The Taxman Cometh?
Google searches are often entertaining. As I was thinking about a title for this column I typed “The Taxman Cometh?” into my browser, looking for information about the various tax proposals from our two presidential candidates. The first thing to pop up was a 1991 episode of the television show Murder She Wrote. In the episode, a close college friend of Detective Jessica Fletcher was the prime suspect in the murder of her husband as her store, Miss Edna’s Pies, was being investigated by the IRS. As always Jessica solves the crime, a clever embezzlement scheme by a mysterious employee. While the stakes we face are less than life or death, we all need to stay tuned to possible tax changes and their impact on our pocketbooks and investment accounts.
Voter polls indicate that the economy is the number one issue in this presidential campaign. Tax policy has taken on an outsized importance as the individual tax provisions of the 2017 Tax Cuts and Jobs Act (TCJA) are set to expire at the end of 2025. Each candidate has put forth a dizzying array of proposed tax changes. By the time you read this column there may be more. Let’s examine how tax law would look if the TCJA expires plus the proposals from each candidate. This review is intended to be informative and analytical, not an endorsement of a candidate or any particular policies.
TCJA Expiration
The TCJA lowered the corporate tax rate to a flat 21% “permanently.” For individuals, reversion to previous tax law would lead to an estimated 91% of all taxpayers facing tax increases. Major changes:
The estate tax exclusion of $13.61 million per individual in 2024 will revert to the lower 2016 exclusion adjusted for inflation, projected to be a bit over $7 million in 2026.
Restoration of previous tax brackets that included a top rate of 39.8%. Also, taxable income ranges generally capture more income in higher tax brackets.
The 20% deduction for small business income expires.
The standard deduction declines by a little less than half and personal exemptions are restored.
The state and local tax deduction (SALT) returns to unlimited instead of today’s $10,000 cap. With SALT restored more taxpayers will itemize.
The child tax credit is cut in half, to $1,000, and the income threshold for phaseout declines meaningfully to about $110,000 for married filers from current law of $400,000.
Lower exemptions and phase-out income levels for the Alternative Minimum Tax (ATM) will lead to many more taxpayers subject to ATM, an estimated 5 million compared to about 200,000 today.
Trump Proposals
Former President Trump’s major tax proposal is the permanent extension of the TCJA. In addition, Mr. Trump has proposed:
Tariffs of at least 10%, if not 20%, on all imports and a higher tariff rate for China.
A reduction in the corporate tax rate to 20% and a 15% rate for manufacturing in the U.S.
Ending taxation of Social Security benefits.
Removing the cap on SALT deductions.
No tax on tip income and overtime pay.
Unspecified tax breaks for parents with children. J.D. Vance, Mr. Trump’s Vice-Presidential candidate, has suggested a child tax credit of $5,000.
Harris Proposals
Vice President Harris has staked out a position that melds President Biden’s 2025 budget tax proposals with additional or amended ones of her own. Major provisions of Mr. Biden’s budget proposal:
Extend provisions of the TCJA for households making less than $400,000.
Increase the top income tax rate to 39.8% for individuals making more than $400,000 and joint filers making more than $450,000.
Unrealized gains upon death are taxable to the deceased’s estate subject to a lifetime gift and death individual exclusion of $5 million and joint exclusion of $10 million.
Changes to estate tax law that would significantly curtail techniques to pass on appreciated assets to future generations tax free.
A minimum 25% income tax on both realized and unrealized capital gains for those with net worth of more than $100 million.
Increase the corporate tax rate to 28% from 21%.
Increase the alternative minimum corporate tax rate to 21% from 15%.
Increase the corporate buyback tax to 4% from 1%.
Expand the current 3.8% net investment income surcharge to include small-business income and create a new bracket rate of 5% for households making more than $400,000.
Expand the child tax credit to $3,000 and $3,600 for children less than six years old.
Changes/additions from Ms. Harris:
Tax long-term capital gains at a 28% rate for taxable income over $1 million. This would create a top rate of 33% including Mr. Biden’s proposed 5% net investment income surcharge.
Expand the child tax credit to $6,000 for newborns in addition to Mr. Biden’s expansion.
Provide up to $25,000 for first-time home buyers.
No taxes on tips.
Expansion of start-up expense deduction for small businesses from $5,000 to $50,000.
Ms. Harris has also endorsed estate tax changes included in the American Housing and Economic Mobility Act of 2024 (AHEMA) introduced by Senator Elizabeth Warren and in the House by Emanual Cleaver. These include:
Reduce the annual gift tax exclusion to $10,000 (from $18,000 today) with a cap of $20,000 for multiple gifts.
Lower the estate tax exemption to $3.5 million.
Replace the current 40% estate tax rate with a series of progressive rates:
55% for estates valued between $3.5 million and $13 million.
60% for estates valued between $13 million and $93 million.
65% for estates valued over $93 million and an additional 10% tax surcharge for estates over $1 billion.
It is very likely that the TCJA will be extended for taxpayers making less than $400,000 given Ms. Harris’s endorsement and Republican’s aversion to tax increases. Even so, some of these proposals, if enacted, would impact individual’s tax liability and the stock market.
With the government running close to $2 trillion in annual deficits and a wide range of voters opposed to tax increases, I see changes to estate and gift taxes as an easy area to raise revenue. The changes proposed by the AHEMA are particularly impactful to even modest estates given the lower thresholds for gifting, lower estate tax exemption and higher estate tax rate.
Proposals to increase corporate taxes could negatively impact stocks. Some studies indicated the market added up to 10% in value after the corporate tax rate was cut to 21% from 35% previously. According to the Tax Foundation, raising the corporate tax rate back to 28% will, when combined with state and local taxes, land the U.S. at a total corporate tax rate of about 32.2%, second only to Columbia’s 35% in the world. While it is difficult to guess the impact on the market, the direction of valuation will tilt lower.
Another possible market negative would be the taxation of unrealized gains for high-net-worth individuals. Sweden, Germany and other countries have tried to tax unrealized gains and ultimately given up as forcing the sale of assets to pay the tax, particularly private ones like businesses or real estate, had a chilling impact on investment and growth. The deeper bite of the AHEMA’s lower estate tax threshold coupled with higher estate tax rates could also have a similar effect.
One certainty over the next few months will be that tax law is changing. Once the election is behind us, we can start to make inferences about how the landscape will change. When that time comes, Provident is here. We have recently increased to full-time status Eric Wathen, CFA, to augment our tax and retirement advice. Eric will be introducing himself in next month’s Viewpoint.
Dan Boyle, CFA