On May 28, President Biden’s Major Tax Plan Proposal and Fiscal Year 2022 Budget was released to Congress where he proffered his vision for the “American Jobs Plan” and “American Families Plan” in much greater detail than his previous announcements. In conjunction with this Budget, the Treasury Department released the “Green Book,” providing extensive explanations of the proposals that would involve changes to tax laws.
What Do You Need to Know about President Biden’s Major Tax Plan Proposal ?
Still just a proposal. Though we have much greater detail of what President Biden talked about several weeks ago, there are still many steps that must be taken before any proposed changes become law, which will likely take at least a few months, and possibly until near the end of the calendar year. This is the President’s opening offer that essentially begins the process of negotiation. Many compromises and changes are expected among the Administration and members of Congress.
The President is proposing retroactive changes to capital gains taxation. Biden is proposing to tax capital gains at ordinary income rates for taxpayers with over $1 million in taxable income. To prevent a sell-off of appreciated investments in advance of an approaching deadline, he has proposed to apply this change retroactively to sales after the “date of announcement.” This has been generally interpreted to mean April 28, but Congress may provide a different date, such as the date legislation to enact such a change is introduced by the House Ways & Means Committee, or even later. Nevertheless, “fire sales” of appreciated assets to avoid higher taxes on capital gains could backfire.
Political analysts also generally expect that compromises with moderate Democratic senators will result in raising the capital gains tax rate, but not as high as ordinary income. Economic studies have suggested that 28-30% is the “optimal” rate, and anything higher may result in lower revenues because of behavioral effects.
Some key new details have emerged, but other key questions remain unanswered. Adding on to the broad outline of President Biden’s tax proposals, here are some key items of interest in the Green Book:
- Gifts and transfers at death would become capital gains recognition events after 12/31/2021. So while it may be too late to sell appreciated assets to avoid a higher capital gains tax rate, it is not too late to make transfers to trusts and other family members for estate planning purposes.
- Sales to irrevocable grantor trusts might become recognition events. The Green Book is ambiguous on this point, but Senator Van Hollen’s STEP Act clearly targets these common planning transactions. Now is the time to execute sales to grantor trusts and private financing arrangements to put in-force life insurance and other assets outside the taxable estate.
- Minority discounts would not be available for valuing capital gains tax due. The Green Book specifies that transfers of partial interests must be valued according to their proportional share of the fair market value of the entire property. This may cause discrepancies between estate and income tax valuations.
- The lifetime $1 million exclusion from capital gains tax recognition would be elective and portable between spouses. When making lifetime gifts of appreciated assets, the donor could elect no capital gains recognition (up to an aggregate of $1 million in gains per donor), in which case the recipient would take carryover basis. If the donor does not elect to use part of their exclusion for the gift, they would recognize their capital gains at the time of the gift and the recipient would have a basis equal to fair market value at the time of the gift.
- It still is not clear what circumstances would qualify a family-owned business for deferring capital gains tax. The Green Book says that “certain” family-owned and -operated businesses could defer tax until they are no longer family-owned and -operated, implying some could not. For businesses and other non-liquid assets that do not qualify or elect deferral, the estate could set up a 15-year fixed interest payment plan with the IRS over which to spread out the payment of capital gains taxes due.
- All business income would be subject to the 3.8% Medicare tax for high-income taxpayers. Sometimes this tax is included in self-employment tax (SECA), and in other cases it is categorized as net investment income tax (NIIT), but it serves the same purpose—to pay for Medicare. Currently, some business income for S Corporation and limited partnership owners is neither subject to SECA nor NIIT. Biden is proposing to subject all pass-through business income to either SECA or NIIT for taxpayers with adjusted gross incomes over $400,000, and to transfer NIIT funds to the Hospital Insurance Trust Fund.
- Section 1031 exchange deferrals would be limited to $500,000 ($1 million per couple) per tax year. By exchanging different properties in different tax years, real estate investors could stretch their ability to continue deferring taxes under the new cap. This limitation does not impact § 1035 exchanges of insurance contracts.
- Except for the capital gains tax rate increase, the changes are proposed to go into effect after 12/31/2021 (or later). There does not appear to be much political appetite for retroactive changes, except where not making it retroactive might hurt stock prices. High-income and high-net-worth clients have a small window for working with their advisors to prepare for possible changes.
Estate tax changes are not part of President Biden’s Major Tax Plan Proposal, but that doesn’t mean they are off the table. President Biden is targeting wealth transfer through capital gains tax proposals instead of making direct changes to the estate and gift tax regimes. If this tactic becomes too controversial within the Democratic caucus, he could pivot back to estate tax changes instead, or a mixture of changes to both tax systems. In any case, the estate tax exclusion will be cut in half in 2026 without any further Congressional action required.
Remember, Biden’s Major Tax Plan Proposal is just that, a proposal and may or may not become effective law in the future. Stay tuned for rapid developments as Members of Congress and the Biden Administration negotiate over the coming months. If you have questions or want to know if these proposed changes effect your planning, contact us today.