As part of his American Families Plan, released in conjunction with his first speech to Congress on April 28, President Biden has proposed large increases in funding for public education, both for pre-school and community college, funding for child-care, paid family and medical leave, additional funding for nutrition and unemployment insurance, as well as extending the expanded child care tax credit.
To pay for these plans, the administration has proposed a number of tax increases through increases to the tax rate and through new tax rules and expansion of existing ones (Read the full fact sheet here). At this time, the proposals are only broad outlines and lack specific detail, but they are nonetheless important as they signal the ways in which the administration intends to fund the enactment of ambitious social reforms. Note that these proposed tax increases are in addition to a separate set of proposed corporate tax increases that were outlined several weeks ago for the specific purpose of funding physical infrastructure (Read our tax alert on this here).
The tax increases and changes to the tax rules being proposed include the following:
An increase in the individual income tax rate for top earners
The administration is proposing an increase in the top individual income tax rate back to 39.6%, the rate in effect before the enactment of the 2017 Tax Cuts and Jobs Act. The plan says the rate increase would apply only to those within the top 1% (presumably referring to the top 1% of income earners).
An increase in the tax rate on capital gains
While the increase in the top individual income tax rate on ordinary income is a return to rates in effect just a few years ago, the administration also proposes a sharp departure from the past several decades of the tax code with an increase in the federal capital gains tax rate to equal the rate on ordinary (wage) income. It says that this proposal is limited to households making over $1 million — which it says is the top 0.3% of households. This proposal is a key aspect of the administration’s broader agenda of addressing concerns over inequality by increasing taxes on investment income.
Taxing Carried Interest as Ordinary Income
In another significant change to current law, the administration asks Congress to change the taxation of carried interest so that it is taxed as ordinary income, regardless of the rate on capital gains. Proposals to change the taxation of carried interest have been made regularly over the past several years but have not gone anywhere. Again, equalizing the tax rates on income from capital and wages is a key part of the administration’s platform.
Partial Elimination of Like-Kind Exchanges
President Biden is proposing to end tax-free treatment under section 1031 of like-kind exchanges for all gains in excess of $500,000. This proposal has already seen strong opposition from industry spokespeople.
Excess business losses
The President would also like to permanently extend the current limitation on excess business losses under section 461(l). Under the rule, taxpayers’ active net business losses in excess of $250,000 (or $500,000 for joint filers) are disallowed and treated as NOL carryforwards in the following year. Before enactment of the CARES Act, the disallowance under that section applied to any tax year beginning after December 31, 2017, and before January 1, 2026. The CARES Act amended section 461(l)(1)(B) to make the disallowance applicable only for any tax year beginning after December 31, 2020, and before January 1, 2026.
Repeal of Carryover Basis
President Biden has proposed repealing the current law that allows for the step-up in basis of assets at death, limited to gains in excess of $1 million (increased to $2.5 million per couple when combined with existing real estate exemptions). The proposal also says that it will “mak[e] sure the gains are taxed if the property is not donated to charity.”
It is not clear whether this means imposing tax at the time of death or whether the repeal of stepped-up basis will automatically result in the gains being taxed at some point. The reform will be designed with protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business.
Expansion of Medicare Tax
The administration is proposing expanding the 3.8% Medicare tax to address what it says are “inconsistent” applications “due to holes in the law.” It says that the tax would apply “consistently to those making over $400,000.” The precise scope of this proposal is unclear.
It is worth noting some important omissions from the administration’s proposal. One, the plan does not include a reduction of the exemption for estate and gift taxes. And, while it proposes to significantly increase the taxation of capital gains, it does not propose to increase the rate of estate and gift tax. Finally, while a number of Democrats in Congress have said that they will not vote for any bill that does not include at least a partial relaxation of the restrictions on deductibility of state and local taxes, the administration’s plan includes no such element.
The President’s plan also does not adopt some ideas from recent proposals for increased taxation of capital gains income, such as a mark-to-market system for high-income earners’ publicly traded assets, as proposed by Senator Wyden a few years ago.
The President’s proposal for individual tax increases come on the heels of an equally ambitious set of proposed corporate tax increases. And, while many of the spending items in the President’s plan are popular, there is far from consensus in Congress on these tax increases. It is also not clear whether any bill that includes tax increases could gain Republican support. If not, the bills would need to make their way through Congress through the reconciliation process, which is more challenging from a procedural standpoint and subject to additional restrictions.
While it is probable that at least some of the President’s proposals will be enacted, it is also likely that some of them will be watered down before they become law.
At this point, it is important to remain flexible and plan for various scenarios.
More detail on the proposals is expected when the administration releases its Greenbook in mid-May.
Please contact your Mazars professional for additional information.
This alert was produced in conjunction with Ivins, Phillips & Barker, Chtd.