In Part I of this analysis, we provided a brief overview of President Joe Biden’s two recent 2021 legislative proposals that could have major implications on Federal income taxation of individuals, businesses, and other entities, as well as on Federal estate and gift taxation. We primarily focused on the major tax funding proposals in President Biden’s Made in America Tax Plan (“MAT Plan”), proposed to fund his American Jobs Plan. You can find Part I by clicking here.
In Part II, we focus on key tax funding proposals included in President Biden’s American Families Plan, designed to fund a $1.8 trillion “investment in our children and our families.” You can find a summary of the American Families Plan, published by the White House on April 28, 2021, by clicking here.
As you read President Biden’s proposals and our summaries, remember that at this time these proposals are only outlines of a “wish list” of sorts. The devil is in the details, about which we know little at this time. Also, these tax funding proposals will be subject to debate and compromise. If a version of this plan were to become law, it would likely be enacted along party lines and, in the Senate, under the budget reconciliation process that requires of the Senate only a majority approval, not a filibuster-proof 60 votes. As you probably know, the Senate is evenly divided, with Vice President Harris holding the tie-breaker vote for the Democrats.
An important outstanding question is whether these proposed changes are only prospective at a future date certain or if all or some of the propositions may be applied retroactively to, say, January 1, 2021. Other applicable dates might apply.
Despite the current lack of details and likely changes, we believe that you should begin to consider seriously the effects of these possible tax increases on you, your businesses, your estate plan, your wealth management structures, and your investments. You may be able to take actions now that could mitigate the tax increases that could arise.
Major Tax Funding Proposals in President Biden’s American Families Plan
- Increase IRS enforcement focused on wealthy individuals.
- The plan would add $80 billion to the IRS budget over the next ten years targeted at increasing audits of and other enforcement activities aimed at high-income people.
- Financial institutions would provide the government with more information about inflows and outflows from accounts.
- The White House estimates that this increase in enforcement would yield $700 billion in additional collections over the ten-year period.
- Increase the top marginal tax rate to 39.6% from 37%, to which it was lowered by the 2017 Tax Cuts and Jobs Act (“TCJA”).
- Households making over $1.0 million “will pay the same 39.6% on all their income, equalizing the rate paid on investment returns and wages.”
- This seems to say that long-term capital gains will be taxed at ordinary income rates, beyond some kind of $1.0 million threshold.
- End the “step-up” in basis for property passing from a decedent on gain inherent in the decedent’s property at the time of death exceeding $1.0 million ($2.5 million for a married couple, including the $500,000 exclusion attributable to gain on a couple’s primary residence).
- Tax gain inherent in a decedent’s property as if it had been sold at the date of death.
- Currently, this gain is not taxed under the Federal income tax regime, although it may now be taxed under the estate or gift tax regimes and would continue to be. The estate tax is based on the decedent’s net worth, not only on the value of their unrealized gain.
- Gain inherent in property donated to a charity would not be taxed.
- The deemed sale rule would not apply to family-owned businesses that are passed to the owner’s heirs, provided the heirs continue to run the business.
- Mr. Biden has proposed previously a 15-year fixed-rate payment plan for the taxes tied to some other illiquid assets, other than such family businesses.
- It appears that assets held in qualified retirement accounts are not affected by this new rule. Income is taxed currently upon distributions to the estate, its beneficiaries, or beneficiaries of an account as ordinary income.
- Eliminate the favorable tax treatment for carried interests.
- The use of carried interests by private equity and hedge fund managers frequently affords them the ability to pay taxes on their share of income (generally gains) at preferable long-term capital gains rates.
- The TCJA extended the carried interest holding period to three years in order to achieve long-term capital gain treatment.
- President Biden proposes to tax carried interest allocations as ordinary income, as opposed to capital gains, regardless of the time period the carried interest has been held.
- It is not clear if carried interest Section 1231 gains are on the table to be treated as ordinary income.
- Limit the availability of gain deferral through like-kind exchanges of real property, where the gain realized exceeds $500,000.
- Real estate is essentially the only type of property now covered by the like-kind exchange gain deferral benefit.
- Make permanent the current limitation that restricts the use of excess business losses.
- The suspension of excess business losses in excess of $250,000 was enacted as part of the TCJA.
- The excess business loss limitation is scheduled to sunset after 2025.
- The American Families Plan would permanently extend this limitation on using business losses against other sources of income.
- Ensure that the Medicare tax is applied equally to all taxpayers making over $400,000 in a taxable year.
- This proposal may be intended to apply the 3.8% tax rate to certain rental real estate activities or income received from through S corporations.
It is too early to know the details of the tax funding provisions of the American Families Plan. We do not know how, or if, these proposals will survive the legislative process. However, they now loom over most planning that incorporates income taxes or estate and gift taxes as a consideration.
Please contact your HM&M advisor to discuss how you might be affected.
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