Update
Please note, many of the proposals in this blog have changed in the updated and proposed Build Back Better Act passed by the House of Representatives on November 19, 2021. You can read the updated proposals in our new blog article here.
We caution taxpayers from acting solely in response to the House Build Back Better Act, understanding the Senate may kill this legislation or may change the bill significantly from the House version. Please contact your trusted advisor at Reese Henry to discuss any tax planning questions you have that may be impacted by these proposals.
Although there is significant uncertainty on which proposals will be enacted into law, it is expected that President Biden’s infrastructure plan will bring a variety of changes to the nation’s tax policies. Below is a summary of some of the key proposals to the tax law and potential planning strategies for consideration.
CHANGE IN TAX RATES
CURRENT LAW
The maximum tax rate on ordinary income for individuals and trusts is 37% while the top rate for long-term capital gain and qualified dividend income is 20% (plus 3.8% net investment income tax).
The federal corporate tax rate was reduced to 21% (from 35%) under the Tax Cut and Jobs Act in 2018.
PROPOSED CHANGES
The Biden administration wants to raise the maximum individual income tax rate to 39.6% for individuals making more than $400,000 per year. Additionally, President Biden’s tax plan is proposing to effectively double the capital gains tax rate on those making more than $1 million (plus any applicable net investment income tax at 3.8%) to 39.6%.
In addition, Biden’s plan would increase the corporate tax rate to 28% as well as integrate a 15% minimum tax on book income for companies with revenue over $2 billion in net income.
PLANNING CONSIDERATIONS
Consider accelerating income (both ordinary and capital) into 2021.
Consider Roth IRA conversions.
Be thoughtful with respect to “asset location” by placing tax inefficient assets in tax-deferred or non-taxable accounts.
TAXATION ON APPRECIATION OF TRAnSFERRED ASSETS
CURRENT LAW
The cost basis of assets included in a taxpayer’s estate are “stepped-up” to their fair market value as of the date of death, which allows heirs to reduce (or eliminate) capital gain upon the ultimate disposition of those assets.
PROPOSED CHANGES
Capital gain on unrealized appreciation (in excess of $1 million per person), would be realized upon transfer of appreciated assets at death or by gift, including transfers to irrevocable trusts. Moreover, gains on unrealized appreciation would be recognized by a trust, partnership, or other non-corporate entity if that property has not been the subject of a recognition event within the prior 90 years. Finally, the proposal indicates that gains at death could be payable over 15 years (unless the gain is generated from liquid assets).
PLANNING CONSIDERATIONS
Review your current estate plan and carefully analyze the impact of the current basis step-up rules and how their potential elimination would affect your overall estate tax liability.
If it looks likely that the basis step-up rules will be eliminated, consider gifting to flexible trusts to remove future growth from your taxable estate.
Review existing trust documents to ensure they incorporate flexibility to substitute assets in and out of the trust depending on what is beneficial from an income tax standpoint.
OTHER POTENTIAL CHANGES
ITEMIZED DEDUCTIONS
Taxpayers are eligible to itemize their deductions in lieu of the standard deduction. This is favorable when taxpayers incur large medical bills, pay significant mortgage interest expense on eligible loans, pay personal or real estate property taxes (up to $10,000 max), or make donations to charity. For the 2021 tax year, the standard deduction is slotted to be $12,550 for singles ($12,400 for 2020), $18,800 for heads of household ($18,650 for 2020) and $25,100 for married filing jointly taxpayers ($24,800 for 2020). The standard deduction was raised dramatically under the TCJA.
Biden’s proposal includes introducing a cap on itemized deductions at 28%, as well as ending the $10,000 cap on state and local income taxes paid allowed as a deduction.
LIMITING THE QUALIFIED BUSINESS INCOME DEDUCTION
Under the TCJA, taxpayers can generally deduct 20% of their qualified business income from a partnership, S corporation, or sole proprietorship (also know as the 199A deduction). Biden’s tax plan intends to only allow this deduction to taxpayers that make under $400,000 per year.
LIMITING 1031 EXCHANGES
The Biden administration is proposing to eliminate the ability to defer capital gain tax on real estate exchanges for gains above $500,000.
CHILD INCENTIVES
Currently, taxpayers are eligible to claim a $2,000 credit for each qualifying child under 17 and $500 for each nonqualifying child or dependent, phased out in higher income tax brackets. Biden’s tax plan would raise the Child Tax Credit for one year to $3,000 per child between the ages of 6 and 17, and $3,600 for children under the age of 6, as well as make the credit fully refundable.
Additionally, the tax plan includes a one-year expansion of the Dependent Care Tax credit, increasing the credit from 35% to 50% on eligible spending now up to $8,000 (for one child) or $16,000 (for two or more children) from the historical $1,500 and $3,000 of eligible spending, respectively.
CLOSING
With a thin majority in the Senate, enacting major reform would likely require complete unity from the Democrats. Historically, policies detailed in the Green Book rarely become law as proposed and we expect all of these proposals to be subject to significant debate over the next few months.
Please contact your trusted advisor at Reese Henry to discuss any tax planning questions you have that may be impacted by these proposals.