The Biden Tax Proposals: Change is Coming
President Biden’s proposals present the most dramatic changes to US taxation seen in a generation. These proposals have collectively been presented in several plans, factsheets, an address to Congress, and the Treasury Budget plan. As presented, these proposals carry the theme of increasing taxes on the top income earners and wealthy individuals as well as tax increases for corporations, incentivizing US production and jobs and incentivizing ‘clean’ energy business sectors.
- An increase to IRS budget and enforcement
- Increased reporting of financial account information to the IRS
Noted Individual taxation and personal investment-related proposals
- Increasing the top marginal individual tax rate (from 37% to 39.6%)
- Eliminating preferential rates for taxpayers with income over $1 million, taxing long-term capital gains and qualified dividends at ordinary income rates (from 20% to 39.6%)
- Taxing carried (profits) interest income as ordinary income
- Subjecting income from pass-through business entities to either NIIT or SECA (additional taxes)
- Eliminating the basis adjustment on inherited assets or treating death as an income taxable event
- Making permanent the current limitation on excess business losses of non-corporate taxpayers
- Extending and expanding the various credits (Child, EITC, Child & Dependent Care TC)
- Extending the expanded Affordable Care Act (ACA) premium tax credits
- Miscellaneous other proposals affecting like-kind exchanges and other more specific tax matters
Corporate Taxation Reform
In his address to Congress, President Biden simply said: “We’re going to reform corporate taxes so they pay their fair share – and help pay for the public investments their businesses will benefit from.”
However, the Made in America plan factsheet and Treasury Budget contains numerous other proposals regarding an overall reform of corporate taxation; here is a summary of proposals:
- Raising the US corporate income tax rate from 21% to 28%
- Pushing for a corporate minimum tax grows; the G7 countries agreed in principle to a 15% minimum tax on global book income for large companies this week
- Reducing to 25% the deduction for Global Intangible Low-Taxed Income (GILTI), eliminating Qualified Business Asset Investment QBAI) exemption, and imposing localised calculations
- New restrictions on inversions by US corporations and new provisions to halt the sourcing of income as “foreign” if the actual management and operations (generating such income) are within the United States; this is paired with provisions eliminating deductions for relocating jobs overseas and establishing credits for returning jobs to the US
- A mix of incentives for ‘clean’ energy production and jobs paired with a revocation of various fossil fuel production tax incentives and the restoration of polluter payments
Most of the actual taxation rate changes mentioned in this post concerning personal income, wealth transfer, and corporate taxes have proposed effective dates for tax years beginning after December 31, 2021 (with special provisions for fiscal year filers). A notable exception being the taxation at ordinary rates for long term capital gains and qualified dividends for taxpayers with incomes in excess of $1 million, this change will become effective “after the date of announcement” according to the Treasury Budget; that reference is to April 28, 2021, when the proposal was announced in President Biden’s address to Congress. However, it is expected the date will be subject to alteration in the legislative process. Another exception being taxation changes for certain publicly traded partnerships involved in the energy sector which are not effective until 2027.
The proposal to expand financial account reporting to the IRS has an effective date for tax years beginning after December 31, 2022.
Several other provisions relating to the operation of the IRS will be effective upon enactment. This includes proposals for increasing the IRS budget, increasing oversight of paid return preparers, rules affecting the audit of partnerships, and the reporting of listed transactions.
Increase IRS Budget & Enforcement
The America Families First Fact Sheet states: “… increase investment in the IRS while ensuring that the additional resources go toward enforcement against those with the highest incomes.”
As tax practitioners who deal with the IRS on a regular basis, we welcome this change. Hopefully, this will lead to an IRS that is more responsive, accurate and capable. With an increased budget the IRS may conduct more audits, but that is all the more reason to have a good tax practitioner advising you, correct? Okay, we may be biased on this one, but really, the IRS should be adequately funded to perform its task and it simply has not been for quite some time (one consequence of this is the many incorrect notices the IRS has sent out, another good reason for having a good tax adviser).
Increased Financial Account Reporting
The US Treasury Department issued a press release to go along with President Biden’s speech. Intriguingly, or perhaps frighteningly depending on your perspective. The press release discusses requiring banks to disclose: “information on account flows so that [the IRS] has a lens into investment and business activity—similar to the information provided on income streams such as wage, pension, and unemployment income.” The referenced information relates to tracking income from partnerships, sole proprietorships and other opaque entities. It appears, if implemented, the IRS will be able to check business bank accounts. That should be “exciting”.
Preferential Capital Gains rates disappear at the top income bracket
If you generate $1 million or more of income in a year, although the $1 million is not specifically defined yet in the proposals, then your tax filings will become a bit simpler, you won’t need to be concerned with preferential rates as they will not be available. The current proposal will impose the top 39.6% income rate (so an increase from 37%) on long term capital gains and qualified dividends, up from 20% which you are paying currently. Note: some sources indicate the capital gains will be subject to a 37% rate instead of the 39.6%, not something we’ll hold our breath on though.
“We’re going to get rid of the loopholes that allow Americans who make more than $1 million a year pay a lower rate on their capital gains than working Americans pay on their work.” – from The White House’s prepared remarks.
According to the Treasury Budget, pass-through business owners will face a higher tax of some sort; either the imposition of additional portions of the Self Employment Contributions Act social taxes (0.9%-3.8%) or the Net Investment Income Tax (3.8%). This proposal appears to only apply to owners who materially participate in the business, so it should not affect investor type owners. The effective date for this proposal is for tax years beginning after December 31, 2021.
No favored capital gains rates for top income earners will, as President Biden says, only hit a small percentage of taxpayers, but it will hit them quite hard. Essentially doubling the tax rate on any capital gain, and do not forget that the 3.8% Net Investment Income Tax (NIIT) will apply to this income in many instances.
If generating $1 million is not a regular occurrence for you, then delaying or advancing the sale of capital assets could be enough to mitigate the most drastic consequences of this proposed change.
This will complicate structured earn-outs and equity rewards, such as stock options, and any bonus compensation as well. We expect to see more programs give flexibility of exercising the vesting of equity rewards to the benefitting employee, so they may control the timing of the income.
Estate Tax – No more basis adjustment!
In our opinion the most impactful change for individuals announced by President Biden was the call to eliminate the basis adjustment for inherited assets; commonly referred to as the “step-up in basis”. As stated, “The President’s plan will close this loophole, ending the practice of “stepping-up” the basis for gains …”.
Current law provides the tax basis of any asset inherited is equal to the fair value of the asset at the date of death even in cases where there is no estate tax paid. This normally operates as an increase in the tax basis of assets, resulting in a corresponding decrease of the asset’s built-in gain(s). Some observers argue this effect distorts normal economic behaviour; causing taxpayers to retain assets with built-in gains as death will eliminate all, or a significant portion, of those gains. So, elimination of the step-up is a silver lining for free markets.
There will also be the fun of proving basis – ask yourself, how much did your grandmother pay for the chestnut credenza? What about that Wilson print of a Flamingo? Although cost basis for certain assets will be easy to establish, others will be much more difficult.
Managing capital gains will be the most important aspect of preserving wealth. With the loss of the basis adjustment and the preferential capital gains rates for high-income earners overall effective tax rates on wealth could be significantly higher than they are today.
The proposal does mention carve-outs for family businesses and farms, and a baseline exemption of $1 million ($2.5 million per couple when combined with existing exemptions on the gain from the sale of one’s principal residence). It is unknown if asset values, for estate tax purposes, will be adjusted for their built-in gain at the time of death.
In prior statements, President Biden has proposed reducing the federal estate tax exemption back to $3.5 million, though the factsheets make no further mention of this detail. Various congressional members have introduced legislation to reduce the exemption to $3.5 million AND increase the maximum tax rate to 60% (from a current top rate of 40%).
To add to the mix of possible changes to the estate tax, the Treasury Budget (Greenbook) indicates a proposal to treat death as a tax realization event. Forcing a mark-to-market deemed sale and realization of any built-in capital gains. The Treasury Budget suggests this tax could be used as a credit against the estate tax.
The proposed effective date of the Treasury proposal is for estates where the decedent dies after December 31, 2021.
Expansion of credits (Child, EITC, Child & Dependent Care TC)
President Biden is pushing to expand several refundable credit programs. These programs are unlikely a concern for non-individuals not resident in the United States. For context, all these programs were expanded as part of the recent COVID stimulus bill, the same legislation which gave the 3rd stimulus check, but only for a single year.
President Biden’s proposal expands the Earned Income Tax Credit (EITC) for childless workers aged 65 and over. The proposal also expands the Child and Dependent Care Tax Credit (CDCTC) to $8,000 ($16,000 for multiple dependents) from a maximum of $3,000 in qualified expenses and increases the maximum reimbursement rate from 35% to 50%.
For 2021 and some duration into the future, this proposal increases 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 six. The CTC would also be made fully refundable.
Depending on the sources referenced, the expansion of credits will have a positive or negative impact on the US economy (and depending on the time horizon).
Corporate Taxation Reform
With a corporate tax rate of 28%, the US will have one of the five highest corporate tax rates in the OECD. This becomes a significant consideration for companies looking to expand into the US where they also need to factor in state taxes. The various new provisions do carry the theme of favouring US production, at least as currently presented. For instance, there is the repeal of the deduction for foreign-derived intangible income, limitation of foreign tax credits for the sale of certain foreign business entities and eliminating GILTI deductions for foreign fossil fuel derived income (oil and gas activities). There is a separate limitation on intra-group interest expensing, which could impact structures taking advantage of certain current treaty benefits. Finally, if you own an interest in a company with over $2 billion as annual income, well, prepare for a 15% tax on global book income.
It remains to be seen to what extent, if any, these various proposals will become law and what sort of effect it will have on smaller businesses that operate internationally. The corporate tax proposals are many and complex. It will take further study to truly determine the likely implications of these changes.
The effective date for these corporate tax-related items is for tax years beginning after December 31, 2021.
President Biden’s address and the fact sheet provide the clearest idea of what we can expect to see in future tax legislation. Right now, these are simply proposals from the White House. Any actual legislation must originate in Congress. On many points, the proposals lack details, and these details will determine who is affected by the proposed rules; assuming they become law.
These changes are arguably far more impactful and profound than those enacted in 2017’s Tax Cut & Jobs Act. The intention appears to be to take a much bolder approach to corporate taxation reform than the prior effort.
International structures will need to be reevaluated and tax planning priorities reconsidered. We will keep our readers informed of developments regarding tax reform and are always glad to address any concerns or questions you may have. Contact us.
For reference the information here is derived from the following sources:
- The America Jobs Plan factsheet: FACT SHEET: The American Jobs Plan | The White House
- The American Families Plan factsheet: Fact Sheet: The American Families Plan | The White House
- Prepared remarks from President Biden’s address to Congress: Remarks as Prepared for Delivery by President Biden — Address to a Joint Session of Congress | The White House
- US Dept. of Treasury press release: Investing in the IRS and Improving Tax Compliance | U.S. Department of the Treasury
- US Dept. of Treasury tax report: MadeInAmericaTaxPlan_Report.pdf (treasury.gov)
- US Dept. of Treasury tax proposed 2022 Budget (Greenbook): General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals (treasury.gov)