Over the past days and weeks, more details related to President Biden’s tax proposal have emerged. Most of the proposed reforms are taking shape in the American Families Plan. During the Biden campaign, it was clear that the new administration would have two driving goals: 1) to raise revenue to help fund the historic spending levels seen during the pandemic, and 2) to shift more of the tax burden to the wealthiest Americans. Now that this plan is coming to light, some taxpayers and tax practitioners alike have started asking questions about how they will be impacted, and when they might expect to see changes.
Basic Components of the Biden Plan
Consistent with the campaign promise, the plan, as proposed, would raise the top marginal income tax rate for high-income taxpayers to 39.6%—this increase would apply to taxpayers earning more than $452,700 in 2022 and married couples making at least $509,300.
Households making more than $1 million will pay the same 39.6% marginal rate on income regardless of character (ordinary, capital gain, etc.), equalizing the rate paid on investment returns (dividends and capital gains) and wages.
Important Take-Away: The top tax bracket penalizes married filers with two high earners. While this aspect of the tax code is not new to this plan, the difference in the per-individual thresholds based on filing status requires additional planning for those taxpayers whose filing status or income levels may be changing.
Another move currently under consideration by the Biden administration is an increase in the corporate tax rate—this increase is part of the currently proposed infrastructure bill in circulation. Initially, the bill was to consider a rate increase from 21% to 28%, but because Republican congressional support for a corporate tax increase appears to be non-existent, and because the Biden administration appears eager to negotiate a bipartisan deal on the infrastructure bill, some are beginning to speculate that a compromise might be reached.
Important Take-Aways: The current administration’s desire to raise revenue from corporate taxpayers is noteworthy, and the public support for doing so seems as strong as ever (debating that viewpoint is beyond the scope of this article). That said, the methods for raising this revenue seem to be in a state of flux. Discussion about a minimum corporate tax rate of 15% looks to raise revenue by reducing the number of “zero tax” corporations, but those rules would only be applicable for corporations with book income greater than $2 billion.
It is worth noting that the corporate tax cuts of 2017 (coupled with the extensive changes to international tax laws) were designed to make the United States more competitive on the global economic stage and to disincentivize the outbound investment of corporate profits. It will be interesting to see what impact these proposed changes might have on the U.S. competitive position in the long term.
Long-Term Capital Gain and Dividend Rate Changes
The current proposal’s possible rate increase on long-term capital gains and qualified dividends may be the change drawing the most attention. In essence, for the highest-earning taxpayers (earning over $1M), long-term capital gains and qualified dividends would be subjected to ordinary tax rates. When compared to historic preferential capital gains rates, this would result in an increased tax burden for those with substantial long-term capital holdings.
Important Take-Away: As more details come to light about the tax proposal, how this change will be implemented—particularly as it relates to timing—will be worth watching. The Green Book—released by the Treasury Department as a guide to the proposals—is quoted as saying the proposal would be effective “for gains required to be recognized after the date of the announcement (April 28, 2021).” Retroactive application of this new rate would mean current securities holders were not given sufficient opportunity to plan for the new tax rate. However, a prospective application of the new investment income rate could be even more problematic, prompting a securities sell-off that could further destabilize the economy, and the recovery we are currently seeing. If this rate increase does end up in the final proposal, lawmakers must consider these possible negative consequences.
Other Significant Changes to Consider
Several changes within the current proposal could have a far-reaching impact. As details become clearer, additional guidance will be forthcoming, but these components of the American Families Plan should be actively monitored, and contingency plans crafted, where possible:
- Taxation of unrealized gains at death (over certain thresholds) could impact a substantial number of long-established estate plans.
- Applicability of the 3.8% Net Investment Income Tax to active pass-through business income (currently limited to amounts over $400K) could increase tax rates unexpectedly. That threshold was put in place so that the administration’s campaign promise to not raise taxes for those earning less than $400K could be preserved.
- Limitation of Like-Kind Exchange deferrals to $500,000 could have a significant impact on investors in, and developers of, real estate projects.
- Rollback of the QBI deduction for high earners (greater than $400K) could create even more unexpected tax liability for pass-through business owners.
- Making the excess business loss limitation on noncorporate taxpayers permanent could impact the economy in unexpected ways.
- Changes to the gift and estate tax regimes currently in discussion could have a tremendous impact on long-range planning for many American families.
- Extension of the enhanced Child Tax Credit and making those credits permanently refundable could help ease the sting of the pandemic-related struggles for families.
- Supporting the current housing and infrastructure challenges through the expansion of low-income housing tax credits, by providing new credits for neighborhood home investment, and making the New Markets Tax Credit permanent should help bolster the employment sector and improve investment in much-needed capital projects.
- Investment in clean energy through an extensive series of credits and tax incentives and the elimination of fossil fuel tax preferences are measures aimed at addressing climate change through investment in green energy alternatives.
Capitol Hill partisanship poses a momentous hurdle for this administration to pass legislation in this form without modification. While we believe changes can be expected, what the proposed plan entails is starting to come into clearer focus.
If you have any questions about these proposed tax law changes, and the impact they might have on you, your business, or your family, contact one of our PYA executives below at (800) 270-9629.