Biden Administration Tax Proposals

The U.S. Treasury Department recently issued its green book which has shed light on many of the income tax proposals that will help fund the Biden administration’s infrastructure plan. The green book details tax proposals of the “Made in America Tax Plan” targeting corporate tax law changes, as well as the “American Families Plan” targeting high-income individuals. Below are some highlights of the proposal:

Individual Tax Proposals

Increase in the Top Marginal Income Tax Rate for High Earners

The Administration has proposed increasing the top marginal individual income tax rate from 37% to 39.6% effective 2022. This top marginal tax rate would apply to taxable income over $509,300 for married individuals filing a joint return, and $452,700 for unmarried individuals.

Application of Ordinary Income Tax Rates to Capital Gains and Qualified Dividends of High-Income Earners

Long-term capital gains and qualified dividends would be taxed at higher ordinary income rates, but only to the extent that the taxpayer’s income exceeds $1 million ($500,000 for married filing separately). To the extent that the $1 million threshold is exceeded, long-term capital gains would be subject to a 43.4% (i.e., 39.6% + 3.8%) federal tax rate, as opposed to the current 23.8% (i.e., 20.0% + 3.8%) federal tax rate.

WM Wisdom:

The Administration has proposed that this tax increase would be retro-actively effective for gains recognized after the date “of announcement,” presumably April 2021. Therefore, taxpayers currently considering large sale transactions (i.e. sale of business or large piece of real estate) need to understand and quantify the impact on the bottom line given the uncertainty of the tax rate.

Changes in Self-Employment Taxes

Currently, wages and self-employment earnings are subject to employment taxes under either the Federal Insurance Contributions Act (“FICA”) or the Self-Employment Contributions Act (“SECA”), respectively. SECA and FICA taxes apply at a rate of 12.4% for Social Security tax on employment earnings, subject to a cap of $142,800 in 2021, and at a rate of 2.9% for Medicare tax on all employment earnings, not subject to a cap. An additional 0.9% Medicare tax is imposed on self-employment earnings and wages of high-income taxpayers.

The Administration has proposed that limited partners, LLC members and S Corp shareholders who provide services and “materially participate” in their entities would now be subject to SECA tax on their distributive shares of passthrough income to the extent that the income exceeds specified threshold amounts which have yet to be determined.

Repeal of Deferral of Gain from Like-Kind Exchanges (Section 1031)

Section 1031 would be repealed, subject to the following limited exception: taxable gain could be deferred up to an aggregate amount of $500,000 for each taxpayer ($1 million in the case of married individuals filing a joint return) each year.

WM Wisdom:

First, the provision would apply to exchanges “completed” in tax years beginning after December 31, 2021. Under this reading, open like-kind exchanges at year-end would lose the benefit of tax deferral. Second, it is not clear if this provision applies to corporations and passthrough entities since this provision only appears in the section addressing taxation of high-income individual taxpayers. Third, it is important to note the possibility that excess gains over $500,000 ($1 million joint) may be subject to 43.4% federal rates for the portion of the transaction that causes income to exceed the $1M threshold.

Make Permanent Excess Business Loss Limitation of Noncorporate Taxpayers

Current law requires that “excess business losses” be carried forward as net operating losses rather than deducted currently. Very generally, an excess business loss caps the amount of business loss available to offset other taxable income at $524,000 for married couples filing jointly ($262,000 for other taxpayers).

These provisions were suspended with the CARES Act and set to be reinstated with year 2021. Under current law, the excess business loss provision expires in 2027; the Biden administration would make the provision permanent. Therefore, taxpayers with multiple business entities may be limited in offsetting loss entities against profitable entities.

Death or Gifting of Assets Becomes a Recognizable Event

Under the Biden proposal, the donor or deceased owner of an appreciated asset would realize a capital gain event at the time of the transfer, reversing an income tax principal dating back to 1918.

Currently, when an appreciated asset is held by a decedent at death, the basis of the asset for their heir(s) is adjusted (usually “stepped up”) to the fair market value at death. This “step-up” enables heirs to sell inherited assets free of capital gains taxes if sold when received. Currently, when an appreciated asset is gifted to another person, the donee typically receives a carryover basis on the date of gift. In both situations, no gain or loss is determined until the underlying asset received by inheritance or gift is sold or disposed.

Biden’s proposed plan is to eliminate the “step-up” in basis and treat death and gifts as recognition events subject to long-term capital gains rates immediately. Individuals would obtain a lifetime $1M gift/inheritance exclusion ($2M per married couple) to offset against appreciated assets that are received by inheritance or gift. Once these thresholds are exceeded, tax would be assessed. The proposal allows a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death and will contain special small business exemptions (however these exemptions are very loosely defined).

WM Wisdom:

The tax proposal would be effective for gains on property transferred by gift, and on property inherited after December 31, 2021. This may create a limited planning opportunity before year-end, so we encourage those with significant appreciated assets to review their estate and succession plans.

Individual Tax Provisions Under Consideration

The details of the Biden administration’s tax proposals and effective dates included in the initial tax provision are a starting point for negotiations with Congress. The discussion will continue for several months and as a result, the details contained are likely to change, including the effective dates. Interesting to note the following items, which may be revived or revisited as the negotiations continue, were not included in the tax proposal:

• Eliminating the Sec. 199A 20% deduction on pass-through income (currently set to expire in 2026).
• Eliminating the $10,000 cap on state and local tax deductions (currently set to expire in 2026).
• Capping the value of itemized deductions to 28%.
• Changing the estate and gift tax exemption thresholds or rates.

WM Wisdom:

If the Section 199A 20% deduction were eliminated, small business owners in the highest current tax bracket could see their top federal tax rate increase from 29.6% (37% bracket adjusted for the 20% deduction) to 43.4%. (39.6% bracket + 3.8% SECA). Therefore, small business owners may be incentivized to accelerate income into 2021 and defer deductions to post-2021 taxable years.

Corporate Tax Provisions

Corporate Tax Rate Increase

The Administration has proposed increasing the income tax rate for C corporations from 21% to 28%. Under the tax plan, the United States would tax corporate income at the highest top rate in the industrialized world, averaging 32.4% (including an average state corporate rate of 4.4%). The proposed change in law would be effective for taxable years beginning after December 31, 2021.

WM Wisdom:

Planning opportunities may exist for start-up businesses when considering entity structure.

With passthrough entities possibly subject to SECA and losing out on the 20% Section 199A deduction; the 100% exclusion of gain from qualified small business stock (Section 1202) available only to C corporations may become a valuable planning strategy.

Fifteen Percent (15%) Minimum Tax on Book Earnings of Large Corporations

The Administration has proposed imposing a 15% minimum tax on worldwide book income of corporations with book income in excess of $2 billion. In calculating this tax liability, book net operating loss deductions, general business credits, including R&D, clean energy and housing, tax credits, and foreign tax credits, would be allowable.

Tax Incentive for Onshoring Jobs

This proposal would create a new general business credit equal to 10% of certain expenses paid or incurred in connection with moving a trade or business located outside the United States (U.S.) to the U.S. to the extent the action results in an increase in U.S. jobs. The proposal would also reduce tax benefits associated with U.S. companies moving jobs outside of the U.S. by disallowing deductions for certain expenses paid or incurred in connection with offshoring a U.S. trade or business to the extent the action results in a loss of U.S. jobs.

Questions?

We will continue to monitor the ongoing negotiations in regards to the tax proposals presented by the Biden Administration. As changes and updates are provided, we will be certain to keep you posted. As always, we are available to discuss your business and personal tax needs at any time.

Stephen J. Slade, CPA and Suzanne Feldman, CPA, MT contributed to this article.

DISCLAIMER: The WM Update, WM Wednesday Wisdom, WM Daily Update COVID-19, COVID-19 Business Resources, COVID-19 Client News Alerts and other related communications are intended to provide general information, including information regarding legislative COVID-19 relief measures, as of the date of this communication and may reference information from reputable sources. Although our firm has made every reasonable effort to ensure that the information provided is accurate, we make no warranties, expressed or implied, on the information provided. As legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that may modify some of the provisions in this communication. Some of those modifications may be significant. As such, be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed.