President Joe Biden outlined $1.5 trillion in individual tax increases on April 28 to pay for a sweeping family and economic security initiative. Many of the tax proposals echo tax hikes he championed in his campaign, but there are several notable additions and omissions.
The American Families Plan was unveiled as a fact sheet
, and proposes substantial new spending on paid leave, child care, health care, and education. While no official score was provided, the White House said the tax increases are intended to raise $1.5 trillion over 10 years, and to fully pay for $800 billion in tax cuts and $1 trillion in spending over 15 years. Nearly half of that total, however, is projected to come from increased IRS enforcement. Official government scorekeepers may not agree with such revenue increase solely from IRS funding changes, which could put pressure on Democrats to reduce the size of the package or identify additional revenue raisers.
The new plan is fairly light on details, and the administration did not offer any information on proposed effective dates. But there is important new information in many areas. The major tax increase proposals include:
- Raising the top individual rate to 39.6%
- Raising the top capital gains rate to 39.6% for “households” with more than $1 million in income
- Expanding the 3.8% Medicare tax on net investment income to cover all unearned income
- Repealing the “step-up” in basis for certain inherited assets
- Taxing carried interest as ordinary income
- Repealing like-kind exchanges
- Making permanent the Section 461(l) loss limitation
- Providing $80 billion in funding for IRS audits
- Requiring new information reporting from financial institutions
Biden has not previously targeted like-kind exchanges, Medicare taxes or carried interest, though a 39.6% rate for capital gains would also address carried interest without any need for a separate change. The plan’s $800 million in new tax cuts largely comprise enhancements to the earned income tax credit, the child tax credit, the Affordable Care Act premium credit and the child and dependent care credit.
Several notable proposals that had been widely discussed were not included, such as:
- Phasing out the Section 199A deduction above certain income thresholds
- Increasing gift and estate tax rates and reducing exemptions
- Repealing the limit on the state and local tax (SALT) deduction
- Capping the value of itemized deductions at 28%
- Imposing Social Security taxes on income exceeding $400,000
These provisions are not off the table. The tax outline is only the first step in what will be a difficult legislative process, and Congress will have significant influence in shaping the package. Congressional Democrats may be a major moderating influence on some tax increases, while at the same time pushing for their own priorities.
Democrats are still considering their options for the legislative process. While a bipartisan bill is not impossible, Republicans and Democrats appear far enough apart that it seems unlikely for now. Democrats can use the reconciliation process to avoid 60-vote procedural hurdles, but it comes with significant limitations. Many of the non-tax proposals, and even parts of the tax package, could run afoul of reconciliation rules. And without Republican support, Democrats will still need complete unity in the Senate and near unity in the House. Moderate Democrats may wield significant leverage.
Grant Thornton Insight: While the final shape of the legislation remains uncertain, significant tax increases appear increasing likely for individuals, pass-throughs, and C corporations. Taxpayers should begin considering the potential effects of the proposals on their tax and business planning, especially with regard to the timing of income and deductions. Various effective dates are still under consideration and are discussed more below.
Individual rate increases
As expected, Biden is proposing to return the top individual rate to 39.6%, the rate in effect before the Tax Cuts and Jobs Act. The fact sheet itself does not specify an income threshold for this change, but the Biden administration has made clear that it does not intend to impose any tax increases on income below $400,000.
Grant Thornton Insight: The administration has signaled that the $400,000 threshold is an ironclad pledge, but that threshold is not well-defined. The administration has not clarified whether it refers to taxable income or adjusted gross income, but an unnamed IRS official told press outlets that the threshold will be at least $452,800 for single filers and $509,300 for joint filers. Under current law, the 37% bracket begins at $523,600 of taxable income for single filers and $628,301for joint filers in 2021.
Capital gains rate increase
Biden is proposing to tax capital gains at ordinary income rates of 39.6% for “households making over $1 million.” Similar to the $400,000 threshold, the Biden administration has not offered any details on how the $1 million threshold is defined, or how it may differ by filing status.
Grant Thornton Insight: Based on the language surrounding this proposal, the administration feels strongly about pursuing it and believes it plays well with the public as a fairness issue. Moderate Democrats, however, may find a 39.6% rate too high to swallow, especially as lobbying ramps up. Final legislation could result in a more moderate increase.
The fact sheet promises to “close the carried interest loophole,” which presumably means treating carried interest like ordinary income. Although no details were provided, proposals from congressional Democrats in the past have more narrowly targeted profits interests from certain investment services partnerships.
Grant Thornton Insight: Biden never targeted carried interest during the campaign, and this proposal is interesting in that it would be largely unnecessary if the top capital gains rate returned to 39.6%. Separately changing the treatment of carried interest could expand the impact to income below the $1 million threshold, but it also may be an indication that the Biden administration does not expect to actually achieve a 39.6% capital gains rate.
Basis step-up for inherited assets
The administration is proposing to repeal the step-up in basis for inherited assets on gains in excess of $1 million for a single filer, or $2 million for joint filers (before any real estate gain exclusion). It is unclear how this this threshold would operate.
This provision was the only estate and gift tax proposal in Biden’s original campaign platform, but he later endorsed a unity task force report that called for returning estate and gift tax rates and exemptions to “historic norms.” Congressional Democrats could push to add these changes, particularly if there is revenue pressure. Congressional Democrats also have many proposals attacking specific types of planning techniques like grantor retained annuity trusts and family limited partnership valuation discounts.
Grant Thornton Insight: The basis step-up provision appears to be a necessary backstop to ensure a capital gains rate increase raises significant revenue. Without it, government scorekeepers may assume that taxpayers would hold onto more assets until death to avoid the higher capital gains rate.
Net investment income tax
The fact sheet proposes to expand the scope of the 3.8% Medicare tax on net investment income (NII). No details were offered, but this proposal echoes one from former President Barack Obama, which would essentially apply the tax to all unearned income. Most income that is not subject to Medicare taxes on earned income is taxed as NII, but there can be exceptions, such as income from a nonpassive owner of an S corporation or limited partnership. Presumably the intent of the proposal is to apply the tax to any income that is not otherwise covered by Medicare taxes on earned income.
The fact sheet proposes repealing like-kind exchanges under Section 1031 for gains greater than $500,000. The TCJA previously limited them to real property.
Biden is proposing to make permanent the limit on deducting business losses exceeding $250,000 ($500,000 for joint filers) under Section 461(l). This limit was created by the TCJA and was originally scheduled to be in effect from 2018 through 2026. It was suspended from 2018 through 2020, but is back in place for 2021 and scheduled to expire with the rest of TCJA’s individual provisions in 2027.
The plan pledges to raise $700 billion over 10 years through additional IRS enforcement. Treasury released a paper
with additional information. The plan is headlined by an additional $80 billion in funding for audits of taxpayers with more than $400,000 in income. The plan would also give the IRS authority to regulative return preparers and usher in a sweeping new reporting regime on financial institutions. Banks and other financial organizations would be required to report “aggregate outflows and inflows” from financial accounts.
Grant Thornton Insight: The Administration’s projection of $700 billion in new enforcement revenue is very aggressive, and it may be hard to convince the Joint Committee on Taxation to score IRS funding increases the same way. This could create a revenue hole in the bill that would put pressure on lawmakers to cut costs or find additional revenue. The JCT may score the new reporting regime more favorably, but it is sure to raise opposition. The breadth of the proposed reporting is expansive, and could raise complaints about the potential burden and privacy. Much of the reporting would not necessarily correlate to specific items on the return, and the IRS could face challenges actually leveraging the information to improve audit selection.
There are a handful of provisions popular with Democrats and discussed by the administration that were not included in Biden’s plan. These provisions can still potentially be added at many points in the legislative process.
Congressional Democrats in particular will be pushing for relief from the $10,000 cap on the SALT deduction, and many Democrats have already threatened to block any tax bill that does not repeal the cap. This issue will likely need to be addressed in order to overcome congressional opposition. Full repeal is very expensive, however, and Democrats may consider compromises such as temporary repeal or a sizeable increase in the cap.
Biden also declined to include his own campaign proposals to cap the value of itemized deduction at 28%, impose Social Security taxes on income over $400,000, and repeal the Section 199A deduction for pass-through business income over certain income thresholds. All of these could still certainly be considered, though the increase to Social Security taxes might be less likely outside of Social Security reform. The Section 199A deduction enjoys a private business constituency that Democrats generally find sympathetic, but Democrats have also complained that too much of the benefit goes to high earners. Phasing out Section 199A above certain income threshold may become a hotly debated issue.
The fact sheet does not offer any information on effective dates. Lawmakers have several options for effective dates. They are not barred from making proposals retroactive in nature. Retroactive rate increases are rare but not unprecedented. Given the still ongoing pandemic and somewhat fragile economic recovery, retroactive rate increases do not seem very likely. Treasury Secretary Janet Yellen has made several comments indicating that rate increases could be made effective prospectively beginning in 2022 or even phased in over a longer period. This is certainly not the only option under consideration, however, particularly for capital gains rates.
Lawmakers can make changes effective as of the date of enactment or the date a proposal is first officially introduced. These remain options, and Democrats have discussed whether to make a proposed increase in the individual capital gains rate effective on the date the proposal is officially introduced. This could be the date a proposal is first unveiled in the Treasury “Green Book” or when formally introduced in Congress, potentially sometime from mid-May to mid-June. An immediate effective date would be designed to prevent taxpayers from selling assets and engaging in transactions ahead of the rate increase.
Grant Thornton Insight: The ultimate decision on effective dates could hinge on how the JCT scores the revenue impact based on how they model behavioral responses. A delayed effective date for a capital gains rain increase could prompt a sell-off and generate short-term revenue. If the JCT believes those sales would not otherwise happen within the 10-year budget window under an immediate effective date, then a delayed effective date could raise additional revenue.
The release of this platform marks only the beginning of a long legislative process. More details will become available when Treasury releases its detailed Green Book on the administration’s tax legislative proposals and as congressional lawmakers begin to draft and debate legislative language. While the proposals will certainly evolve, taxpayers should already be assessing the potential impact on their tax and business planning, particularly in regard to the timing of income and deductions.
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