President Biden recently announced two spending proposals, the American Jobs Plan and the American Families Plan. The American Jobs Plan focuses on job creation, workforce development, clean energy, infrastructure improvement (including transportation, technology and human infrastructure) and U.S. economic competitiveness. The American Families Plan introduces a broad range of initiatives aimed at lower income and middle class families including free community college, universal pre-school, paid family and medical leave and tax credits to help families afford child care and health care.
To pay for these investments, the American Jobs Plan and the American Families Plan include a number of tax changes. Some of these “pay-fors” would have major implications for tax strategies, estate planning and wealth management, so it is important to start considering now and discuss contingency plans for your personal and financial circumstances with your RKL advisor.
The president’s plans are just the beginning of the legislative process, with much work and negotiation required before any of the components take effect as law. Here are the key proposals we are tracking as the plans evolve. We will continue to monitor developments in Washington, D.C. and provide updates, so make sure you’re signed up for RKL alerts and webinar invitations.
What We’re Watching: Business Tax
- Corporate income tax rate increase: The corporate tax rate dropped from 35 to 21 percent, and the American Families Plan would boost that back up to 28 percent. The president has signaled a willingness to negotiate on this and other corporate proposals.
- New corporate minimum tax: The Tax Cuts and Jobs Act repealed the Alternative Minimum Tax. President Biden’s proposals would essentially reinstate it via a 15 percent minimum tax on corporations with global book income of $100 million or more.
- International tax reform: President Biden is proposing additional international tax changes with a focus on the Global Intangible Low-Taxed Income (GILTI) provisions, as well as the potential for establishing a global minimum tax. RKL’s international tax team will provide more detailed updates on these and other proposed changes as talks progress.
- Ordinary income treatment for carried interests and limit on 1031 exchanges: Currently, if carried interest is held for at least three years, it is taxed at long-term capital gain rates. The American Families Plan would change that to ordinary income tax rates. Also, the proposal would eliminate Section 1031, or like-kind, exchange treatment for gains greater than $500,000.
- Section 199A not mentioned…for now: The American Families Plan does not explicitly mention the Section 199A deduction but the president previously proposed phasing out this deduction for income over $400,000.
What We’re Watching: Individual Tax
- Individual tax rates and brackets: The proposed American Families Plan would increase the top income tax rates from 37 to 39.6 percent for incomes of $400,000 or more. The proposal does not specifically define income, so we do not yet know at this time whether the $400,000 represents gross income, adjusted gross income, taxable income or some other measure. We also do not yet know whether this will apply differently or across the board for the various filing statuses.
- Changes to capital gains treatment: President Biden’s proposal would raise the top capital gains tax rate from 20 to 39.6 percent for households making more than $1 million. It also proposes a change in tax treatment for carried interests, moving them from capital gains rates to ordinary income rates. On May 28, the Biden administration released the FY 2022 budget proposal along with the U.S. Department of the Treasury’s “Greenbook,” both of which propose a retroactive effective date of April 28, 2021 – i.e. the date of announcement – for the changes to capital gains treatment.
- Medicare tax: The American Families Plan would apply the 3.8% Medicare tax consistently to those making over $400,000. Currently, it applies to the lesser of net investment income, or excess of modified adjusted gross income over an applicable threshold amount.
- State and Local Tax (SALT) limitation: The proposals do not currently include a change to the SALT deduction limitation. This could change (through complete reinstatement or an increase of the cap) through the advocacy of lawmakers from affected states.
- Increased IRS enforcement: IRS funding would dramatically increase under these proposals to give the agency more resources for audits and enforcement around higher net worth and business taxpayers.
What We’re Watching: Estate Planning
- Step-up in basis at death: The Biden administration is proposing the elimination of the step-up in basis at death for gains in excess of $1 million. Under current law, the step-up increases the basis of a decedent’s capital assets (i.e. stocks, real estate, business interests, etc.) to fair market value as of the decedent’s date of death. While the Biden administration has provided little detail on how this proposal would work, a draft bill in the Senate (and companion bill in the House) would not only eliminate the step-up in basis but create a deemed realization event upon making a lifetime gift and upon death. The application of both the capital gains tax and estate tax at death could create combined tax rates in the 60 to 70 percent range for larger estates. The Biden administration is proposing an effective date of January 1, 2022 for these changes, unlike the retroactive effective date for the changes to capital gains treatment.
- What is missing…for now: In its current form, the American Jobs Plan and American Families Plan contains no changes to the estate tax exemptions and rates and no wealth tax. However, as negotiations begin in earnest, we are watching to see if new proposals come into the mix as trade-offs for others.
- All-time high exemption – use it or lose it: Even if the estate tax exemption is unchanged during this legislative process, there is still another deadline on the horizon. The exemption is one of several provisions of the Tax Cuts and Jobs Act that will revert to pre-2017 levels (from $11.58 million to $5.49 million) in 2026 if Congress does nothing.
- Planning tip: Higher net worth individuals should consider making large gifts to family members or trusts as soon as possible to maximize the current exemption. Your RKL advisor can help you design and implement a tax-advantaged gifting strategy.
What We’re Watching: Investment and Wealth Management
- Capital gains strategy: The proposed capital gains tax rate increase would have the most impact on owners who are planning to sell their businesses, real estate investors and clients who have large concentrated positions in highly appreciated public securities.
- Planning tip: Taxpayers already considering a near-term sale of significantly appreciated assets should consult with their RKL advisor immediately as to whether it makes to accelerate that sale in light of potential higher capital gains tax rates. However, accelerating gains now comes with some risk in light of the Biden administration’s desire to set the effective date for the proposed capital gains tax increase retroactive to April 28, 2021.
- Tax rate arbitrage: Also referred to as “filling out the bracket,” tax rate arbitrage is a maneuver that allows individuals to realize income now at lower tax rates instead of doing so in the future when rates may be higher. This strategy may prove valuable if proposed tax rate increases come to fruition.
Early consideration and planning always beats a reactionary and rushed approach. Let’s get as prepared as possible for what could happen next in the context of your unique financial and personal situation. Count on us to be your primary source of objective advice as the news, analysis and interpretation continues to swirl around these complex topics. Contact your RKL advisor to discuss specifics and stay connected as these proposals continue to evolve.