Over the course of the last three-plus years there have been a number of significant economic assistance and tax legislation bills passed: Tax Cuts & Jobs Act (TCJA), CARES Act, Consolidated Appropriations Act and, most recently, the American Rescue Plan Act (ARP).
There are more changes likely ahead, as the Biden administration has introduced The Made In America Tax Plan focused on businesses and The American Families Plan focused on individuals. While introducing these plans is only an initial step in the legislative process, it signals the direction in which the president and his administration would like to see tax legislation move toward.
What’s in The Made in America Tax Plan for Corporate Taxpayers?
This plan focuses on corporate income tax reform and includes:
Increasing the corporate tax rate from 21% to 28%.
- The plan eliminates half of the rate reduction offered by the TCJA. Prior to the passage of the TCJA, corporations were subject to tax brackets ranging primarily from 15% to 35%.
Enacting a 15% minimum tax on book income for corporations with book income exceeding $100 million.
- This provision is targeted at large businesses that have “book” income but little or no taxable income. However, the policy does not indicate the method for measuring book income (U.S GAAP, IFRS, etc.). Additionally, the discrepancies between book and taxable income are related to timing of income and/or deduction recognition; therefore, if some type of system similar to the minimum tax credit is not available, companies may effectively end up paying tax on the same item in two different years.
- Assuming the potential for double taxation of timing items is corrected, the corporate minimum tax would have little impact on reportable earnings, since most companies report earnings based on accounting standards that include current and deferred tax provisions based on financial statement income.
Changing or eliminating provisions added by the TCJA related to the U.S. taxation of foreign income.
- These provisions stand to impact global intangible low taxed income (GILTI), foreign derived intangible income (FDII), and the base erosion and anti-abuse tax.
There are a couple other important areas to note as well, such as increasing tax enforcement efforts on corporate taxpayers. In addition, the administration has begun discussions with some of our international trading partners on the implementation of a cohesive global tax regime, aimed at preventing corporations from leaving the U.S. to minimize their global tax burden.
What’s in The American Families Plan for Individual Taxpayers?
While many of the details are unknown at this point, this plan focuses on noncorporate taxpayers. Some of the most discussed tax provisions include:
Increasing the top income tax rate from 37% to 39.6% for income in excess of $400,000.
- For 2020, the top bracket of 37% applies to taxable income over $622,050 for married filing jointly; $311,025 for married filing separately; and $518,400 for single and head of household.
Eliminating the preferential long-term capital gains and qualified dividends tax rate for households with income over $1 million.
- Currently, the maximum capital gains income tax rate is 20% plus a net investment income tax of 3.8% for a combined rate of 23.8%, with some exceptions for gains related to certain types of property. This provision would nearly double the rate on long-term capital gains and qualified dividends for high-income taxpayers by imposing a combined rate of tax of 43.4%. Since qualified dividends are initially taxed at the corporate level, with a proposed corporate rate of 28% corporate income will be subject to an overall rate of tax of approximately 60% by the time those earnings reach the hands of individual shareholders. Currently corporate earnings are subject to a combined corporate/shareholder rate of tax of about 36%.
Eliminating basis step-ups in excess of $1 million ($2 million for a married couple) with some caveats for the sale of a personal residence, donations to charity, and family owned businesses and farms that continue to be run by the decedent’s heirs.
- While changes to the estate tax itself are often discussed, no changes to the estate tax rate or exemption level were outlined in The American Families Plan.
- Although the specifics on the elimination of basis step up have not been outlined in detail, the assumption is that an income tax would be imposed on previously untaxed appreciation at the time of transfer, whether by gift or inheritance. This system would be similar to the “transfer tax” regime currently used in Canada. Note that under the Canadian system, a separate gift/estate tax does not exist. So, retaining those taxes in the U.S. system would make transfers to heirs very costly.
Eliminating like-kind exchanges of real property for gains greater than $500,000.
- Section 1031 exchanges are designed to allow a taxpayer to defer gain if they are exchanging similar property for use in a trade or business or for investment. The TCJA limited the application of Sec. 1031 to real property after 2017. The benefits of this code section would be further diminished under this proposal.
Eliminating carried interest.
- Carried interest or profits interest are used by businesses of all sizes as a way to attract and retain employees and incentivize developers and innovators to assume deal risk. The current proposal discusses eliminated carried interest but does not provide many details. The TCJA added a provision under Section 1061, which increased the long-term capital gain holding period from one year to three years for carried interests in certain types of partnerships. It will be important for businesses to monitor whether this proposal will have a similar focus or take an expanded approach.
Expanding the application of the 3.8% Medicare tax for taxpayers making over $400,000.
- Medicare taxes have received more attention since the passage of the Affordable Care Act and the implementation of the 3.8% tax on investment income, which previously was not subject to Medicare taxes; and the 0.9% additional tax on wages and self-employment income, which was previously subject to a 2.9% Medicare tax. While the proposal does not specify the types of income it will target, it may be safe to assume all income could become subject to a total of 3.8% Medicare tax for taxpayers making over $400,000.
Permanently extending the excess business loss limitation, which would otherwise expire for tax years beginning after December 31, 2026.
- The excess business loss rules limit the amount of business losses for noncorporate taxpayers that may be used to offset other types of income. The amount is limited to $250,000 per taxpayer or $500,000 for a joint return. This rule originally took affect for tax years beginning after December 31, 2017, but was later changed to tax years beginning after December 31, 2020, as part of the CARES Act.
Extending the expanded Child Tax Credit through December 31, 2025, and making the credit fully refundable permanently.
- Under the ARP the credit amount is $3,600 for children under the age of six and $3,000 for children ages six to 17.
Permanently extending the expanded Child and Dependent Care Tax Credit.
- The credit would be up to a 50% reimbursement for the qualifying childcare expenses for children under the age of 13 up to a maximum of $4,000 for one child, and $8,000 for two or more children. The credit would begin phasing out at $125,000 and completely phase out at $400,000.
Increased tax enforcement efforts for taxpayers making over $400,000.
- Current estimates are that increased enforcement targeted at high income taxpayers would yield an additional $80 billion per year in collections over the 10-year budget period. It is unclear how this figure is derived, but for perspective, this would equate to roughly an average understatement of tax liability of 20% per year by this category of taxpayer. In our experience, most IRS audit issues revolve around the timing of the recognition of income or deductions rather than a failure to report income or an overstatement of deductions. Therefore, most increases in tax in early years of the program would be offset by decreases in tax in later years.
Who Will Be Impacted the Most?
To what extent any or all of the provisions in these two plans will find a way into any future tax bills are unclear, but what is clear is that taxpayers should be mindful of the possibility that change on some level is coming.
Small business owners and their employees should be especially mindful. A small business owner whose annual income has historically been under $400,000 but realizes a large capital gain from the sale of their business, a piece of real estate or an appreciated investment in a year in which these provisions apply could see a drastic increase in taxes. In such a scenario, the elimination of the capital gains tax rate and the expansion of the net investment income tax could result in a combined federal tax rate of 43.4% as opposed to 20%.
Business strategy decisions could also be impacted. For example, a small business owner wants to expand its manufacturing capacity by selling its old plant for a $2 million gain with the intention of reinvesting all of the proceeds into a new larger modern plant. That new plant would make the business more profitable, in turn allowing the employer to hire more workers, pay higher wages and better benefits, and ensure the business remains stable and competitive. The elimination of the like-kind exchange provisions and the increased tax on the one-time gain, which could be almost $900,000 approaching half the gain, could reduce capital available for reinvestment and ultimately limit expansion plans.
For now, taxpayers and their professionals should begin considering when these changes would potentially become effective and what their impact may be — as there is talk of making many of the changes effective beginning with the 2021 tax year, even if a bill is not passed until the fall of 2021.
Contact Robert Venables at firstname.lastname@example.org or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.