voters before the midterm elections in 2022. There are also certain political limits to implementing such drastic changes. Still, it’s likely that Biden set his sights high, knowing that Congress would try to rein in his ideas.
The new proposal includes several different parts. That would raise corporate tax rate from 21% to 26.5% for businesses reporting revenues over $5 million. It would raise the top income tax rate from 37% to 39.6% for households making more than $450,000 a year and individuals making more than $400,000 a year. The top rate of capital gains tax will rise more modestly from 20% to 25%. An additional 3% surtax on those earning more than $5 million a year is also in the works. Another important provision Democrats would like to include is $80 billion in IRS funding over the next decade. That kind of package has the potential to add up to hundreds of billions of dollars in lost tax revenue over the same period of time.
Who does the proposal affect?
A key feature of both the original and updated tax proposals is the fact that they are designed to affect only extremely high earners. As a result, most people will not be affected by any changes. The top tax rate increase, for example, only affects those earning at least $400,000 a year. Corporations that bring in more than $5 million a year are the only ones that will see a change. Businesses that bring in less than $400,000 will actually see a reduction in their tax liability.
The new top tax rate on capital gains will work in a similar way. In 2021, you will only owe the increased top rate of 25% if you are a single filer earning more than $445,850 or married filing jointly earning more than $501,600. The additional 3% tax only applies to those , who earn more than $5 million a year. Needless to say, these changes really only affect a percentage of top 1% of earners.
How should you react or prepare?
Unless you or your business brings in a significant amount of money each year, you probably won’t have to worry about the effects of the new tax proposals. However, if you are concerned about reducing your overall tax liability, you can maximize your contributions to tax-free or tax-deferred retirement accounts such as 401(k)s and contribute to tax-free health savings account (HSA)among other tax strategies.
For those making millions in capital gains, financial advisor can help you think through your options if the new tax proposal becomes law.
Bottom row
Although the new tax proposal presented by House Democrats is more sweeping than Biden’s original proposal, it still has major implications for federal spending over the next decade. Those changes could reportedly raise $2.9 trillion in new revenue to help fund critical parts of the U.S. social safety net. The House Democrats’ proposal still needs to pass the Senate before it can be signed into law, and even then it is expected to affect only some of the top earners in the nation’s top 1 percent. However, there are still tax moves you can do to prepare.
Tax planning tips
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