President Biden has proposed a package of incentives aimed at cutting taxes for low-income taxpayers, including refundable credits for everything from childcare costs to home purchases. However, he also plans to raise taxes by nearly $3.5 trillion during the next 10 years on corporations and individuals who earn more than $400,000 annually.
Here are the most significant proposed changes for dentists.
It will raise the top marginal tax rate on incomes above $400,000 from 37% to 39.6%. This and other targeted tax hikes will place a premium on keeping your income below $400,000 through deferring income, increasing deductions, and shifting income.
It will increase the tax rate on capital gains and dividends from a maximum of 20% now to 39.6% (in addition to the 3.8% Affordable Care Act tax) to the extent your taxable income exceeds $1 million. You’ll most likely be affected when you sell your practice or real estate. You can minimize this impact by closing these sales on January 1 of the new year, harvesting losses from stocks and other investments that have declined in value, and using an installment sale to the extent necessary to keep your taxable income below the $1 million threshold.
It will increase payroll taxes by imposing the 12.4% Social Security tax (6.2% on both the employer and employee) on all earned income (salary) exceeding $400,000 annually. The combined impact on raising the tax rate on earned income and applying the additional Social Security payroll taxes could result in some doctors paying a marginal tax rate of 60% or higher after considering state income taxes. You can dodge this higher Social Security payroll tax by operating as an S corporation and withdrawing no more than $400,000 as salary, with your remaining practice profits taken as a dividend distribution free of payroll taxes.
It will reduce the tax benefit from itemized deductions. Currently, you’re entitled to deduct the standard amount ($12,400 if single, $24,800 if married), or the sum of your itemized deductions (mortgage interest, state and local income and property taxes, charitable contributions, and medical expenses) if greater, at your current tax rate. President Biden’s plan would reduce your total itemized deductions by 3% for every dollar that your income exceeds $400,000 and would cap the tax savings from itemized deductions at a 28% tax rate. Bunching charitable contributions in alternate years and using the standard deduction in the other years can maximize your income tax savings.
It will reduce tax savings from 401(k) salary deferrals by replacing the tax deduction with a tax credit, likely equal to 26% of the deferral amount. This change would increase the tax savings for those below the 26% tax bracket but reduce it for doctors in higher tax brackets.
It will repeal the Section 199A 20% deduction for practice and real estate profits if taxable income exceeds $400,000.
It will slash the estate tax exemption from $11,580,000 now to only $5 million and increase the estate tax rate on amounts left to your children from 40% to 45%. You should consider taking advantage of your annual gift tax exclusions ($15,000 per donee), split gift election, and valuation discounts.
It will repeal stepped-up basis at death. Currently, your children can inherit your assets with a “stepped-up basis” equal to their fair market value at your date of death. Thus, while the value of your assets may be subject to an estate tax, any predeath appreciation in the assets (stocks, real estate, etc.) will not be subject to income taxes when your children later sell them. Under President Biden’s plan, your death would be financially painful, suddenly creating a taxable event with all appreciation in your stocks and real estate being immediately taxed.
JOHN K. McGILL, JD, MBA, CPA, publishes The McGill Advisory newsletter through John K. McGill & Company Inc., a member of The McGill & Hill Group LLC. It’s your one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. For more information visit mcgillhillgroup.com.