Author: Daniel T. Staszak, CPA MS (Tax)
El Dorado Community Foundation Board President
Earlier this year, President Joe Biden revealed his new budget proposal to improve the tax system currently in place. The plan, split as the “American Families Plan” and “American Jobs Plan,” aims to make modifications that would address issues such as increasing tax revenue, prioritize the future by introducing clean energy incentives, and focus on education and infrastructure. The President’s plan also seeks to eliminate “loopholes” to ensure that high income individuals and corporations that were previously able to avoid taxes pay their “fair share.”
For most situations, the proposed changes aren’t too drastic. However, for some it could create a greater tax liability and make significant differences in how their income is taxed.
Increased Tax Rates
One part of President Biden’s plan is to add a new income tax bracket that would raise the top bracket from 37%, which was put into place by the Tax Cuts and Jobs Act (TCJA) in 2017, to 39.6%. When considering the additional Net Investment Income Tax (NIIT), this could further increase the maximum rate by 3.8%. Under the American Families Plan, the new maximum rate of 43.4% would only apply to those whose income falls under the highest bracket, those with a taxable income over the threshold of $452,000 ($509,300 for married, filing jointly.) These thresholds, if adopted, would be indexed for inflation in the future and these proposed changes wouldn’t be effective until tax years beginning after December 31, 2021.
New Tax Rate for Capital Gains for High Income Taxpayers
Another area where this proposal is looking to make significant changes is for taxes applied to capital gains. As of now, capital gains are taxed at a maximum rate of 20%, though for most taxpayers, it’s usually even less. The new changes would make capital gains (along with qualified dividends) eligible to be taxed at the maximum rate 39.6% – just like ordinary income. This wouldn’t apply to all capital gains though; only capital gains of more than $1 million would be subject to the 39.6% rate. It remains to be seen how this change would impact the economy as taxpayers would look to buy and hold capital investments.
Gain Recognition on Unrealized Gains on Gifts and Bequests
Biden’s proposal would subject gifts and bequests with gains in excess of $1 million to tax. This rule eliminates the “step up” in basis on the transfer of property at the death of a taxpayer. This would have a dramatic impact on wealthy Californians and residents of other community property states as the basis step up at death applies to both the decedent’s share and the surviving spouse’s share of community property. There are proposed concessions for small business owners, applied “generationally” – every 21 – 30 years, and create valuation issues for taxpayers at death.
Corporate Tax Rates Would Increase
Under the American Jobs Plan, big changes are proposed for corporations as well. The first of which, just like for individuals, is the adoption of a new tax rate. The new proposal would eliminate the flat tax of 21% put in place by the TCJA and raise it to 28% for all C Corporations for tax years beginning after December 31, 2021.
What’s not being proposed……for now.
There are no plans to modify the estate and gift tax lifetime exemption which is currently at $11.7 million per person. The exemption is indexed for inflation and is slated to revert back to $5.48 million (adjusted for inflation) in 2025.
The Qualified Business Income Deduction (QBI) will remain in place for now. The QBI deduction applies to qualified business income from S corporations, partnerships, sole proprietorships, certain rental activities, and other business income (but does not apply to C corporations). The QBI deduction is 20% of qualified business income from these sources. This may change if the tax rates applied to C corporations is increased. These are just some of the proposed changes and have yet to be made into law. It remains to be seen how many of these will be adopted and in what form.
