Some of Joe Biden’s tax plan is helpful, other portions are downright scary. Keep in mind that the President of the United States doesn’t just get to enact his tax plan. Congress has to pass it and with a likely Republican Senate majority there will be some compromises on any tax system overalls. In the meantime it is a good idea to assess how Joe Biden’s tax plan could affect you and your heirs as you strive to build wealth.
The Good Part of Joe Biden’s Tax Plan:
Increased Child Tax Credit:
Joe’s plan calls for increasing the child tax credit from $2,000 to $3,000 AND to make it refundable. For me personally this give me $3,000 more real dollars per year. If I put that extra $1,000 into each child’s investment account it will grow to $145,000 in 50 years with 10% annual returns. This is even more important for low income families. By making the entire tax credit refundable, low income families will have much more discretionary income. To profile a friend of mine who earns $20,000 a year and has 3 children, rather than receiving a $9,000 tax refund (roughly $6,000 Earned Income Credit and $3,000 Child Tax Credit) She will receive a $15,000 tax refund. That $6,000 difference is massive. This is a major anti-poverty tool that will stimulate the economy and help people on the lower in of the income ladder gain some traction. Ideally they would do a prebate for the Earned Income Credit or the Child Tax Credit. Instead of receiving $15,000 all at once, perhaps half the money would come all at once at tax time and the other half, in this scenario $7,500 would come in monthly installments of $625. I feel this would be a lot more helpful to people.
The child tax credit cost $57 Billion last year, so if we increase it by 75%, 50% to account for the $1,000 increase and 25% for making a portion of it refundable the total cost of this is around $43 Billion.
1st Time home buyer tax credit:
I talked about something like this for helping with the wealth gap in our country. This tax credit would essentially take away one of the largest barriers to entry for home ownership, which is the down payment. The tax credit would be instantly refunded, as in applied at the closing. With a 10% tax credit and a maximum of $15,000 this ensures that people can start on the rung to home ownership with a chunk of equity and not be stuck as renters forever while trying to save up that 5 to 10%. This is a great tax credit for our children. I would plan for my kids to match that tax credit with their own savings and then after they closed I would pay an amount equal to 10% of the house value on the mortgage, cutting several years off their mortgage.
Currently there are about 2.5 million first time home buyers each year. If this incentive doubles that to 5 million and all the median credit value is $10,000 this represents a yearly cost of $50 Billion per year.
Equalize the retirement saving incentives:
I’ve also written about this at great lengths. This would encourage a lot of lower income people to save for retirement. Think of your kids. Currently a high earner receives a 35% tax break for saving for retirement, while a low earner receives a 0% to 10% tax break. The vast majority of retirement tax incentives go to the top 20% of income earners, people who are much more likely to save for retirement anyways. This could in theory cost nothing to do and greatly increase the number of people who are actively building wealth for retirement.
The Bad Part of Joe Biden’s Tax Plan:
Eliminate Stepped Up Basis at Death:
This is kind of a weird one anyways. Under current law if your grandfather paid $30,000 for a house in 1950 that today is worth $500,000 when he dies and gives it to you, your basis is now $500,000, so if you decide to sell it, no taxes are owed. If the stepped up basis were eliminated, you would owe taxes on the $470,000 gain. This will affect buy and hold investors of property to a large degree.
Eliminate 1031 exchanges:
1031 exchanges are a major part of building a real estate empire. Essentially as long as you continually reinvest your gains, you never have to pay taxes on them. Say I buy a house for $50,000 and I sell it 5 years later for $100,000. I can go buy a $100,000 house using a 1031 exchange and defer those taxes. A few years later I sell that property for $1,000,000 and as long as I reinvest in new property and don’t take any cash I pay no taxes on the gains. I can keep doing this until I have several millions of dollars in real estate. I would never pay taxes on the capital gains. This is a massive change to how real estate investing is done. If this happens every real estate investor needs to have a plan B to avoid taxes on their properties.
Reduce the Inheritance Tax Exemption to from $11 Million to $5.8 Million.
This is a biggie. The inheritance tax quickly reaches 40%, so its best to not have a taxable estate at all. Recently you could pass on $11 Million at death with no problem, dropping this to $5.8 Million adds a 40% tax on $5.2 million of wealth, or a total of just over $2 million of taxes to an estate, PER PERSON.
Institute a 12.4% Social Security tax for wages above $400,000:
This is really interesting because it leaves this gap of the Social Security tax for wages between $137,700 and $400,000. This may help fund Social Security, however it is a very large marginal tax rate increase. From a micro view I get why he chose $400,000, because 90% of the population will agree its OK to tax the people of that high of income. Whereas you might find less than 50% accept it for <$150,000. From a bigger picture it makes no sense to have this large break in the collection of Social Security taxes.
How to Adapt To Joe Biden’s Tax Plan:
- Give away your money while you are alive and in good health. This is the most important strategy for building generational wealth and it doesn’t change that much even with a 50% reduction in the exemption amount. Currently tax laws allow every individual to give up to $15,000 per year to any other individual without doing any paperwork or paying any taxes. Think about this. If you and your wife are well off and have 2 married children who each have 2 kids, you could each give $15,000 to each individual each year. That’s $240,000 a year with no tax implications, meaning it doesn’t go against your $11 million or soon to be $5.8 million lifetime allowance. Also by giving the money away now, rather than at death 30 years in the future you give the money away before it appreciates. Every dollar that grows for 30 years at 8% returns will turn into $11. That $240,000 in 30 years would be $2.6 Million!
- Rather than selling properties that have gained in value, refinance them. Proceeds from a refinance are not taxed. You can pay back the debt overtime and it is tax deductible. You can use the loan proceeds to invest in the next project, and you keep the original asset.
- Buy investment property initially inside of a self directed Roth IRA. You set up an LLC that is wholly owned by the Roth IRA. All expenses and income dealing with the property must go through the LLC and can not be commingled with the owners personal funds. For example, the owner can not receive a check for Rent or pay out of pocket to have the lawn mowed. The rent check must be deposited in the LLC and the lawn mowing expense must be paid from the LLC with money that was originally contributed to the Roth IRA. Most people who invest with a self directed IRA hire out full service property management to make the accounting clean. The owner also can not perform any type of work on the property because that would effectively be a contribution to the Roth IRA.
- For high earners who may see a reduction in their tax benefit through the Joe Biden tax plan making contributions to Roth accounts instead of traditional accounts may be worth investigating. If the tax benefit is reduced from 35%-50% (depending on state taxes) to around 20% forgoing the tax deduction may be worth it for the benefit of not having to pay taxes on the back end with a Roth account.
- Earn less than $400,000 from W2 income. Work on building up your rental real estate income. Rental Income is considered passive and is not subject to Social Security taxes. Consider increased differed comp options from your employer. If you are a business owner spend more inside the business to grow over the next few years rather than paying the money out to yourself as increased salary.
Potential Additional Items:
Extension of the Solar Power tax credit. This would be a big deal for the country. Price parity with the grid has already occurred in many areas. The price of a Tesla 8.2KW system is $16,400 before tax incentives and $12,136 after incentives. This could eliminate the majority of a $150 monthly electric bill. Let’s give it a $125 a month savings, that’s $1,500 a year. It takes 8 years to reach the break even point. Within the next few years prices of solar will continue to drop and that system should cost $12,000. After tax incentives it would be about $8,900, giving just a 6 year break even. This is a no brainer for virtually every house in America. Currently the tax credit gets reduced in 2021 and goes away in 2022. If the solar credit stayed in place I would certainty buy a system in 2022.
Baby Bonds: This is perhaps the best anti poverty and generational wealth tax incentive ever devised. It’s incredible inexpensive, is targeted towards lower earners, and uses the power of compounding interest. I would like to see it with an equity option to allow the investment to be made in something like a Vanguard Target Retirement Date Fund, composed mostly of the Total Stock Market Index Fund and an International Index fund, rather than being based on government bonds. The growth would blow the returns from bonds away and rather than the most disadvantaged children having around $45,000 at 18 they would have closer to $100,000. This program is expected to cost around $60 billion per year. With $3 Trillion+ annual spending this should be a high priority.
By the way, outside of any government program all parents should strive to do something like this. Start an account for your child as early as possible and set a goal to contribute $20 a week into it. If some weeks you can only do $5 or $10 that’s OK. Then when you get your tax refund, or have more earnings throw that money into the account. With the baby bonds program Corey Booker estimated by JUST doing this we would increase the median wealth among young Black Americans from $2,900 to $57,845, and for young White Americans from $46,000 to $79,159. Instead of White Americans having 16 times the wealth of Black Americans, this would drop to under 1.5X. If it were invested in stocks rather than government bonds the wealth gap would disappear. Even if we cut this program in half it would eliminate the scarcity mindset for the majority of our population and would make everyone an investor.
The Bottom line is we must be adaptable to change. In the big picture it shouldn’t matter to a great extent what tax changes our government makes. As long as we are paying attention we should be able to plan accordingly and make the best decisions at the the time to minimize our taxes and maximize the effective utility of our money.
What do you think of Joe Biden’s Tax Plan?