Democrats enter 2021 with an opportunity to make significant changes to tax policy. Their victories in both Georgia runoffs give them nominal control over all three levers of government, but their razor-slim congressional majorities and the economic climate may temper their agenda.
The 50-50 split in the Senate will make them dependent on moderate Democratic senators from red states and a difficult budget reconciliation process. The ongoing pandemic and fragile economy will also dominate the agenda for the first year of President Joe Biden’s term. Democrats may be forced to focus on stimulus and economic recovery while the more transformational aspects of their tax platform wait. Democrats will also be under less pressure to pay for spending and tax cuts during a health and economic crisis.
For a compilation of 10 key highlights of this Democratic tax agenda analysis, click here.
Still, Biden campaigned heavily on promises to make corporations and high-income taxpayer pay their “fair share,” and many congressional Democrats will be eager to use their newfound power to address long-standing tax priorities. Democrats will certainly seek opportunities to advance campaign tax pledges. Many businesses and investors are particularly focused on whether and when tax rates could increase on individuals, capital gains and corporations.
How aggressive Democrats approach the coming year will depend on a variety of factors, including economic conditions, Republicans’ willingness to compromise, reconciliation restrictions and the progressive policy limits of moderate Democrats. This article will analyze Democratic tax proposals in more detail, discuss the legislative challenges and potential timing for changes, and highlight important regulatory considerations.
The White House and both chambers of Congress have fallen under single party control twice in the last 12 years, and each time it led to significant tax policy. Democrats passed the Affordable Care Act (ACA) in 2010 and Republicans enacted the Tax Cuts and Jobs Act (TCJA) in 2017. However, Democrats enjoy slimmer majorities in both the House and the Senate than in previous instances of single party control (see chart), and are also facing a pandemic and economic challenges.
Democrats flipped the Senate in January by winning two hotly contested runoff seats in Georgia. The party ratio is now an even 50-50 split (including two independents who caucus with Democrats), with Vice President Kamala Harris giving Democrats an effective majority with the tiebreaking vote. Sen. Chuck Schumer, D-N.Y., becomes the Senate majority leader, while former Majority Leader Mitch McConnell, R-Ky., swaps jobs with him and takes over as minority leader.
Senate procedural rules like the filibuster offer the minority party significant influence. The coming power sharing agreement will be crucial. The last time the Senate was evenly split in 2000, the two parties agreed to 50-50 committee ratios, but allowed bills to move out of committee in the event of a tied committee vote under special procedures. Negotiations over these procedures will be important if Democrats expect to move legislation through the reconciliation process, which requires committee action. Reconciliation may be the best option for Democrats to bypass 60-vote procedural hurdle, and is discussed in more detail more below.
Finance Committee ranking minority member Ron Wyden, D-Ore., is expected to take over as chair of the committee if Democrats retake the Senate. He has long been a proponent of tax reform, and has already signaled an interest in pursuing increases taxes on corporations and capital gains, including a mark-to-market regime on publicly traded securities.
Democrats underperformed their election expectations in the House, but retain a slim 221 to 211 majority, with one seat still contested and two vacancies. House rules give the majority fairly strict control of the chamber, so Republicans may have little influence. But Democrats’ extremely thin majority could make it more difficult for leaders to manage tension between liberal and moderate factions.
House Speaker Nancy Pelosi, D-Calif., was re-elected without a major challenge, but previously pledged not to serve beyond 2022. Current Ways and Means Committee Chair Richard Neal, D-Mass., retains the tax-writing gavel.
Administration and guidance
Biden won the presidency with an electoral vote advantage of 306 to 232, and has given every indication that he intends to act aggressively with executive actions upon taking office.
Tax regulations have often been less politicized than regulations in other areas, but a Biden Treasury could still bring a meaningful shift. After Trump was elected, he ordered a broad review of tax regulations issued in the year before he took office. This led to changes in a small number of rules, including the debt-versus-equity regulations under IRC Section 385. Trump also removed an exception that had allowed tax regulations to avoid administrative review.
Biden is nominating former Federal Reserve Board Chair Janet Yellen as Treasury Secretary. She does not have a long record of tax policy positions, and Biden himself has not yet indicated any plans to revisit tax guidance outside of his order for a routine freeze on regulations not yet published in the Federal Register. A review of past tax regulations certainly remains possible, and could affect favorable TCJA guidance. Although the guidance largely emerged from genuine efforts to interpret sometimes difficult and ambiguous statutory language, there are generous interpretations and safe harbors that could be targeted.
Some speculation has centered around international provisions, as the Biden administration has shown interest in these areas. The high-tax exception for the global intangible low-taxed income (GILTI) tax appears nowhere in the statute, for instance, and the interpretation of the exception from the base erosion and anti-abuse tax (BEAT) for the cost services method was considered very favorably broad.
The Senate will be the key battleground for Democrats pursuing their agenda over the next two years. With a 50-50 split, they will need absolute unanimity among their members for any legislation that doesn’t attract Republican support.
The need to placate moderate Democratic senators from red and swing states could limit the Democratic agenda. Tax legislation may hinge on the votes of Sens. Joe Manchin, D-W.V., Jon Tester, D-Mont., Kyrsten Sinema, D-Ariz., and Mark Kelly, D-Ariz. Democrats could also look to pick up votes from moderate Republicans such as Susan Collins, R-Maine, Lisa Murkowski, R-Alaska, and Mitt Romney, R-Utah. This moderate faction could wield significant influence and force the consideration of more moderate tax proposals.
Even more importantly, Democrats will be 10 votes short of the 60 needed to overcome filibusters, giving Republicans significant leverage. Given this hurdle, Democrats will have three basic options to pass tax legislation through the Senate, all with important limitations:
- Compromise with Republicans – Democrats could choose to seek bipartisan agreement, and pass legislation by getting at least 10 Republican votes. This would likely require significant compromises and take many tax increases of the table.
- Change the Senate rules – Democrats could abolish the filibuster altogether and allow for legislation to pass on simple majority votes. Democrats have already pushed back against Republican requests to explicitly protect the filibuster as part of any Senate power sharing agreement. But removing the filibuster remains very controversial and could have major political downside. It would also require every Democrat, even the moderates, to agree. This would be a significant hurdle, and Democrats are likely to consider this “nuclear” option only after significant deliberation and only for a transformative legislative priority.
- Use reconciliation – Democrats could use a budget reconciliation procedure that bypasses filibusters on revenue bills, but there are important restrictions to this process.
Reconciliation may be Democrats’ best hope for substantial tax legislation this year. It is a budget process that allows the Senate to pass revenue bills on simple majority votes. It has been used repeatedly in the past to enact major tax legislation, including the 2001 and 2003 tax cuts, the ACA, and the TCJA. However, there are important limitations:
Timing and effective dates
- Need budget resolution – Lawmakers must agree on a budget resolution giving committees reconciliation instructions. This in itself can be difficult and could significantly extend the timeline for passing a reconciliation bill.
- One reconciliation bill per budget – Generally, only one reconciliation bill can be passed for each budget cycle. Democrats will need to weigh using reconciliation on tax legislation against other priorities such as COVID-19 relief, infrastructure or health care, though bills covering those issues could also carry tax provisions. However, because no budget resolution was passed last year, Democrats could attempt to move two reconciliation bills this year with two separate budget resolutions. Republicans attempted a similar maneuver to repeal the ACA and enact tax reform in the same year, though the ACA repeal failed.
- Committee action – The tax writing committees must fulfill the reconciliation instructions. A reconciliation bill cannot be brought straight to the floor, but must emerge from committee. This could be difficult in the Senate if committee ratios are even, and may depend on a power-sharing agreement.
- Revenue restrictions – A reconciliation bill cannot create a net revenue loss outside the 10-year budget window. Republicans used the reconciliation process to pass the TCJA and were forced to sunset the individual tax changes in order to remain revenue neutral outside the budget window. Democrats may not feel as hindered by this rule as Republicans, since their tax platform includes significant tax increases that could offset other tax benefits. There are no restrictions on a tax bill raising revenue through reconciliation.
- Only revenue measures – Reconciliation bills cannot include law changes that do not affect revenue. This is not an issue for most spending provisions and tax changes, which typically have a direct revenue impact. But it can affect broader legislation paired with a tax title, such as paid leave requirements, minimum wage increase or private health coverage rules.
There are several factors that will affect whether and how quickly Democrats pursue any tax increases, and when they seek to make them effective. Lawmakers’ first priority will be economic recovery and stimulus legislation, and an economic crisis also allows lawmakers more leeway to spend on recovery without the pressure to pay for it with revenue offsets. With less revenue pressure, there could be more danger of tax increases intended to target a fairness issue or address a policy consideration like offshoring.
However, key Democrats have signaled a reluctance to raise taxes while the economy is still fragile. Ben Harris, a top economic advisor for the Biden campaign, has said that: “If any of these tax initiatives are found to be economically damaging at this point during this fragile recovery, they’re not going to be part of the plan.” Fellow Biden economic advisor Jared Bernstein has said any tax increases will be “very dependent on economic conditions.”
Key Senate Democrats have echoed these sentiments. Sen. Dianne Feinstein, D-Calif., said: “We ought to make a decision [on tax increases] when we have a better sense of where the economy is going.” When asked about tax increases, Sen. Debbie Stabenow, D-Mich., said the number-one priority would be COVID-19 and Sen. Richard Blumenthal, D-Conn., said: “A tax bill can be made effective at a time when we think the economy will be sufficiently robust that some increase in taxes will have no detrimental effect.” Yellen also mentioned at her confirmation hearing that corporate rate increases could potentially wait.
Still, retroactive tax increases cannot be ruled out. They are relatively rare, but not unprecedented. There have been six major rate increases since 1980, and as the table below shows, only the 1993 increases in the corporate and individual rates were retroactive.
Legislative priorities and issues
Stimulus and recovery
Biden is pursuing a two-step plan toward economy recovery. He has laid out an immediate $1.9 trillion stimulus bill he is hoping to push through the Senate immediately without reconciliation. Major concessions may be needed to get Senate Republicans on board, and Democrats are already considering passing a shell budget resolution to use reconciliation quickly, while preserving the ability to use reconciliation on another budget resolution later in the year. The current version of the proposal does not have revenue offsets and includes only a handful of tax provisions:
- Providing a new round of $1,400 stimulus checks for each taxpayer and dependent
- Making the Child Tax Credit (CTC) fully refundable and permanently increasing it to $3,600 for children under the age of 6 and $3,000 for children under the age of 17
- Allowing children aged 17 to qualify for purposes of the CTC in 2021
- Expanding the Earned Income Tax Credit (EITC) for childless adults to nearly $1,500 and raise the maximum income for the credit to roughly $21,000.
- Extending the emergency sick pay and paid family leave requirements enacted by the Families First Coronavirus Relief Act (FFCRA), but extending them to all employers while providing offsetting tax credits only to those with less than 500 employees
If Democrats can enact this bill, they hope to follow it with larger long-term economic recovery legislation centered around infrastructure that could be passed using reconciliation. Lawmakers have not yet begun outlining the details, but there are several stimulus tax provisions left off of previous bills that could be considered:
- Expanded WOTC – There is bipartisan support for expanding the work opportunity tax credit (WOTC) to a new category of workers who have received unemployment during the crisis.
- Mobile workforce – Lawmakers have responded to the widespread workplace disruption by renewing efforts to push legislation that would bar states from imposing withholding or tax on individuals who work fewer than 30 days in any state. Schumer’s opposition continues to make this an uphill battle.
- PPE tax credits – There is some bipartisan support for providing employers relief from the costs of personal protective equipment and making workplaces safe for employees and customers. There may be less support to do this retroactively now that many businesses have already made these changes.
- Refundable business credits – Republicans have pushed to make general business credits refundable, but Democrats have resisted these efforts.
- NOL changes – Democrats have pushed to rescind some of the benefits offered by the net operating loss (NOL) carryback provisions in the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Democratic opposition seems to center around the suspension of the Section 461(l) loss limitation and the ability to use NOLs against higher rates in place before 2018. Any change would be difficult to implement now that taxpayers have already filed and received many refund claims.
Early indications are that Democrats envision this package as largely deficit-funded, but tax increases could be considered, particularly if there are tax cuts or spending outside the 10-year budget window that must be offset.
Lawmakers will be faced with more than a dozen popular “extender” provisions that are again scheduled to expire again at the end of the year. Their coming expiration coincides with two of the first “sunrise” tax provisions from the TCJA scheduled to take effect. These provisions, which affect research cost recovery and the limit on interest deductions, were enacted because of revenue constraints. Although Democrats have been reluctant to help Republicans fix unfavorable aspects of the TCJA without broader changes, there could be bipartisan support for addressing these unpopular changes. Bonus depreciation, popular with both parties, is also scheduled to decrease from 100% to 80% beginning in 2023.
Lawmakers could also begin early discussions on major expiring portions of the TCJA scheduled for 2026. Democrats would likely demand major reforms to the underlying bill as part of any permanent extension, so action on these issue may wait for several years. A list of important scheduled tax changes is included below.
Biden has proposed a corporate rate of 28%, significantly higher than the current corporate rate, but well below the former 35% rate that many other Democratic presidential candidates championed. Wyden has discussed a top corporate rate between 24% and 28%. While a corporate tax rate increase was a key aspect of the agenda, lawmakers may not be as eager to pursue it quickly while the economy is recovering, and compromise could lead to a more modest increase.
Minimum tax on book income
Biden has proposed a 15% minimum tax on corporate book income “so that no corporation gets away with paying no taxes.” There are virtually no details available on this proposal, which often appeared to be more of a talking point in response to press reports revealing large corporations showing financial statement profits while paying little federal income tax. Although there is little information in official campaign documents, the press has reported that it is intended to apply only to companies with more than $100 million in net income. It seems unlikely Democrats will truly impose a minimum tax on financial statement income, but they could consider a new form of an alternative minimum tax that uses a measure of tax income and adjusts the tax treatment of certain items to align them more closely to book. Lawmakers would need to make policy decisions over which preferences to target.
Biden proposes taxing capital gains as ordinary income for taxpayers with over $1 million in income, nearly doubling the current rate from 20% to 39.6% (not including net investment income tax). Wyden has an even more ambitious proposal that would require high-income taxpayers to mark-to-market publicly traded securities each year and pay tax on the gain. Wyden’s proposal would also apply a look-back rule to sales of “non-tradeable assets” like real estate and business interests to eliminate the benefit of deferring the implicit gain throughout the holding period.
Wyden has already told reporters he wants move forward with this proposal, but specifically tied it to funding for Social Security. It is unclear whether he envisions passing it outside of broader efforts at reforming Social Security. While capital gains increases are key part of the Democratic platform, the weak economy and strong opposition from moderates, investors and businesses could lead to a more modest outcome.
Biden has proposed several tax increase on those earning $400,000 per year or more:
- Raising the top rate from 37% to 39.6%
- Capping itemized deductions at 28%
- Reinstating the “Pease” phaseout of itemized deductions
- Phasing out the Section 199A deduction
His campaign did not specify whether the $400,000 threshold would apply to taxable income or adjusted gross income, or how it could differ by filing status. There is no information on the potential interaction between a cap on the value of itemized deductions and the Pease phaseout, and it is unclear how either of these provisions could interact with any potential modification or repeal of the $10,000 cap on state and local tax (SALT) deductions. Biden himself has been relatively quiet on the SALT cap, but raising or repealing the cap is a top priority of many congressional Democrats.
Tax rate increases for top earners will be a target for Democrats, and could be paired with legislation addressing the SALT cap to avoid a net tax cut benefiting high-income taxpayers.
There is bipartisan interest in encouraging the return of supply chains to the United States, particularly for medical devices and pharmaceutical equipment. Lawmakers could explore bipartisan tax legislation in this area, and Biden made “onshoring” production a major campaign issue, using tax proposals as a major aspect of a carrot-and-stick approach. There are significant definitional challenges to writing administrable standards for implementing the Biden proposals, but they offer insight into the direction of possible legislation.
To incentivize onshoring, Biden proposed 10% advanceable credit for companies that make investments to:
- Revitalize manufacturing plants that have closed or are on the verge of closing
- Retool facilities to “advance manufacturing competitiveness and employment”
- Re-shore production or service jobs, including shipping, moving and training costs
- Increase overall manufacturing wages in the United States above a company’s pre-COVID baseline up to $100,000
To combat offshoring, Biden proposed a penalty on the profits of U.S. companies derived from producing goods or services overseas and selling them in the United States. For services, the penalty applies if those jobs could have been performed in the United States. The penalty is imposed as a 10% surtax on the amount of a company’s corporate tax, which, under Biden’s proposed 28% corporate tax rate, would result in a 30.8% tax against applicable profits.
Biden has proposed reforming GILTI significantly. He has discussed raising the effective rate to 21% and applying it separately to each country. It is not entirely clear how else he envisions reforming the operational rules, and how this might affect the proposed rate. Much of the language surrounding this proposal appears to contemplate expanding the scope of GILTI so that it operates more like a true global minimum tax.
This is a significant area of focus for the administration and may get more traction even if Democrats are reluctant to pursue tax increase. It is not necessarily solely about revenue, but is aimed at a policy objective that the administration believes could help encourage domestic investment and discourage offshoring. If legislation proves difficult, the Biden administration could also seek to adjust GILTI through changes to the regulations.
Finance and investment
Biden never formally proposed a financial transactions tax, although he has expressed support for it in informal comments. Financial transaction tax proposals floated by other Democrats during the presidential primary would generally tax high-volume trade of stocks, bonds and derivatives at varying rates equal to a fraction of 1%. Any effort to enact such a tax will generate fierce resistance to some constituencies that support Democrats, and it could be opposed by Schumer.
Biden was largely silent on carried interest, perhaps because he proposed treating capital gain as ordinary income anyway, but the tax treatment of carried interest will continue to be a Democratic target. Wyden has already specifically mentioned a desire to address it.
Biden plans to make climate change a major focus, and his platform includes many green energy tax proposals that would:
- End “tax breaks” for the fossil-fuel industry
- Enhance tax incentives for carbon capture, use and storage
- Allocate tax credits for upgrading to energy efficient equipment and processes and deploying low-carbon technologies
- Adopt “scaled-up” tax credits for renewable energy projects that meet certain labor standards
- Restore the electric vehicle credit and refining it to benefit middle-class taxpayers
- Reinstate the “Cash for Clunkers” program, which provided incentives to trade older vehicles in for newer, more fuel-efficient ones
- Create direct cash rebates for individuals to upgrade appliances, install more efficient windows and cut energy bills
While Biden has placed a great deal of emphasis on promoting green energy, particularly to promote economic growth and create jobs, several of his tax proposals lack specificity. He hasn’t identified which particular fossil fuel tax incentives he intends to eliminate. Similarly, while his plan appears to suggest he would restore expired green energy incentives or revamp existing ones, he has offered few details on which incentives he’s considering, the value of the incentives, or how they would be administered.
Employee benefits and retirement
Biden’s tax platform includes tax credits aimed and savings and employer-provide childcare, and also included a pledge to “equalize” the tax benefits of defined contribution retirement plans. He has offered few details on the meaning of this phrase. He is likely proposing to increase the benefit of deducting or excluding from income any contributions from taxpayers in lower tax brackets, but it is also possible he is proposing to limit the benefit of these deductions or exclusions for taxpayers in higher tax brackets.
Retirement savings could emerge as an area of agreement. Neal and House Ways and Means ranking minority member Kevin Brady, R-Texas, recently released the Securing a Strong Retirement Act
, a bipartisan tax bill to encourage retirement savings that includes the following provisions:
Social Security taxes
- Increasing the three-year credit for small business pension plan startup costs to 100% for employers with up to 50 employees, capped at $5,000 annually, and providing an additional credit of up to $1,000 per employee for contribution’s made on an employee’s behalf
- Allowing small businesses that join an existing multiple employer plan (MEP) to claim the small business pension plan startup cost credit for all three years
- Permit employers to make matching 401(k), 403(b) or SIMPLE IRA contributions for “qualified student loan payments” made by an employee
- Allowing 403(b) plans to participate in MEPs under SECURE Act rules, including granting relief from the “one bad apple” rule
- Replacing the current tiered rate structure of the Saver’s Credit with a single 50% rate, increasing the maximum credit to $1,500 per person and raising the income eligibility amount
- Increase the age for required mandatory distributions from retirement plans from 72 to 75
- Indexing the $1,000 Individual Retirement Account catch-up contribution limit for individuals 50 years or older to inflation, beginning in 2022
- Creating a higher retirement plan catch-up contribution limit for individuals 60 years or older, with a limit of $10,000 -- or $5,000 for SIMPLE plans -- both indexed for inflation
Biden has proposed imposing Social Security tax on earned income over $400,000. The current cap would be retained ($137,700 per person for 2020). This is often called a “doughnut hole” approach because only wages between the current cap and $400,000 would be free from tax. It is not clear, however, whether Biden is proposing to impose only the individual 6.2% share of the Social Security tax on earned income over $400,000, or if employers would also be required to pay their 6.2% share on this income.
Social Security has long been a politically fraught issue, and this change may be one of the more difficult proposals to enact. It would require changes to the benefit calculations to prevent the extra taxes from creating extra benefits, which would likely be contentious.
Biden was surprisingly restrained on the estate tax. For most of his campaign, the only proposal he included was to eliminate the stepped-up basis for inherited capital assets. As part of the Unity Task Force report with Sen. Bernie Sanders, I-Vt., he then pledged to restore estate taxes to “historic norms.”
Congress is likely to lead on this issue, as it has been a major focus for Democrats in the past. Past legislation from key Democrats has included proposals that would:
- Mandate uniform estate and gift and income tax treatment of grantor trusts
- Restrict valuation discounts for lack of marketability and control
- Impose transfer taxes on trusts with a life of more than 50 years
- Require minimum 10-year GRAT term with gift value at least 25% of overall value
The delayed election victory for Democrats in the Senate significantly changes the tax legislative outlook. It expands what is possible, but Democrats will still face major challenges to achieving their tax agenda and will be focused largely on economic recovery. The outlook for tax legislation will continue to evolve as economic conditions change, leaders flesh out their agenda, and moderates assert their priorities.
Taxpayers should continue to evaluate their long-term and short-term business and tax planning, particularly as more information on potential effective dates is revealed. Taxpayers may want to consider extending their 2020 tax returns to monitor the situation so that they can make informed elections and other decisions affecting the timing of income and deductions. Any decisions to accelerate transactions or income should be made after carefully evaluating the risk and downside to all options.
For more information, contact:
Washington National Tax Office
Grant Thornton LLP
+1 202 861 4144
Washington National Tax Office
Grant Thornton LLP
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