The Green Book That Calls For More Taxes
On April 28, President Joe Biden introduced The American Families Plan which will be implement the largest tax increases we have seen since 1993. The tax increases are slated to pay for the administration’s planed economic security and family initiative. The American Families Plan in its current outline form will provide substantial new spending on childcare, healthcare, paid leave and education.
On June 1, the Treasury Department released additional details of the tax proposals in a report known as the “Green Book.” The Biden administration plans to raise $2.4 trillion in revenue from the proposed tax changes. It also proposes significantly increasing IRS resources and staffing and estimates that over $700 billion of federal revenue would be generated from increased information reporting and increased tax enforcement.
I. Increase of Individual Tax Rates to 39.6%
President Biden proposed increasing the top tax bracket from the 37% to 39.6% which will be a return to the top tax rate in the Obama administration. In 2022, this top marginal tax rate would apply to taxable income over $509,300 for married individuals filing a joint return, and $452,700 for unmarried individuals (other than surviving spouses). As in the current tax regime, the thresholds would be indexed for inflation.
II. Increase the Top Capital Gains Rate to 39.6%
President Biden proposed increasing the top capital gains rate for household’s with income in excess of $1,000,000 to 39.6%. Currently households in the top income bracket of 37% would be subject to a capital gains rate of 20%. As a result, the capital gains rate under The American Families Plan will be tied to taxable income, not an individual’s tax rate as currently. Long-term capital gains and qualified dividends derived by taxpayers with adjusted gross income of more than $1 million would be taxed at ordinary income rates, but only to the extent that the taxpayer's income exceeds $1 million ($500,000 for married filing separately). For example, a client with $850,000 in W-2 wages and $300,000 in dividends would have $150,000 of dividend income taxed at the current preferential tax rate and $150,000 taxed at increased ordinary income tax rates. The proposal would be effective for gains required to be recognized after the date of announcement, interpreted to mean late April 2021.
III. Increase of Corporate Tax Rates to 28% and Other Provisions
President Biden proposed to increase corporate tax from 21% to 28%. The Green Book also called for the implementation of a 15% “minimum tax” on corporations with more than $2 billion of “book income.” The plan also called for imposing an “offshoring penalty” 10% surtax on U.S. company offshore production profits for sales back into the United States (for example applying to call centers serving the United States). Conversely, the plan called for creating a new business credit equal to 10% of certain eligible expenses associated with onshoring jobs and investments into the United States.
IV. Applying the 3.8% Medicare Tax to All Income and Earnings Over $400,000.
The Green Book proposes that all taxpayers with trade or business income over $400,000 will be subject to the 3.8% Medicare tax, either through the Net Investment Income Tax (NIIT) or Self Employed Contributions Act (SECA) tax. The NIIT would apply to all gross income and gains from a trade or business not already subject to SECA tax. Limited partners and LLC members who provide services and materially participate in their partnerships and LLCs would be subject to SECA tax on their distributive shares of partnership or LLC income to the extent that this income exceeds certain threshold amounts. S corporation owners who materially participate in the trade or business would be subject to SECA taxes on their distributive shares of the business’s income to the extent that this income exceeds certain threshold amounts.
V. Limit 1031 Like-Kind Exchange Deferral for Gains Above $500,000
One significant change for real estate investors will be dramatically changing the like-kind exchange rules under section 1031. Currently, as long as an owner of appreciated real property follows the rules of the statute, one can defer all recognized gain, but under the administration’s proposed rules, only the first $500,000 ($1 million for clients filing as married) gain would be deferred. Since the expense of hiring professionals to conduct a 1031 exchange, may be cost prohibitive, this proposal may effectively eviscerate the statute.
VI. Change in International Tax Regime
The Green Book lays out a proposal changing the Global Intangible Low-Taxed Income (GILTI) regime, by essentially increasing the rate to 21% for tax years after December 31, 2021. For tax years after December 31, 2022, the Biden Administration also proposes to replace the Base Erosion Anti Abuse tax with a new one designed to prevent multinational corporations from channeling profits to low-tax jurisdictions. This proposed mechanism is referred to as Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD). The SHIELD proposal would disallow deductions for certain payments made by a domestic corporation, or subsidiary to an affiliate in a low-tax jurisdiction.
VII. Repeal for Step-Up in Basis for Inherited Assets for Large Estates
President Biden proposed to repeal the step-up in basis for inherited assets on gains in excess of $1 million for single filers and $2 million for married filers.
VIII. Increase to the IRS Budget
The Biden administration plans to increase the IRS budget by $80 billion to audit taxpayers with income of $400,000 or more. The administration projects that the additional IRS enforcement will raise $700 billion over 10-years.
PMG Intrinsic clients are counseled that The Green Book is a broader outline of the Biden administration’s goals and is not the actual bill submitted before Congress for a vote. As a result, the contours of the bill may change. For example, Senator Joe Manchin indicated that he would be open to an increase in the corporate tax rate to 25% and not the proposed 28% rate. Additionally, The Green Book is silent on Section 199A and Net Operating Loss carryback treatment. Consequently, PMG Intrinsic believes that it is prudent for clients to plan around a tax landscape with increased taxes, but if the landscaping is merely Spring-cleaning or a complete tear-down will be determined shortly by Washington.