This article, originally published on November 10, 2020, has been amended following Congress’ certification of Joe Biden’s election win and the results of the Georgia run-off election.
This past November, we outlined selected tax law changes that President-elect Joe Biden has proposed, both in speaking engagements and on his campaign website, some or all of which could be enacted in 2021 or future years.
As a result of the January 6th Georgia run-off election, the Senate will be split 50-50 between the Republican and Democratic caucuses, with the Vice President having the tie-breaking vote. Consequently, the likelihood of the President-elect being able to pass many of his policies has greatly increased. Of course, control of the Senate by the Democratic caucus is incredibly narrow, so any new tax legislation could only be approved with the complete agreement within the party.
With the newfound relevancy of the President-elect’s proposed tax plan, we are resharing our thoughts on these potential changes. History proves that rate increases can be adopted late in 2021 but made retroactive to January 1, 2021; however, the fact that the United States will remain under the cloud of a global pandemic and the economic recovery therefrom will certainly be a consideration for making any law retroactive.
To the extent that the items discussed herein may affect you, Jackson Walker stands ready to assist with your tax planning and help you consider potential techniques that may benefit you.
Selected Issues for Businesses and Individuals – Taxation of Estates, Gifts, and Trusts
Biden has proposed significant changes to estate and gift taxation, which may prompt many individuals to consider estate planning techniques for reducing their taxable estate.
Estate and Gift Taxes
As enacted under the Tax Cuts and Jobs Act (TCJA), the current estate and gift exclusion sits at $10 million per individual taxpayer ($11.7 million in 2021 as adjusted for inflation), or $20 million for married couples ($23.4 million adjusted for inflation). Unless otherwise extended by future legislation, these TCJA-level exemptions are scheduled to sunset on December 31, 2025, returning to 2017 levels ($5 million per individual taxpayer or $10 million for married couples, as indexed for inflation) on January 1, 2026.
Biden has proposed a return of estate and gift taxes back to 2009 levels, meaning an estate tax exemption of $3.5 million and a capped lifetime gift tax exemption of $1 million per individual taxpayer. In addition to significantly reducing the current estate and gift tax exclusion amounts (whether compared to the current TCJA-level estate and gift tax exemptions or post-sunset of the TCJA exemptions), Biden’s proposal would de-couple the estate and gift tax exclusions so that lifetime gifts would be capped at a much lower amount than the amount that can pass estate tax free at death. The practical result is that wealthy individuals will be more limited in their ability to maximize lifetime planning techniques by giving away more assets during their lifetime.
In addition to adjustments to the estate and gift tax exclusion amounts, Biden has also proposed an increase in the applicable estate and gift tax rates. The current top estate and gift tax rate is 40%*. Biden has proposed increasing the top rate for the estate and gift tax back to the 2009 level of 45%.
*This rate was not adjusted by the TCJA so the sunset on December 31, 2025, would have no effect on this rate, absent other legislation.
Basis Step-Up and Capital Gains
Under current law, the basis of assets passed on from an individual’s estate to such individual’s beneficiaries or heirs at death is increased (aka “stepped up”) to the fair market value of the asset as of the individual’s date of death. Biden has proposed an elimination of the basis step-up rule that allows people to pass capital gains to heirs and beneficiaries without tax at death. Given the technicalities, the full scope of a potential repeal of a step-up in basis is not clear.
Selected Issues for Businesses and Individuals – Income Taxes
Under current law, there are seven tax brackets for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. These brackets are set to expire January 1, 2026, under the TCJA. Biden has proposed to maintain the current seven brackets but increase the top bracket to 39.6%. This increase would largely affect individual taxpayers with more than $400,000 in annual income.
For C corporations, the current corporate tax rate is 21% with no corporate alternative minimum tax (AMT) since 2018. Biden seeks to increase the corporate tax rate to 28% and add a 15% corporate minimum tax on book income in excess of $100 million.
Under current law, individual taxpayers may deduct the greater of (1) the standard deduction (for 2021, $12,550 for single taxpayers and $25,100 for married taxpayers filing jointly) or (2) the sum of the itemized deductions, with no cap (“Pease limitation”) on the latter through 2025. Also through 2025, the deductibility of state and local tax (SALT) payments are capped at $10,000.
Biden has proposed to cap itemized deductions at 28% and restore the Pease limitation for taxpayers with incomes above $400,000 and to end the SALT cap of $10,000.
Capital Gains Tax Rates
Under current law, the capital gains tax rate varies based on income with a 0% rate ($0 to $40,000), a 15% rate ($40,001 to $441,450) and a top rate of 20% for individuals with income above $441,451. Net investment income tax adds 3.8% rate to households earning over $250,000 for joint filers and $200,000 for other taxpayers.
Biden has proposed to eliminate the 20% capital gains rates for taxpayers with taxable annual income over $1 million and instead tax capital gains at the top ordinary rate (currently 37%, but increasing to 39.6% under Biden’s tax plan).
Under current law, a 100% first-year deduction for the adjusted basis (often called “bonus depreciation”) is allowed for qualified property acquired and placed in service by a taxpayer through 2022, then phased down each year through 2026 to 20% (expires after 2026). Special rules apply for longer-production-period property and certain aircraft. Bonus depreciation was enacted under the TCJA.
Biden has not directly proposed to eliminate or reduce the availability of bonus depreciation. Early in his campaign, he expressed support for the repeal of the TCJA. However, such a sweeping position has not been seen in Biden’s latest tax proposals. Instead, recently, Biden has focused on repealing only certain TCJA components for individuals with more than $400,000 in annual income. If the TCJA were to be completely repealed, then several items discussed herein would also be repealed, contradicting Biden’s current tax plan. For example, if the TCJA were repealed, there would be no Qualified Opportunity Zone tax incentives, as they were created under the TCJA. Consequently, a wholesale repeal of the TCJA doesn’t currently appear to be part of the Biden tax plan.
With the above explanation in mind, if the TCJA were wholly repealed, then prior TCJA law (the PATH Act) would be in effect. This would result in the elimination of bonus depreciation, as bonus depreciation was set to expire in 2020 under the PATH Act.
Income that flows to a general partner of a private investment fund, known as carried interest, generally is taxed under current rules at preferential long-term capital gains rates, usually provided that a carried interest is held for three years.
Biden seeks to effectively eliminate this preferential tax treatment by taxing carried interest at higher ordinary income rates.
Qualified Business Income Deduction (QBID)
Currently, taxpayers other than C corporations are generally permitted up to a 20% qualified business income deduction from a partnership, S corporation, or sole proprietorship, as well as 20% of qualified REIT dividends and qualified publicly traded partnership income in certain circumstances. See IRC § 199A.
Biden intends to maintain the QBID but alter the phase-out for taxpayers earning more than $400,000. Biden also proposes to end the special qualifying rules, including for real estate.
Global Intangible Low-Taxed Income (GILTI)
The GILTI rate generally applies to the “global intangible low-taxed income” (GILTI) of U.S. shareholders of CFCs. The GILTI is currently at an effective 10.5% tax rate.
Biden proposes increasing the effective GILTI rate to 21%. Biden also proposes to assess GILTI on a country-by-country basis and eliminate GILTI’s exemption for deemed returns under 10% of qualified business asset investment (QBAI).
Employment/Social Security Taxes
Currently, wage and self-employment income are subject to a 12.4% Social Security tax that is evenly split (6.2%) between the employer and the employee and paid 100% by a self-employed individual. This tax only applies to taxpayers’ wages of less than $142,800 for 2021 (adjusted upward each year) (“Social Security Tax Cap”).
Biden proposes to eliminate the Social Security Tax Cap for individual earnings over $400,000. His proposal would leave wages between $142,800 (in 2021) and $400,000 not subject to the 12.4% Social Security tax. Biden’s plan would not index the $400,000 threshold so the untaxed gap between $142,800 and $400,000 would be effectively eliminated in about three decades.
1031 Exchanges (Like-Kind Exchanges)
Under current law, capital gains normally triggered by the sale of real property can be deferred by exchanging real property for like-kind real property. The basis in the replacement real property generally becomes the basis of the relinquished property.
Biden has called for eliminating “unproductive and unequal tax breaks for real estate investors with income over $400,000.” Arguably, this could include eliminating like-kind exchange tax benefits – either completely or for taxpayers with income over $400,000.
Qualified Opportunity Zone Investments – Capital Gain Rollovers
Under current law, taxpayers may defer recognition of capital gain by investing the gain in a qualified opportunity fund (QOF), which then invests in businesses and property located in geographically designated Qualified Opportunity Zones (QOZs). When certain requirements are met, taxpayers are also able to avoid future recognition of new gain created from the new QOF investment into QOZs.
Biden has proposed to reform QOZ requirements by:
- Encouraging QOFs to partner with nonprofit or community organizations, and jointly create a community-benefit plan for each investment, focusing on job creation for low-income residents and direct financial impact on households within the QOZs.
- Requiring the Department of Treasury to review the QOZ benefits to ensure these tax benefits are only being allowed where there are clear economic, social, and environmental benefits to a community, and not just high returns — like those from luxury apartments or luxury hotels — to investors.
- Requiring recipients of the QOZ tax break to provide detailed reporting and public disclosure on their QOF investments and the impact on local residents, including poverty status, housing affordability, and job creation.
Various Tax Credits
Biden has proposed various new or expanded tax credits, including the following:
- Expand the Earned Income Tax Credit (EITC) for childless workers aged 65+. Under current law, the EITC is a refundable personal credit available to individuals with low to moderate income from wages.
- Increase the Child and Dependent Care Tax Credit (CDCTC) from a current maximum of $3,000 in qualified expenses to $8,000 ($16,000 for multiple dependents) and increases the maximum reimbursement rate from 35% to 50%, although the full 100% reimbursement may not be available to families making between $125,000 and $400,000.
- Raise the Child Tax Credit (CTC) from a maximum value of $2,000 to $3,000 for children 17 or younger, while providing a $600 bonus credit for children under the age of 6. The CTC expansion would for be for 2021 or as long as economic condition require also and be made fully refundable.
- Reestablish the First-Time Homebuyers’ Tax Credit to provide a refundable, advanceable tax credit of up to $15,000 for first-time homebuyers.
- Establish a Manufacturing Communities Tax Credit to reduce the tax liability of businesses that experience workforce layoffs or a major government institution closure.
- Expand the New Markets Tax Credit program to provide $5 billion in support every year and make it permanent.
- Offer tax credits to small businesses adopting workplace retirement savings plans.
- Expand tax credits related to renewable energy, including tax credits for carbon capture, use, and storage, as well as credits for residential energy efficiency, and restore the Energy Investment Tax Credit (ITC) and the Electric Vehicle Tax Credit. Biden also proposes to end tax subsidies for fossil fuels, and perhaps by that, the plan targets depletion deductions and the current deduction for intangible drilling and development costs.
- Create a 10% “Made in America” advanceable tax credit for companies making investments that will create jobs for American workers and accelerate economic recovery. The credit will be available for revitalizing existing closed or closing facilities, retooling any facility to advance manufacturing competitiveness and employment, reshoring job-creating production to the U.S., and expanding or broadening U.S. facilities to grow employment in the U.S. It will also apply when a company is increasing manufacturing wages above the pre-COVID baseline for manufacturing jobs paying up to $100,000.
- Provide a refundable tax credit for certain retirement account contributions. Biden proposes to eliminate deductible contributions into 401(k)s, individual retirement accounts (IRAs), and other types of traditional retirement vehicles and instead to provide a 26% refundable tax credit for each $1 contributed. The tax credit would be deposited into the taxpayer’s retirement account as a matching contribution. Existing contribution limits would remain, and Roth-style tax treatment would be unaffected.
- Increase the Affordable Care Act’s premium tax credit.
- Create a refundable tax credit for low-income renters that caps rent and utilities at 30% of monthly income.
- Increase the Low-Income Housing Tax Credit.