The White House today released The American Families Plan, which includes some new details regarding the Biden administration’s proposed 2021 tax reform. The tax changes expected to be enacted this year will be substantial and far reaching and will 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 House and Senate are already working on tax and budget proposals that will become part of the next budget reconciliation bill. 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 of a comprehensive, single package 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 congressional committee action 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 circumstances, significant tax savings may be achieved by those who anticipate the expected changes and take steps now to take advantage of existing tax provisions and rates. This alert addresses only a fraction of the tax changes expected to be enacted this fall; additional details will be released over time, including at the time Treasury publishes its so-called Green Book (“General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals”) in the coming weeks.
Expected Corporate Tax Rate Increases and Related Changes
Corporate tax rates are proposed by the Biden administration to increase from 21 percent to 28 percent. Most believe the corporate rate will increase to no more than 25 percent. The Section 199A pass-through deduction may become unavailable for taxpayers earning in excess of $400,000. Net Operating Loss (“NOL”) carrybacks are expected to be prohibited for tax returns not filed by the date of enactment. The American Families Plan states that it will “permanently extend the current limitation in place that restricts large, excess business losses.” IRC Section 162(l) generally disallows use of noncorporate losses in excess of $250,000 ($500,000 for joint filers). The CARES Act removed the Section 461(l) limitation for tax years 2018-2020. The American Rescue Plan Act of 2021 (“ARPA”) pushed out the current expiration of Section 461(l) from 2026 to 2027. The ARPA did not remove or change CARES Act provisions relating to Section 461(l). The Biden administration also is proposing:
- Adding a 15 percent so-called minimum tax on corporations with more than $2 billion of “book income.”
- Doubling the global intangible low-taxed income (GILTI) tax rate on foreign-sourced income, 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.
- Eliminating the foreign-derived intangible income (FDII) regime.
- Replacing the base-erosion and anti-abuse tax (BEAT) with a so-called stopping harmful inversions and ending low-tax developments (SHIELD) proposal. SHIELD generally would deny tax deductions for certain related-party payments where the recipient is in a low-tax jurisdiction.
- 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; it 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 bonus depreciation, including 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. All 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. Treasury’s Green Book is expected to include many of the corporate tax changes proposed in the Obama administration’s fiscal 2017 budget, released on Feb. 9, 2016. That Obama administration budget included more than 140 tax proposals, including a repeal of the last-in, first-out (LIFO) method of accounting for inventories. A copy of that Treasury Green Book is available here.
Expected Changes to Existing Timeline for Certain Tax Cuts and Jobs Act Provisions
Many of the provisions of the 2017 Tax Cuts and Jobs Act (TCJA) that currently are scheduled to change or expire in the coming years will be addressed in the budget reconciliation package this fall and, as a result, may change or expire earlier than previously provided.
Expected Capital Gains and Dividend Tax Rate Increases for Higher-Income Individuals
Capital gains and dividend tax rates are proposed to increase for certain higher-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 as high as 43.4 percent (the expected higher ordinary income tax rate of 39.6 percent plus the 3.8 percent tax on net investment income). Higher rates are proposed to apply to households with adjusted gross income in excess of $1 million, although that threshold could be lowered to $400,000. The Biden administration proposal would tax higher-income individual taxpayers on their long-term capital gains and qualified dividends at the same rate as short-term capital gains and ordinary dividends. It appears that a number of senators may be uncomfortable with capital gains rates in excess of 28 percent (31.8 percent once you add the 3.8 percent tax on net investment income); for now, taxpayers should anticipate at least a nominal increase of 8 percentage points (8/20=40%; 8/23.8=33.6%), or effectively a 33.6 percent increase in capital gains rates. Most expect increased capital gains rates will be proposed to apply at some date in 2021 tied to congressional committee action. Most also believe, based on history, that those effective dates may slip and ultimately may apply to sales occurring on or after the date of enactment of the legislation. We anticipate a single, substantial tax reform package to be enacted sometime in the last calendar quarter of 2021.
End of S Corporation / ‘Active Income’ Medicare Tax Loophole
The American Families Plan explains that high-income workers and investors “generally pay a “3.8 percent Medicare tax on their earnings, but the application is inconsistent across taxpayers due to holes in the law.” The American Families Plan goes on to propose that such taxes “apply consistently to those making over $400,000, ensuring that all high-income Americans pay the same Medicare taxes.” This proposal seems targeted to change Section 1411(c)(2), which currently provides that the net investment income tax does not apply to income from trades or businesses that are not passive activities due to the material participation by a taxpayer.
Expected Carried Interest and Like-Kind Exchange Changes
Profits from carried interest are expected to be further targeted (perhaps modestly so) for taxation at ordinary income tax rates. The like-kind exchange rules are proposed to be repealed for gains greater than $500,000. The effective date of like-kind exchange repeal is expected to be the date of the legislation’s enactment this fall, though helpful transition rules are expected for partially completed exchanges.
Expected Individual Income Tax Rate Increases and Changes
For individuals (including households of joint filers) earning more than $400,000 in a calendar year, the top marginal income tax rate is expected to return from its current level of 37 percent to the pre-2018 level of 39.6 percent. 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), may be repealed or may become unavailable to taxpayers with adjusted gross income in excess of $400,000.
The $10,000 cap on state and local tax (SALT) deductions may be repealed and replaced with limitations on itemized deductions (i.e., phaseouts, a 28 percent cap on the value of itemized deductions, etc.) for taxpayers earning in excess of $400,000. The outright repeal of the SALT cap is expected to cost the government in excess of $600 billion over 10 years. Congress is looking for ways to score SALT repeal as a revenue-neutral “adjustment” to the original cap provision; that type of change may have retroactive effect for certain taxpayers, going back to calendar year 2018.
Expected Estate and Gift Tax Increases and Changes
The estate tax and lifetime gift tax exemption (which was temporarily doubled until 2025) is currently $11.7 million per person ($23.4 million for married couples). In addition, there is a $15,000 per donee gift tax exclusion ($30,000 if spouses agree). The current estate tax rate on amounts in excess of the exemption amounts is a flat 40 percent, and the tax basis in inherited assets is “stepped up” to the fair market value upon the death of the decedent. The Biden team stated during the presidential campaign that it would seek an increase in the estate tax rate to 45 percent and to reduce the exemption amounts to their pre-TCJA level ($5.3 million per person, $10.6 million for married couples). Some have proposed an even higher tax rate and a lower exemption amount.
The American Families Plan omits (for now) the Biden campaign plan to raise the estate tax rate from 40 percent to 45 percent and lower the exemption from $11.7 million to $5.3 million, and focuses on ending the so-called step-up in basis at death. Specifically, the American Families Plan states that it will end “the practice of stepping up the basis for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions)” and “mak[e] sure gains are taxed if the property is not donated to charity.” The American Families Plan states that the proposed reform “will be designed with protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business.” These proposals seem to contemplate capital gains taxes at death, in addition to the estate tax (presumably with an estate deduction for capital gains taxes paid), with a carry-over basis (instead of a capital gains tax) for assets used in certain family businesses and family farms.
The portability of exemption amounts between spouses is expected to continue, but many of the planning techniques (including valuation discounts obtained in related-party transactions) presently utilized by taxpayers may be curtailed or eliminated entirely. While it is worth noting that (i) the Tax Reform Act of 1976 would have imposed carryover basis on inherited assets, but the provision was repealed before it could ever take effect, and (ii) the Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the estate tax and curtailed step-up in basis, but only for one year (2010), Treasury Secretary Janet Yellen has stated that elimination of the step-up in asset basis at death is a priority for the Biden administration. Most believe that these changes will occur in legislation expected to be enacted this fall.
Securing a Strong Retirement Act Provisions
Many of the items contained in the Ways & Means Committee bipartisan Securing a Strong Retirement Act (e.g., automatic enrollment in company 401(k) plans, increasing the Saver’s Credit, increasing the 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) are expected to be included in the fall 2021 budget reconciliation bill or otherwise enacted in 2021.
Expected Additional Clarifications, Details and Changes
As the administration and congressional committees continue to work on tax and budget proposals, clarifications and details regarding the various proposals will emerge. Some of the initial proposals may be abandoned and revised, and additional proposals may 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, transaction pipelines, restructurings, operational affairs and estate plans in a manner that takes advantage of current tax provisions and rates.
As soon as the Biden Treasury releases its Green Book, BakerHostetler will prepare additional analysis.