What Businesses & Individuals Should Know About Biden’s Tax Proposals
There has been a flurry of activity on the Hill the last few weeks as the Senate passed its version of a $1.2 trillion bipartisan infrastructure package and a $3.5 trillion budget resolution.
The bipartisan infrastructure bill includes $550 billion in new spending with set-asides for roads, bridges, transit, and more. From a tax perspective, if enacted as written, this bill would terminate the Employee Retention Credit three months early at the end of the third quarter of 2021 (except for recovery start-up businesses) and would strengthen tax enforcement on transactions involving cryptocurrencies.
In an important initial step, Senate Democrats also approved their $3.5 trillion budget resolution on August 11. The resolution outlines instructions that would allow every major program proposed by President Biden to receive funding. Think of it as putting together a budget and marching orders for each Senate committee to focus on various policies within its expertise. For example, the Committee on Finance is instructed to focus on issues such as paid family and medical leave, Child Tax Credit extension, and SALT cap relief; all of which should be offset with things such as corporate and international tax reform and IRS tax enforcement.
Congressional committees are working toward a September 15 deadline to write the legislative text for the budget reconciliation bill, but their starting place from a tax policy perspective is likely the “Green Book,” a U.S. Department of the Treasury publication providing general explanations of the tax proposals included in the $4.1 trillion fiscal year (FY) 2022 budget presented to Congress by the Biden administration.
President Biden’s budget is primarily made up of two parts: the American Jobs Plan and the American Families Plan. The American Jobs Plan includes revenue proposals that reform corporate taxation, support housing and infrastructure, and prioritize clean energy. The American Families Plan consists of revenue proposals that strengthen the taxation of high-income taxpayers, expand tax credits for low-and middle-income workers and families, and invest in improved taxpayer compliance and services.
The American Jobs Plan
At the core of the American Jobs Plan is reforming corporate taxation. The proposal with the most general application is to raise the corporate income tax rate from 21 percent to 28 percent, effective for taxable years beginning after December 31, 2021. However, in recent negotiations with Senate Republicans, the White House proposed a 15 percent minimum tax rate for corporations in lieu of raising the corporate tax rate to 28 percent.
The other corporate tax proposals in the American Jobs Plan center around international tax policy changes, including:
- Eliminating the qualified business asset investment (QBAI) deduction, which would then subject a U.S. shareholder’s entire net controlled foreign corporation (CFC) tested income to U.S. tax
- Reducing the Section 250 deduction for a global minimum tax inclusion from 50 percent to 25 percent, resulting in a U.S. effective global minimum tax rate of 21 percent (assuming a proposed corporate income tax rate of 28 percent)
- Reforming taxation of foreign fossil fuel income
- Repealing the deduction for foreign-derived intangible income (FDII)
- Replacing the Base Erosion and Anti-Abuse Tax (BEAT) with the Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) rule, which would disallow deductions to domestic corporations or branches by reference to low-taxed income of entities that are members of the same financial reporting group
- Limiting foreign tax credits from sales of hybrid entities
- Restricting deductions of excessive interest of members of financial reporting groups for disproportionate borrowing in the U.S.
- Imposing a 15 percent minimum tax on corporations with worldwide book income in excess of $2 billion
- Providing tax incentives for locating jobs and business activity in the U.S., e.g., a new general business credit equal to 10 percent of the eligible expenses paid or incurred in connection with onshoring a U.S. trade or business, and removing tax deductions for shipping jobs overseas
In addition, the Biden administration proposes to expand the Low-Income Housing Tax Credit, make permanent the New Markets Tax Credit (NMTC), and provide federally subsidized state and local bonds for infrastructure. The American Jobs Plan also would create a new tax credit—the Neighborhood Homes Investment Credit (NHIC), worth $2 billion per year. The NHIC would support new construction for sale, substantial rehabilitation for sale, and substantial rehabilitation for existing homeowners of single-family homes, condominiums, or residences in a housing cooperative.
The president’s FY 2022 budget also includes tax credits for electricity transmission investments, qualifying advanced energy manufacturing, heavy- and medium-duty zero emissions vehicles, carbon oxide sequestration, disaster mitigation, and electric vehicle charging stations.
The American Families Plan
The second revenue proposal, the American Families Plan, consists of five sections: (1) Strengthen Taxation of High-Income Taxpayers, (2) Support Workers, Families, and Economic Security, (3) Close Loopholes, (4) Improve Compliance, and (5) Improve Tax Administration.
Strengthen Taxation of High-Income Taxpayers
- Top Marginal Income Tax Rate for High Earners – Currently, the highest marginal income tax rate is 37 percent for years beginning before January 1, 2026; however, it is scheduled to increase to 39.6 percent for years beginning after December 31, 2025. For calendar year (CY) 2021, the 37 percent rate is effective for taxable income in excess of $628,300 for married individuals filing jointly and surviving spouses (half that amount for married individuals filing separately), and for single individuals and heads of household, the 37 percent rate is effective for taxable income in excess of $523,600.
The proposal would be effective for years beginning after December 31, 2021, i.e., CY 2022. The top marginal rate is proposed to be 39.6 percent, and for CY 2022, it would apply to taxable income in excess of $509,300 for married individuals filing jointly and surviving spouses (50 percent of that amount for married individuals filing separately). For unmarried individuals and heads of household, the threshold level above which the proposed new rate would apply would be $452,700. These threshold levels would be indexed for inflation in future years.
- Taxation of Capital Income – This proposal would change the taxation of capital income not only as to the rate of tax, but perhaps even more significantly, the time at which the tax would be owed.
Currently, most realized long-term capital gains and qualified dividends are taxed at the existing graduated rates with 20 percent being the highest rate. This increases to 23.8 percent if the taxpayer is subject to the net investment income tax. Under the proposal, long-term capital gains and qualified dividends of taxpayers with adjusted gross income (AGI) in excess of $1 million would be taxed at ordinary rates with a cap of 37 percent (40.8 percent if the taxpayer is subject to the net investment income tax). The proposal specifies that the higher capital gain rate applies only to the extent that the taxpayer’s income exceeds $1 million ($500,000 for married individuals filing separately).
For example, if a taxpayer had $600,000 of labor income and $700,000 of long-term capital gain income, only $300,000 of the long-term capital gain income would be taxed at the higher proposed rate; the other $400,000 of the long-term capital gain would be taxed at the current preferential rates. The effective date of this proposal would be for gains required to be recognized on or after the “date of announcement,” which is generally believed to be April 28, 2021. This would mean the proposed increased marginal tax rates could be retroactively effective if ultimately implemented into law in present form.
The second major proposed change relates to the timing of the recognition of certain capital gains for income tax purposes. Currently, when a donor gifts an appreciated asset during the donor’s lifetime to a donee, such as a child or grandchild, the donee’s tax basis in the asset will generally be the same as the tax basis to the donor. The donor recognizes no capital gain at the time of the gift and the donee would only recognize gain or loss upon the sale of the asset during the donee’s lifetime. When an appreciated asset is held by a decedent at death, the basis of the asset to the heir receiving it is generally adjusted to (referred to as “stepped up”) the fair market value of the asset at the date of the decedent’s death. The result of this is the appreciation that occurred during the decedent’s lifetime is not taxed for income tax purposes.
Under the proposal, the donor or deceased owner of an appreciated asset would realize a capital gain at the time of the transfer (date of gift or date of death). In both cases, the amount of the gain subject to income tax would be the excess of the fair market value of the asset over its tax basis to the donor or decedent on the transfer date (date of gift or date of death). For a decedent, capital losses realized from transfers at death would be allowed to use against capital gains and up to $3,000 of ordinary income on the final income tax return filed for the decedent for the year of death. The proposal also would allow a $250,000 per person exclusion for the gain on all residences that is portable to the decedent’s spouse. Finally, the proposal would allow the capital gain tax paid on the deemed gains realized at death to be a deducible cost on the estate tax return of the decedent if one is filed. The tax on the unrealized gains on property transferred by gift or at death would be subject to a $1 million per person exclusion on transfers by gift or at death; $2 million in the case of married couples.
The proposal has another significant provision regarding certain family-owned and -operated businesses. The tax on the unrealized appreciation attributable to those assets would not be due until such time as the asset is sold or it ceases to be a family-owned and -operated asset. In addition, in the case of the tax assets transferred at death that are subject to tax on the unrealized appreciation, the tax would be allowed to be paid over a 15-year time period. This deferral would not apply to publicly traded and other liquid assets.
The proposal also has a rule to determine the fair market value of a transfer of a partial interest in an asset. The determination of the fair market value of a partial interest in an asset would simply be the proportional share of the fair market value of the entire property. This provision would effectively curtail valuation discounts for lack of control or marketability by providing the amount of the transferred partial interest that would be its proportional share of the fair market value of the entire property.
Finally, the proposal contains a provision that would eliminate the ability to capitalize certain noncorporate entities (partnerships, LLCs, trusts, and other noncorporate entities) tax free by the transfer of appreciated assets to the entity. Under the proposal, this transferor would be subject to tax on the unrealized appreciation at the date of the transfer to the noncorporate entity. This rule would not apply to any such transfer to a grantor trust or disregarded entity such as a single-member LLC. This portion of the proposal would be generally effective for transfers by gift or on property owned by decedents dying after December 31, 2021.
In addition, beginning December 31, 2030, noncorporate entities would recognize unrealized appreciation if property held by the entity has not been the subject of a recognition event within the prior 90 years.
- Net Investment Income Tax (NIIT) and Self-Employment Tax – Current rules subject married filing jointly taxpayers and unmarried taxpayers with incomes above $250,000 and $200,000, respectively, to a 3.8 percent tax on their net investment income. Net investment income generally includes interest, dividends, royalties, capital gains, nonqualified annuities, and income from trades or businesses that the taxpayer does not materially participate in. Specifically excluded from the definition of net investment income are most earnings from self-employment.
The proposal aims to ensure high-income taxpayers pay either the NIIT or self-employment tax on pass-through business income, to make the application of the self-employment tax rules more consistent and to subject ordinary business income of nonpassive S corporation shareholders to self-employment tax. These objectives would be accomplished by three proposed provisions:
- For taxpayers with an AGI in excess of $400,000, all trade or business income would be subject to either the 3.8 percent Medicare tax (via the NIIT) or self-employment tax.
- Expand the definition of income subject to the self-employment tax to capture more limited partners and LLC members making their distributive shares of the partnership or LLC income subject to the self-employment tax.
- S-corp owners who materially participate in the trade or business would be subject to self-employment taxes on their distributive share of the trade or business income.
In the case of items 2 and 3 above, the amounts subject to the self-employment tax would only be amounts above certain thresholds that have not been disclosed. The proposals would be effective for years beginning after December 31, 2021.
Support Workers, Families, & Economic Security
The proposals would make permanent or extend certain existing credits that are targeted toward working families. Those credits and the changes being proposed are:
- Premium Assistance Tax Credit – Currently, this credit is scheduled to expire on December 31, 2022. The proposal would make the credit permanent by removing the current expiration date.
- Earned Income Tax Credit – Effective for CY 2021, the earned income tax credit was expanded to allow the credit to be claimed by individuals meeting certain income thresholds to qualify for the credit even if they had no children. The proposal would make this portion of the earned income tax credit permanent.
- Child and Dependent Care Tax Credit (CDCTC) – The American Rescue Plan Act (ARPA) made certain changes to the CDCTC that are effective for 2021 and then expired. The proposal would make these changes permanent.
- Child Tax Credits (CTC) – The ARPA expanded certain provisions of the CTC for CY 2021. The proposal would continue the ARPA expansion rules of the CTC through 2025. In addition, the provision would permanently make the CTC a fully refundable credit, regardless of the earned income of the CTC recipient.
- Childcare Tax Credit for Businesses – Currently, employers that provide child care facilities or contract with an outside facility for the provision of child care may claim a nonrefundable credit of 25 percent of the qualified child care expenses and 10 percent of referral expenses. The current maximum total credit is $150,000. The proposal would expand the limits to 50 percent of the first $1 million of qualified child care expenses. Referral costs would remain at 10 percent with a $150,000 maximum credit amount.
- Carried Interests Taxed as Ordinary Income – Currently, certain partners receive their partnership interests in exchange for services they provide to the partnership. These interests are known as profits interests or carried interests. Due to the flow-through nature of the taxation of partnership income, if and when the partnership recognizes long-term capital gain, the partners that received the carried interests for services would receive an allocation of the long-term capital gain and if the holder of the carried interest is an individual, such gain would be taxed to the service-providing partner at the preferential long-term capital gains tax rates. In addition, because capital gain income is specifically exempt from the self-employment tax, the holder of the carried interest would not pay self-employment tax on the long-term capital gain allocated to the holder of the interest even though such allocation was received for the performance of services.
The proposal would generally provide that income to certain service-providing partners received through a carried interest or profits interest would be taxed at ordinary income tax rates and not at the preferential long-term capital gains rates. This income also would be subject to the self-employment tax regardless of the nature of the income. The above provisions also would apply to a gain on the disposition of the partnership interest itself. The provisions also are extended to convertible or contingent debt, options, or any other derivative interests with respect to the partnership.
This provision would only apply to a partner whose taxable income from all sources was in excess of $400,000 and would be effective for taxable years beginning after December 31, 2021. Note that the effective date refers to the date of income or gain recognition, not the issue date of the carried interest.
- Repeal of Deferral of Gain from Like-Kind Exchanges – Under the current provisions of §1031 of the Code, all taxpayers who own appreciated real property used in a trade or business or held for investment purposes may defer gains realized on the sale or exchange of such property if the proceeds of such sale are invested in real property of a like-kind. Effective for exchanges completed in taxable years beginning after December 31, 2021, the amount of gain that may be deferred each year would be limited to $500,000 ($1 million for married filing jointly). It is important to note the nuance of the effective time of the proposal. It states for exchanges completed in years beginning after December 31, 2021. Due to the timing of closing on replacement property in a 1031 exchange, the proposal is potentially effective for sales of appreciated real estate as early as July 5, 2021.
- Make Permanent Excess Business Loss Limitation of Noncorporate Taxpayers – Under current law, the extent to which pass-through business losses may be used to offset other types of income for noncorporate taxpayers is limited. In particular, for taxable years beginning after December 31, 2020, and before January 1, 2027, “excess business losses” cannot be deducted in the current year but must be carried over to later years as if they were net operating losses. Excess business losses are the excess of losses from trade or business activities of the taxpayer over gains from business activities and a specified threshold that is indexed to inflation. For 2021, the threshold is $524,000 for married filing jointly and $262,000 for all other taxpayers.
The proposal would remove the sunset date of the existing law and make the provision permanent.
Improve Compliance & Improve Tax Administration
The proposals under these two sections are, by definition, largely not related to the tax paid by a taxpayer, but to the administration of the tax system. Many of the provisions will affect the reporting and other filing-related provisions. Notable proposal provisions under these sections include:
- Substantial reform to the current 1099 reporting regime for financial institutions. This would include expansion to report on corporate taxpayers, reporting of inflows and outflows for accounts, and expansion of the reporting requirements to crypto exchanges and custodians. Effective date would be years beginning after December 31, 2022.
- The Secretary of the Treasury would be given additional authority to require electronic filing of returns. This may not be too significant given that most returns are already filed electronically. This provision now would give the authority for the Secretary to mandate electronic filing for certain returns. Currently, the filling of electronic returns is, in many cases, voluntary.
- The proposal would expand the scope of information reporting by brokers who report on crypto assets to include reporting on the beneficial owners of such accounts. The proposal also would require brokers, including crypto asset exchanges and wallet providers, to report information relating to passive entities and any foreign owners. This proposal would be effective for returns required to be filed after December 31, 2022. In general, that would mean effective for 2022.
- The proposal would allow a refund of any net negative tax change in excess of a partner’s reporting year tax liability to be refunded to the partner. This is a technical correction to what has been historically perceived as an inherent unfairness in the centralized partnership audit regime (CPAR) regulations. This proposal would be effective upon enactment of the legislation.
While the bipartisan infrastructure bill comfortably passed in the Senate with a 69-30 vote, it faces an uncertain path forward in the House with progressive Democrats indicating they won’t approve the Senate bill until a budget reconciliation deal also has been approved by the Senate, which could take months to iron out.
The budget reconciliation bill would need the support of all 50 Democratic Senators and almost all the House Democrats to be enacted without the support of congressional Republicans. However, moderate House Democrats are saying they won’t help advance the $3.5 trillion budget blueprint until the infrastructure bill is signed into law.
On August 23, House members temporarily returned from their August recess to vote on the bipartisan infrastructure bill and the Senate-passed budget framework. The House voted to adopt the Senate’s $3.5 trillion budget resolution, and House Democrats negotiated an agreement to vote on the bipartisan infrastructure bill by September 27. Congress set September 15 as a target for the House Ways and Means and Senate Finance committees to draft their portions of the reconciliation bill, which should provide a clearer picture of the specific tax provisions to be included and the likely path forward. The Senate is scheduled to return September 13, and the House is officially back September 20.
While there is much that is uncertain at this time and certainly much more to come, there is one area that appears clear: it will be both a dynamic and busy fall in Washington! If you’re wondering how these developments might affect your personal tax situation and if there are ways to plan amid the uncertain outlook, tune in to the latest episode of our Simply Tax® podcast to learn more about these and other tax-related developments: Episode 126: Tax Legislative Halftime Report.