With expected passage in the next few weeks of the Biden Administration’s first COVID-19 relief bill, the focus in Washington, D.C., will shift to a second budget reconciliation bill – Biden Administration tax changes. The tax changes are expected to be substantial and far-reaching, and to include corporate, individual and capital gains tax rate increases, international tax changes, and estate and gift tax changes.
Expected Timing of Biden Administration Tax Changes
Congressional committees in the Democrat-controlled House and Senate are already working on tax and budget proposals that will become part of a second budget reconciliation bill. President Biden’s fiscal year 2022 budget is expected to be released in mid to late April, at which point the House and then the Senate will craft and approve a budget resolution to serve as the vehicle for the reconciliation process. Most expect committee action to begin in early May, with ultimate enactment in the fall. Only 51 votes are needed to pass budget reconciliation legislation in the Senate. The effective dates of the newly enacted provisions generally are expected to be Jan. 1, 2022, but certain provisions may have proposed effective dates tied to committee action or the date of enactment (for example, capital gains tax rate increases may be proposed to apply to sales occurring after the date of committee action in early October or the date of enactment of the legislation later in the fall). The effective dates of certain provisions may be phased in over time, and certain provisions may be enacted on a temporary basis to help keep the scored cost of the legislation within acceptable parameters.
Depending on a taxpayer’s specific facts and circumstances, significant tax savings may be achieved by taxpayers who anticipate these expected tax changes and take steps now regarding their business plans, transactions pipelines, restructurings, operational affairs and estate plans in a manner that takes advantage of existing tax provisions and rates. This alert addresses only a fraction of the tax changes expected to be enacted in the fall of 2021 (fiscal year 2022 budget reconciliation legislation), with a focus on those changes most relevant to 2021 planning opportunities for companies and individuals who previously may not have had any reason to undertake actions this year as opposed to future years.
Expected Corporate Tax Rate Increases and Related Changes
Corporate tax rates are expected to increase from 21 percent to 28 percent, and the Section 199A pass-through deduction is expected to become unavailable for taxpayers earning in excess of $400,000. NOL carrybacks would be prohibited for tax returns not yet filed. The Biden Administration also is proposing;
- a 15 percent so-called “minimum tax” on book profits in excess of $100 million
- doubling the GILTI tax rate from 10.5 percent to 21 percent and imposing it country-by-country and with no exclusion (or a lesser exclusion) for a deemed return on tangible assets
- imposing an “offshoring penalty” surtax on U.S. company offshore production profits for sales back into the United States (10 percent surtax leading to a 30.8 percent effective tax rate; would also apply, for example, to offshore services or call centers serving the United States)
- denying all deductions and expensing write-offs for moving jobs or production overseas
- establishing a 10 percent advanceable “Made-in-America” tax credit for certain service or call center jobs brought back to the United States
- providing or expanding tax credits and incentives for manufacturing, renewable energy, carbon capture and small businesses
- repealing fossil fuel tax preferences
- eliminating deductions for consumer drug advertising
- repealing the increase in bonus depreciation from 50 percent to 100 percent.
Certain of these proposals are not yet well-defined and may be difficult to draft and administer. Others may be achieved only in part (for example, there may not be support to increase the corporate tax rate to as high as 28 percent). All of the proposals are relevant in the sense that they provide insight into what the 2021 reconciliation bill may attempt to achieve. Changes in Social Security taxes, the minimum wage, and many other Biden Administration or congressional proposals do not qualify for consideration as part of budget reconciliation legislation.
Expected Changes to Existing Timeline for Certain Tax Cuts and Jobs Act Provisions
Many of the items contained in the 2017 Tax Cuts and Jobs Act that currently are set to change or expire in the coming years – for example, requirements that research and development costs not be deducted but instead be amortized over a five-year period beginning in 2022, and that the deduction for business net interest expense be limited to 30 percent of EBIT (not EBITDA) beginning in 2022 – are expected to be addressed in the budget reconciliation package this fall.
Expected Capital Gains and Dividend Tax Rate Increases for High-Income Individuals
Capital gains and dividend tax rates are expected to increase for certain high-income taxpayers from their current level of 23.8 percent (a 20 percent tax rate plus the 3.8 percent tax on net investment income) to 43.4 percent (the expected higher ordinary income tax rate of 39.6 percent plus the 3.8 percent tax on net investment income). The higher rates are expected to apply to taxpayers with adjusted gross income in excess of $1 million, though that threshold could be as low as income in excess of $400,000. This expected change would tax high-income individual taxpayers on their long-term capital gains and qualified dividends at the same rate as short-term capital gains and ordinary dividends.
Expected Individual Tax Rate Increases and Changes
Individual tax rates are expected to increase from their current level of 37 percent to 39.6 percent for individuals earning more than $400,000. The Section 199A pass-through deduction, which allows certain pass-through business owners to deduct up to 20 percent of their qualified business income (leading to a current-law marginal rate of 29.6 percent), is expected to become unavailable to taxpayers with income in excess of $400,000. It also may be changed in additional ways that would raise federal revenue.
The $10,000 cap on state and local tax deductions is expected to be repealed and replaced with limitations on itemized deductions (i.e., phase-outs, a 28 percent cap on the value of itemized deductions, etc.) for taxpayers earning in excess of $400,000. Child tax credits are expected to be increased and otherwise expanded. A first-time homebuyer’s credit of $15,000 also is proposed.
Securing a Strong Retirement Act Provisions
Many of the items contained in the Ways & Means Committee bipartisan “Securing a Strong Retirement Act” (automatic enrollment in company 401(k) plans, increase in Saver’s Credit, increase in minimum distribution age to 75, allowing student loan pay-downs and employer matching in lieu of 401(k) contributions, increasing allowed contributions by individuals 60 and older, etc.) are expected to be included in the fall 2021 budget reconciliation bill or otherwise enacted in 2021.
Expected Carried Interest and Like-Kind Exchange Changes
Profits from carried interest are expected to be further targeted for taxation at ordinary income tax rates. The like-kind exchange rules are expected to be repealed in their entirety.
Expected Estate and Gift Tax Increases and Changes
The estate tax and lifetime gift tax exemption (which was temporarily doubled until 2025) currently is $11.7 million per person ($23.4 million for married couples). In addition, there is an exclusion for the first $15,000 gifted to each other person ($30,000 gifted to each other person together by spouses). The current estate tax rate on amounts in excess of the exemption amounts is 40 percent and basis of inherited assets are “stepped up” to their fair market value upon death of the decedent. The Biden Administration is expected to raise the estate tax rate to 45 percent and to return the exemption amounts to their pre-TCJA level ($5.3 million per person; $10.6 million for married couples) or less. Tax basis of inherited assets are expected to have carry-over, rather than stepped-up basis. Portability of exemption amounts between spouses is expected to continue.
Expected Additional Clarifications, Details and Changes
As Biden Administration and congressional work continues on the tax and budget proposals expected to become law in the fall of 2021 as part of the second budget reconciliation bill, clarifications and details regarding the various proposals will emerge. Some of the initial proposals may be abandoned and new and additional proposals will emerge. As noted above, depending on a taxpayer’s specific facts and circumstances, significant tax savings may be achieved by taxpayers who anticipate expected tax changes and take steps regarding their business plans, transactions pipelines, restructurings, operational affairs and estate plans in a manner that takes advantage of current tax provisions and rates.