The Biden Administration released the American Families Plan (AFP) which includes far-reaching tax law changes and is expected to be enacted later this year.  The changes will raise taxes on individuals and businesses as well as estate and gift transfers.  Many of these changes are revolutionary in that they overturn long-standing tax provisions that have been accepted by both political parties for decades.

Timing of Anticipated Changes

Committees in the House and Senate are already working on proposals that will become part of the next budget reconciliation bill.  This work will ramp up in early May and we expect a comprehensive new law to be passed in the fall.  Remember, that only 51 Senate votes are needed to pass budget reconciliation legislation.

The effective date for many of the tax law changes will likely be January 1, 2022, but some of the provisions, like capital gains rate increases, may be tied to the date of enactment.  Some changes may phase in over time and others may only be temporary to keep the cost of the legislation within acceptable limits.

Depending on your situation, big tax savings could be gained by those who take steps to lock in current advantages and lower rates.  It will be critical to pay attention to the effective dates of the various new provisions and take action before then.

Corporate Tax Changes

• The Biden White House will propose an increase in the C corporation tax rate from 21% to 28%, though the final rate might be more like 25%.
• The Section 199A tax deduction available to pass-through entities (which effectively lowers the corporate tax rate on non-C-corporations) will be repealed or restricted to taxpayers earning less than $400,000.
• Net operating loss (NOL) carrybacks are expected to be prohibited for tax returns filed after the date the new law is enacted.
• The AFP may also expand or re-initiate tax credits for manufacturing and renewable energy

Changes to the Existing Timeline for Certain Tax Cuts and Jobs Act (TCJA) Provisions

Many of the tax cuts in the TCJA of 2017 were to last through the end of 2025.  These timelines may change or expire earlier under the upcoming tax law.

Higher Capital Gains and Dividend Taxes on Individuals

The tax rate for capital gains and dividends is expected to rise from 23.8% (20% plus 3.8% Obamacare tax on net investment income) to as high as 43.4% (39.6% plus 3.8%).  The higher rates are expected to apply to households with AGI higher than $1 million, but that threshold could be lowered to $400,000.   Some in Congress might object to such high rates, particularly on long-term gains, so the final number may be reduced to 31.8% (28% plus 3.8%).  It’s expected that the new rate will kick in at some date in 2021 that is tied to congressional committee action, but it’s possible that it may get pushed back to the date that the law is enacted sometime this fall.

End of the S Corporation Medicare Tax Loophole

For decades, doctors have enjoyed the ability to practice through an S corporation, set their W-2 compensation at a lowish figure, and draw out the remaining profit free from the 3.8% tax on Medicare wages.  The AFP may end this by subjecting profits earned from one’s own corporation to the 3.8% Obamacare tax on new investment income.

Expected Individual Tax Rate Increases

For individuals (and joint filers!) earning more than $400,000, the proposal would raise the top marginal rate from 37% to 39.6%.  This is a substantial increase and is kicking in at a very low level of taxable income.

The Section 199A pass-through deduction, which permits owners of pass-through businesses to deduct up to 20% of their qualified business income (leading to a current marginal rate of 29.6% on that income) may be repealed or become unavailable for those with AGI over $400,000.

The $10,000 cap on state and local taxes (SALT) may be repealed and replaced with limits on itemized deductions such as phase-outs as AGI rises or a 28% cap on the value of those deductions for those earning over $400,000.  An outright repeal of SALT would be too costly for the federal government.  Congress will try to score SALT repeal as a revenue-neutral “adjustment” to the original cap provisions which could mean that taxpayers in high tax states could find themselves entitled to refunds going back to 2018.

Estate and Gift Tax Changes

It’s worth noting that the Biden proposal (for now at least) leaves the current $11.7 million per person ($23.4 million per couple) exemptions and the 40% estate tax rate alone.  Biden campaigned on lowering the exemptions to $5.3 million and raising the tax rate to 45%.  Of course, this could change in the final law.

His proposal eliminates the step-up in basis rule on assets held until the time of death.  Rather than the heirs getting a stepped-up basis (and eliminating the capital gain), the assets will be deemed to be sold and a capital gain tax triggered.  If the capital gains rate is going up significantly, say to 43.4%, then the elimination of the step-up in basis rule becomes necessary (to Biden at least) to prevent taxpayers from simply avoiding the higher rate by holding onto their assets until death.  Technically, the Biden proposal would end the step-up rule for gains in excess of $1 million ($2.5 million per couple), and it would not apply for gifts made at death to charities.  And, presumably, if an estate tax is owed, there would be a deduction for capital gains taxes paid at death.

The portability of the exemptions between spouses is expected to continue, but some of the planning techniques that wealthy families use to transfer assets down the generational line before death, like valuation discounts when assets are transferred through family limited partnerships, are expected to be curtailed or eliminated.

Retirement Plan Changes

The Biden proposal changes retirement savings by including automatic enrollment in company 401(k) plans, increasing the Saver’s Credit, raising the age for required minimum distributions to 75, and opportunities for employees to potentially deduct their student loans (and employer matching) rather than contributing to 401(k) plans.

Changes to Like-Kind Exchanges

The Biden proposal will amend like-kind exchanges (when a taxpayer sells one piece of property and then buys replacement property of like-kind) to disallow the deferral of gains greater than $500,000, and this is expected to go into effect on the date of the legislation.

Final Notes

As the Congressional committees and the administration work through the details, clarifications, and changes will emerge.  Some of these initial proposals will be revised or abandoned, and additional proposals will emerge.  We will keep you updated in the Newsletter with the specifics, and more importantly, with ways for you to achieve significant tax savings before these provisions go into effect.