President Biden ran a platform to raise taxes on the rich. That time has come, and you might be surprised to know you’re the target.

The changes currently discussed are to increase taxes on incomes over $400,000, although it’s not even clear yet if that differs between single filers and married filing jointly.

The tax increases will include increased federal tax rates, new taxes, decreased deductions, and a major change to the estate tax exemption. Here are the some of the proposals:

1. Tax rate over $400k jumps to 39.6%
2. Wages above $400k subject to OASDI tax of 6.2%
3. Itemized deductions capped at 28% for those earning over $400k
4. 401k contributions receive 22% tax credit instead of tax deduction
5. Long term capital gains jump to top fed tax rate for those making over $1M
6. Estate exemption drops to $3.5M (from $11.7M); step-up in basis could go away

These are significant changes if you’re in the “target zone.” Hopefully, your advisor and CPA are starting to think through the impact for you, but if not, you should ask about it.

Let’s get into the details of each proposal and talk about the potential impact on you and strategies to help manage it.

Tax 1: Tax rate over $400k jumps to 39.6%

The taxes for Married filing jointly with $400k income are 32% but rising to 35% at $412k. We’ll call this a 4.6% tax increase, even though it’s a 7.6% increase on the first $12k.

Single filers already pay a 35% tax starting at $207k, so their increase is a pretty clear 4.6% tax if $400k remains their magic number.

Tax 1 Mitigation Strategy

The only way to “avoid” this tax is to get your taxable income down. There are a couple of ways to accomplish this: pre-tax 401k contributions, HSA contributions, and itemized deductions.

Itemized deductions come in various forms, but the easiest is charitable giving and any business losses if you have a separate business or real estate.

As I’ll say with all of these tips, it will be essential for you to discuss all of these items with your CPA and advisor to start making a plan.

Tax 2: Wages above $400k subject to OASDI tax of 6.2%

The OASDI (old age, survivors, and disability insurance) is the social security tax which most of us can agree has created a great safety net for people in the US.

However, you’re limited in how much social security you can receive, so the income this tax hits is also limited. Currently, once you make over $142k in taxable income, the OASDI taxes stop.

The new Biden tax plan would start OASDI tax again once you make over $400k. So any income between the current top ($142k) and the new “restart” of $400k doesn’t get taxed, but over $400k does.

I don’t believe a recent tax proposal directly targets wealthy people like this one. Tax rates have been much higher in the past on higher incomes, but a restart of the OASDI is pretty brutal.

Tax 2 Mitigation Strategy

As the first tax strategy, the only way to avoid this extra tax is to keep your taxable income down.

Tax 3: Itemized deductions capped at 28% for those earning over $400k

Currently, the higher your income, the more your deductions are worth.

For example, let’s say you’re in the 35% tax bracket and itemize your deductions. If you make a $10,000 charitable contribution, you’d save $3,500 in taxes.

However, if you were in the 10% tax bracket under the same conditions as above, your $10,000 donation only saves $1,000 in taxes.

It’s a little weird how it works out, but that’s how the current tax system is designed.

The proposed change would mean even if you’re in the 35% tax bracket and met the itemized threshold, your deductions are capped at 28%.

Using the example above, your $3,500 in tax savings would go down to $2,800.

The capped deduction can be a pretty substantial change if you’re itemizing your taxes with lots of deductions. If you’re not itemizing, it won’t impact you.

Tax 3 Mitigation Strategy

There’s not a whole lot you can do about this one as the cap is the cap. Even if you grouped your charitable giving into one year to increase the total amount, you’re still capped at 28%.

You should be aware of the impact and know it could substantially increase your taxes if you currently have many deductions.

Tax 4: Changes tax deduction on 401k contributions to a tax credit (22%)

It seems like each one of these could be the “biggest impact,” and this one also warrants major attention. Currently, your pre-tax 401k contributions receive your marginal (or top) tax rate deduction.

Just like in the example above, if you’re in the 35% tax bracket, your pre-tax 401k contribution of $19,500 saves you $6,825 in taxes.

If you’re in the 10% tax bracket, the same contribution would only save you $1,950 in taxes!

Once again, it’s pretty eye-opening when you look at it that way, but that’s how our current tax system is designed.

Under the proposed changes, everyone would receive a 22% tax credit for 401(k) contributions. For both examples above, the taxpayer would receive $4,290 in tax savings.

Thie 22% credit is great for lower income Americans as it makes savings much more valuable, but it will mean an increase of $2,500 in taxes for those maxing contributions in the 35% tax bracket.

Tax 4 Mitigation Strategy

You’ll want to get very strategic if this tax change comes to fruition because it might make more sense for you to switch to a Roth 401k option.

Essentially, you’re only “saving” 22% in taxes by making this contribution.

If your taxes are at least 22% in retirement, you’re now losing money by making the pre-tax contribution, unless, of course, it helps you with one of the other strategies above.

If you’re single, the 22% tax bracket starts at $85k, which many people with large IRA/401(k)s combined with social security can easily hit.

Tax 5: Long term capital gains jump to top tax rate for those making over $1M

This change is a big one for MDs in the L2/L1 compensation range and most MDs during the new MD grant vesting year.

That’s because, with the Accenture stock price growth, many MDs will make over $1M when their new MD grant vests.

Currently, capital gains taxes max out at 23.8% when including the Net Investment Income tax of 3.8%.

If you’re making over $1M in taxable income, your capital gains tax will jump from 23.8% to the top income tax of the proposed 39%.

That’s over a 15% jump in the tax rate!

Tax 5 Mitigation Strategy

Of all the proposed tax changes, this one should be the most manageable. If you’re already making over $1M in taxable income, you should do everything you can to avoid unnecessary capital gains.

If you’re in your MD vest year and expect to jump over $1M in taxable income, make sure you’re very careful to plan stock sales the year before or after so you don’t expose yourself to this tax.

Tax 6: Estate exemption drops to $3.5M

The estate tax has become a moving target in the last decade as it seems to change every couple of years.

As I mentioned when discussing multigenerational wealth, the rate more than doubled in 2018 from $5.45M to $11.4M per individual.

However, the new proposal would bring the estate tax exemption back down to $3.5M per individual. This change won’t impact most Americans, but you’re not most Americans.

If you’re married, your combined estate exemption would be $7M based on this change, although who knows what this will look like in 30-50 years when this affects you!

Another HUGE bombshell proposed in the Biden tax change is eliminating the “step-up in basis” upon death.

Currently, this step-up provides a massive windfall because you don’t have to pay capital gains taxes on anything you inherit.

If your parents bought $1,000 of Apple stock in 1990 that’s now worth over $3M(!), your cost basis would adjust to $3M when you inherit it.

If the step-up is taken away, you’d instead owe capital gains taxes on the entire increase in value, so you’d go from zero taxes to something like $750k in taxes.

Tax 6 Mitigation Strategy

The step-up in basis changes everything because it applies to all assets. There are many discussions on if this would pass and how it’s implemented, but it’s a scary one.

While this could impact you more immediately if you have aging parents, everyone should be thinking about how they can start mitigating their estate tax situation, even if it’s way down the road.

We talked about some of the strategies in the past, like building multigenerational 529 plans and utilizing the UTMA.

It’s estimated that only 1% of Americans will be impacted by these tax changes, but the problem is you’re likely in that one percent.

You might even be fuming over this because you don’t see yourself as the evil rich person, but you’re definitely at least the “rich” part of it under this proposal.

Right now, you should keep an eye on this or make sure you have someone keeping an eye on it for you.

I’ll write an updated post if/when this comes to fruition, but I’m already working with my clients to get them set up for it.

One example is building up as much in Roth accounts as you can today, either through after-tax contributions converted through Accenture or even straight conversions before tax rates go up.

These strategies get highly technical very quickly, so please work with a professional if you’re going to start making these changes. This post is informational only, and in no way should it be used to direct your particular situation.