Should You Plan to Pay Even More Taxes in 2025?

In an election year, we tend to hear the proposals of each candidate. As of now, we know that President Biden has released his current tax proposal for 2025. With this, the focus for the current administration has been increasing taxes on those making over $400,000 annually or $450,000 for couples who file jointly. The additional focus is on billionaires and corporations. What might be valuable is to understand where we are now before we start talking about changes so there is an understanding of what we currently pay Uncle Sam each year.

Targeting this group $400k or $450k earners seemingly makes sense. Those are large numbers. According to Credit.com, only 18% of Americans are making at least six figure incomes. When you look at those making more than $400k, the group is substantially smaller, only 1.8% of Americans earn over $400k per year. Therefore, it would seem likely that this bill would receive support, because in theory, the tax proposal wouldn’t impact those making less than $400k, right?

Let’s take a look at a rough breakdown of what Delawareans at varying income levels (both single and married) will pay in taxes in 2024. We’ll assume that in all scenarios, these people earn their income via a W2 salary:

When look at the current tax liabilities, you quickly realize that the government collects a fair amount of money from those that earn above $200,000. 

So, what changes with the proposed Biden Tax Plan for 2025?

• Expansion of the definition of investment income to include all pass-through business income like S-Corporations subjecting them to the current 3.8% tax. Think about this for small business owners. This could impact an S-Corporation that has $1M in pass through income down to the Teacher with a side gig who has $20,000 of pass-through income. Currently the 3.8% tax is only represented above in the capital gains category.  Anyone who earns more than $200k/$250k and has a capital gain, they are subject to the additional 3.8% tax on top of the corresponding capital gain rate which is either 15% or 20%.
  • What are some potential impacts of this rule? First, it would immediately make current business valuations drop. This may also force prices to go up in order to combat the loss in profit. Considering a strong business is making a 20% margin, this proposal is asking these companies to pay nearly 4% (or in relative terms 20%) of that margin to the government. And remember, that’s regardless of the size of the company.
    
• Increased long-term capital gain rates when taxable income is over $1M. The proposal would make long-term capital gains for taxpayers with income above $1M taxable at ordinary income rates as high as 37%.  The current top capital gain rate is 20%. This could impact people all along the wealth spectrum.  Someone who got lucky with a purchase of a beach house in the early 2000s could easily have a substantial gain on it.  If they sell the house while they are still working their overall taxable income could easily go above $1M.  Unfortunately, this is another one that could hit those who aren’t making over that $400k magic number.
  • What are some potential impacts of this rule? There is a good chance that any assets that would produce a sizable gain may not be otherwise sold. It’s also possible that sales would be stretched over a longer period of time in hopes of staying under the $1M taxable income number.  Either way it would likely disincentivize larger transactions and slow down the economy. While that isn’t a direct impact on those making less than $400k/$450k it is certainly an indirect impact. If you are someone who holds a property or a business that would cause a $1M taxable income scenario, if the capital gain rate nearly doubled would you consider paying 2x as much in tax, or would you sit tight?  Chances are, if you are able, you would likely sit tight.
    
• Adjustments to the like kind 1031 rules are also in the proposal. Think about the example above where someone decides to sell, and they want to exchange that beach house to avoid the increased capital gain. The new proposal limits deferral to only $500,000 and therefore would force those who got lucky with a beach house purchase or many small investors to pay more in taxes. Again, this one isn’t limited to those who only make above $400k.
  • What are some potential impacts of this rule? Once again, property owners may be more inclined to hold, instead of sell.  This could lead to an even lower housing supply and potentially inadvertently increasing prices for those homes that do go on the market.
    
• Increasing the corporate tax rate from 21% to 28%. Why does this matter? This is more of an indirect hit to those making less than the targeted $400k/$450k levels. This would likely increase costs and potentially lower wages.  With the increased drag on corporate profits it would immediately weaken the economy.

Why does all this even matter?  It’s hard to escape how life has changed since 2020.  We are now at a point where according to a recent study, a family of four needs a median income of $226,886 to live comfortably in the United States.  What is this number based on? It’s broken down as 50/30/20:

• 50% toward necessities
• 30% toward discretionary spending
• 20% toward savings or investment

Things can change very quickly, just 10 years ago, a family of four was able to live comfortably on approximately $130,000 annually. $400,000 of income is much different than it was just 10 short years ago. As depicted in our earlier chart, if we are putting out approximately 40% of our gross income on taxes we need to be diligent and mindful of what we are doing with the residual.

Here are a few other stats as we get closer to the November election:

• # of households making more than $400k:        2,360,000
• # of billionaires in the United States:                    735

Why is this important? First, households that make $400,000 of annual income are in a very different financial position than billionaires.  Grouping these two categories can be dangerous, considering we’ve seen our cost of living rise substantially over the last decade.  We could see many more households subject to a tax law change targeting those based on income.

If you remember, there’s an old tax law, Alternative Minimum Tax, which was originally created to ensure that the wealthy paid taxes.  In 1966 there were 155 households with income over $200,000 who paid no tax 1966. So the AMT was enacted in 1969 to ensure those people paid taxes.  By 2015, 50 million Americans were subject to the AMT.

The biggest question that has been posed: If additional tax revenues are achieved, where will the money go? That question isn’t addressed in the Biden Tax proposal for 2025. Regardless of who ends up in the White House, it’s important to understand how the candidate proposals would impact all of us individually and potentially understand how the economy would respond. Many would hope any excess revenues would be allocated to reduce the federal debt, unfortunately, neither side has declared whether or not they plan to focus on reducing the debt. The strength of the US Dollar is based on the full faith and credit of the United States Government. Currently, many of our higher income earning citizens are paying the federal government approximately 30% of their income or more. Add in other taxes and in most cases that number tops 40% of total income going to taxes.

So I can’t help but wonder, what’s more important, more tax revenue OR less spending? What do you think?

Source: @themoneycruncher, Credit.com, CNBC, smartasset state income tax calculator, TaxFoundation.org