Tax Rule Changes President Biden Wants to Make
There’s a lot to think about, so I’m going to break this topic into three parts.
Let’s start with Code Section 121. It authorizes a break long used by home sellers to lower their taxes, allowing millions of Americans to exclude––IRS lingo for escape––income taxes on sizable portions of their profits (as distinguished from and not to be confused with sales prices) from sales of their principal residences.
While the break benefits most sellers, the good news is tempered by some bad news.
Good: The profit exclusions provide the largest tax break that sellers will ever get, though they can’t completely sidestep taxes on profits from sales of their year-round homes, as distinguished from vacation retreats.
Section 121 imposes caps on the exemptions: $500,000 in profits for married couples filing jointly and $250,000 for those who file single returns or are married and file separate returns.
Bad: There’s no increase in the exemption amounts since their introduction in 1997, when Bill Clinton was president, notwithstanding their steady erosion by more than a quarter-century of increases in sales prices for homes.
Indexing. Lawmakers unwilling to index the exclusion amounts are willing to index the tax brackets for ordinary income from sources like salaries and the standard deduction amounts that are available to nonitemizers who don’t use Form 1040’s Schedule A to itemize.
How the IRS taxes net profits from sales of principal residences when profits exceed the exclusion amounts. Suppose two things happen.
First, sellers wind up with net profits (“net” meaning after gross profits are offset by things like improvements, as opposed to repairs, broker’s commissions and legal fees). Second, their net profits amount to more than their exclusions of as much as $500,000.
Just how much of their gains will wind up in the IRS’s coffers? That’s the kind of question that has more than one right answer. Why? Because, alas, there are complications.
True, the IRS does tax profits that exceed the exclusion amounts as long-term (homes owned longer than one year) capital gains. But there’s more than one rate for long-term gains. They’re 15 percent for most sellers and then 20 percent for those with higher levels of income.
Surtax of 3.8 percent. Added on top of the rates of 15 percent and 20 percent is a 3.8 percent surtax for an aggregate rate of 23.8 percent. The surtax, introduced by the Affordable Care Act, better known as Obamacare, helps pay for health care reform.
The IRS imposes the surtax on NII, short for net investment income. NII includes, among other things, all capital gains from sales, of, say, stocks and bonds, though there’s a much-misunderstood exception that benefits sellers of personal residences. The surtax applies only to sellers who have gains greater than their $500,000/$250,000 profit exclusions.
What causes the surtax to kick in? When the portion of the seller’s gain that’s greater than the exclusion amount of as much as $500,000 causes the seller’s MAGI, short for modified adjusted gross income, to exceed a threshold amount. The amounts are based on the seller’s filing status.
Before we get to President Biden’s wish lists for changes in the tax rules, let’s first decipher MAGI and the threshold amounts.
MAGI. For most people, MAGI and AGI are the same. “Modified” applies only to those individuals who live outside the United States and satisfy the requirements imposed by Code Section 911 for the earned income exclusion for wages, salaries and other amounts paid for personal services.
The exclusion is indexed. For 2021, it’s $108,700, up from 2020’s $107,600. Expatiates have to add back excluded amounts when they calculate MAGI.
No indexing for the threshold amounts. They’re $250,000 for couples filing jointly and qualifying widows/widowers (surviving spouses who qualify for the same tax breaks as married couples for two years after a spouse’s death); $200,000 for single filers and heads of household (mostly single parents with children); and $125,000 for married couples filing separately.
What’s ahead. Part two will discuss some of what’s on President Joseph R. Biden Jr.’s wish lists. In particular, he urges Congress to okay changes in the tax laws that will help finance his legislative agendas.
Long-term capital gains: He’d like Congress to replace the present top rate of 20 percent for profits from sales of assets owned for more than one year with a new one of 39.6 percent.