On Thursday, March 9, President Biden released his proposed budget for 2024, articulating the administration's priorities and detailing where they would seek to generate the revenue to pay for them. This year's budget largely resembles what the administration proposed last year, for 2023, and like that budget, this proposal is unlikely to become law, especially now that control of Congress is divided between Democrats and Republicans.
What's being proposed?
The budget proposal seeks to generate revenue by raising taxes on the wealthiest Americans:
- The top individual income tax rate would rise to 39.6% from 37% for income above $400,000 (single filers) or $450,000 (married filing jointly).
- The net investment income tax rate would rise to 5% from 3.5% for those earning more than $400,000 in regular income, capital gains, and pass-through business income combined.
- Qualified dividends and long-term capital gains would be taxed as ordinary income, plus the net investment income tax, for income that exceeds $1 million.
- Transfers of property by gift or death would trigger a tax on the asset's appreciated value if in excess of the applicable exclusion.
- Roth IRA conversions would be prohibited for high-income taxpayers, and "backdoor" Roth contributions, where after-tax traditional IRA contributions can be rolled into a Roth IRA despite income limits, would be eliminated.
For taxpayers with a net worth greater than $100 million, a 25% minimum tax would be imposed on total income, including unrealized gains.
The budget would also eliminate the ability to defer gains on the like-kind exchange of real property and impose limits on the duration of generation-skipping trusts. "These would be meaningful changes," says David Peterson, head of Wealth Planning at Fidelity. "More family wealth would be taxed, and fewer assets would be transferred to the next generation."
Who would be affected?
Generally speaking, the income tax changes laid out in the budget would impact a very small number of taxpayers if they were implemented. The increase in the top marginal income tax rate would affect about 1.8% of Americans, while the proposed tax on total income and unrealized gains would only affect the top 0.01%.
What is the likelihood that this becomes law?
Presidential budgets are largely symbolic. “Every year, the current administration puts out a budget proposal to express their policy priorities that lays out a wish list on what they’d like to accomplish,” says Alice Joe, a vice president on Fidelity’s Government Relations team. “Elements of it can get incorporated into various bills, but the president’s budget as a whole is rarely, if ever, turned into law.”
Joe views the proposed budget primarily as a messaging tool to Democratic legislators and voters. “The overall budget is mostly a campaign document,” says Joe, "and the likelihood of these changes moving forward with a split Congress is extremely low. However, we may see these proposals resurface again down the road."
How should you prepare?
Though President Biden's proposed budget isn't expected to become law, some of its tax provisions are going to happen anyway in a few years. The reduction of the top marginal income tax rate to 37% was brought into effect by the Tax Cuts and Jobs Act (TCJA) of 2017 and is scheduled to sunset at the end of 2025. This means that unless Congress acts to extend those provisions of the TCJA, the top rate will jump back to 39.6%. The Biden budget simply proposes to do this sooner, in 2024.
"While we don't expect these changes to come into effect next year, it's still worth considering what strategies might make sense in a higher tax environment," says Greg Doyle, a vice president on Fidelity's Advance Planning Team. Doyle points to 4 strategies that could potentially help minimize your tax burden and facilitate wealth transfer to the next generation should income taxes increase:
- Roth IRA conversions: If you are likely to be affected by the increase in the highest marginal income tax rate, converting a traditional IRA to a Roth IRA now, when the rate is still relatively low, could be advantageous. A Roth IRA can help provide tax-free growth potential and tax-free withdrawals in retirement or for your inheritors, especially if they live in high-tax states like New York or California.
- Bunching charitable deductions: If you itemize your deductions and plan on making a large charitable gift, it may make sense to defer that gift if you expect to be in a higher tax bracket in future years.
- In-kind transfers: If you have a grantor trust, you may want to consider moving high-cost-basis assets into your trust and taking low-cost-basis assets of equal value out. Bringing those low-basis assets back into your estate will allow your spouse or children to "step-up" the basis of the assets to the fair market value when they inherit them, offering a substantial savings on capital gains taxes.
- Tax-smart strategies: Investors of every income level can implement strategies designed to help manage, defer, or reduce taxes, such as tax-smart asset location and tax-loss harvesting.
A good opportunity to reassess
Doyle suggests that while there may not be any immediate need to make a change to your plan, it's never a bad time to assess your situation. "This could be a good time to revisit your plan, and test assumptions around your tolerance for risk and your time horizon," he says. "Having a plan in place that's designed for the long term can help you avoid making reactionary decisions that could lead you to miss out on potential growth."
"Taxes are just one consideration when making decisions about your portfolio," says Peterson. "It's best to stay focused on your long-term goals while building flexibility into your plans and into your mindset."
As always, before you consider making any changes to your personal plan, make sure to look at your whole financial picture and consult your tax advisor.