House Democrats have proposed legislation that could end Trump’s tax cuts for the wealthy and corporations. If passed, it could implement some of the biggest tax increases in decades. But while these tax changes aim to deliver on President Joe Biden’s promises to tackle inequality, they are on a smaller scale in an effort to win moderate support from Democrats. The new plan proposes raising the top tax rate on capital gains from 20% to 25% instead of nearly doubling it to 39.6% as Biden originally proposed. And the corporate tax rate would only rise to 26.5% instead of 28%. Let’s see how these tax changes might affect you. A financial adviser may be able to help you with your tax planning. SmartAsset’s free advisor matching tool can match you with financial advisors in your area.
What was originally offered?
Initially, President Biden introduced various tax proposals, including increasing the top tax rate on capital gains from 20% to 39.6%. With the Medicare surcharge of 3.8% for high earners, the maximum rate would become 43.4%. Under his original plan, short-term and long-term capital gains would be taxed equally, with the top tax bracket having a rate of 39.6%.
Biden also proposed closing a loophole that allows capital gains passed through an estate to avoid taxation. The president suggested the IRS needs to do a better job of auditing high earners to make sure they are paying their fair share. The tax increases are also designed to help fund increased IRS oversight.
What does the current proposal look like?
House Democrats just released an updated version of the tax overhaul outlined by Biden in April. While there are certainly consistent themes, some numbers have been recalled. This move likely stems from Democrats not wanting to alienate voters ahead of the 2022 midterm elections. There are also some political limits to implementing such sweeping changes. However, it’s also likely that Biden was aiming high, knowing that Congress would try to put the brakes on his ideas.
The new proposal includes a number of different parts. It would raise the corporate tax rate from 21% to 26.5% for businesses that report income over $5 million. It would raise the top tax bracket from 37% to 39.6% for households earning more than $450,000 a year and individuals earning more than $400,000 a year. The top capital gains tax rate would increase 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. This type of program has the potential to generate hundreds of billions of dollars in lost tax revenue over the same period.
Who does the proposal affect?
A key feature of the original and updated tax proposals is that they are designed to affect only very high earners. As a result, most people will not be affected by the changes. The increase in the top tax rate, for example, affects only those who earn at least $400,000 a year. Companies that make more than $5 million a year are the only ones to see a change. Businesses that bring in less than $400,000 will actually see their tax liability go down.
The new top capital gains tax rate would work the same way. In 2021, you should only pay the top rate plus 25% if you are a single filer earning more than $445,850 or if you are married and file jointly while earning more than $501,600. The 3% surcharge only applies to those earning more than $5 million per year. Needless to say, these changes only really affect a percentage of the top 1%.
How to 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-exempt or tax-deferred retirement accounts like 401(k)s and contribute to a free health savings account. (HSA), among other tax strategies.
For those earning millions in capital gains, a financial adviser could help you understand your options if the new tax proposal becomes law.
At the end of the line
Although the new tax proposal introduced by House Democrats is on a smaller scale than what Biden originally introduced, it still has big implications for federal spending over the next decade. These changes could generate $2.9 trillion in new revenue to help fund significant parts of America’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 only expected to affect some of the top earners of the nation’s wealthiest 1%. However, there are still tax steps you can take to prepare.
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