- U.S. President Joe Biden in his address to a joint session of Congress on April 28, 2021, unveiled the American Families Plan, which focuses on "human infrastructure" and is the third part of his Build Back Better initiative.
- The $1.8 trillion American Families Plan is composed of $1 trillion in spending and $800 billion in tax cuts and credits for moderate/lower income families.
- The spending in the American Families Plan is partially offset by income tax increases for wealthy Americans, an increased IRS budget for compliance, and notably does not include any of the estate and gift tax changes proposed during the campaign (other than the associated elimination of step up in basis).
- The legislative pathway for enactment and effective dates are yet undetermined.
The American Families Plan is the third part of the Biden Administration's Build Back Better agenda, addressing "human infrastructure" and containing proposals on free education, direct support to children and families, and the extension of tax cuts for families with children and American workers. It was introduced by President Joe Biden in his address to a joint session of Congress on April 28, 2021.1
The infrastructure portions of the Build Back Better plan amount to approximately $4.1 trillion - $2.3 trillion under the American Jobs Plan and $1.8 trillion and the American Families Plan - and are among the most ambitious government agendas in decades.
Income Tax Increases on the Wealthy
The Biden Administration proposes to increase income taxes on the wealthy and provide more resources to the IRS to enhance compliance. The headline increases relate to taxing capital gains and qualified dividends at the top ordinary income tax rates and the elimination of the "step up" in basis rule.
- Increase Top Income Tax Rate. The rate would be increased to 39.6 percent (from 37 percent) for taxpayers within the top 1 percent.2 Note, the 39.6 percent rate was the top rate in effect prior to the Tax Cuts and Jobs Act of 2017 (TCJA).
- Subject Long-Term Capital Gains and Qualified Dividend to Ordinarily Income Tax Rates. The rate applicable to long-term capital gains and qualified dividends would be increased to 39.6 percent for households earning more than $1 million. A long-term capital gain derives from assets that are held longer than a year. A "qualified dividend" is an ordinary dividend that meets specific criteria to be taxed at the current law lower capital gains rate rather than at the higher individual ordinary income tax rate.
- Eliminate the Step Up in Basis. Generally under current law, the income tax basis of property acquired from, or passing from, a decedent is its fair market value at the decedent's death rather than its original cost to the decedent. The benefit of this rule is that the economic gain of property that appreciated prior to death will not be subject to federal income tax upon a disposition by a heir. Under the proposal, the appreciation prior to death would become taxable upon a subsequent disposition by a heir. Significantly, legislation would be designed with protections that would exclude family-owned businesses and farms if the decedent's heirs continue to run the business.
- Eliminate the Carried Interest Rule. Income associated with "carried interests" would be taxable at the ordinary income tax rate rather than the current law preferential capital gains rate (20 percent). A "carried interest" is a contractual right that entitles a fund manager to a share of a partnership's profits and under current law is taxable at the preferential capital gains rate, provided certain conditions are satisfied.
- Eliminate "Like Kind" Exchanges for Gains in Excess of $500,000. A "like kind" exchange transaction is a swap of one real estate business or investment property for another that enables deferral of capital gains taxation. The proposal would eliminate that deferral for gains in excess of $500,000.
- Permanently Extend Current Limitation that Restricts Large Excess Business Losses. This provision restricts the current deductibility of "excess business losses." Under current law, noncorporate taxpayers (to include "pass-through" entities such as partnerships, limited liability companies (LLCs), and "S" corporations) are subject to a limitation for "excess business losses." An excess business loss is the amount by which the total deductions attributable to all of a taxpayer's trades or businesses exceed total gross income and gains attributable to those trades or businesses plus $250,000 (or $500,000 in the case of a joint return). The Coronavirus Aid, Relief and Economic Security Act (CARES Act) had removed the excess business loss limitation for 2018, 2019 and 2020. However, beginning in 2020, the limitation returned and now is in effect.
- Apply the 3.8 percent "Medicare" Tax to Taxpayers Making More Than $400,000. Under current law, the Medicare tax is a 3.8 percent tax imposed only on a portion of a taxpayer's income. The tax is paid on the lesser of 1) the taxpayer's net investment income or 2) the amount the taxpayer's adjusted gross income exceeds the application of the adjusted gross income threshold ($200,000 for single taxpayers and $250,000 for married taxpayers). Under the proposal, the threshold for application of the 3.8 percent Medicare tax would be limited to taxpayers making more than $400,000.
- Regulate Income Tax Preparers. The administration will ask for legal authority for the IRS to regulate tax return preparers and enact stricter penalties for unscrupulous preparers.
- Increase IRS Enforcement Budget. The administration will ask for about $80 billion over 10 years to overhaul the tax administration and provide the IRS the resources and information it needs to investigate large corporations, partnerships and high-net-worth individuals. American households with less than $400,000 in annual income will not be targeted, according to the administration.
- Additional Reporting by Financial Institutions. The administration will ask for enhanced reporting by financial institutions, which would require reporting on balances and account flows.
What Was Not Included
The Biden Administration did not include any of the estate and gift tax changes that were proposed during the campaign. These proposals included a reduction of a taxpayer's unified exemption from estate and gift taxes from the current $11.7 million (inflation-adjusted) amount to as low as $3.5 million, as well as an increase of the estate and gift tax rate from the current 40 percent rate to 45 percent. While these changes to the estate and gift tax system are not included in the American Families Plan, the proposed elimination of the step up in basis for income tax purposes would have a significant impact on the estate and tax planning of wealthy families. Further, the absence of any proposed changes to the estate and gift tax system currently does not mean that such changes will not be proposed at a later date. There continues to be a strong interest among many leading Democrats to expand the estate and gift tax as a means to target inherited wealth.
The Way Forward
As noted in prior alerts, there are two ways to pass tax legislation through Congress.3 First, through "regular order," which requires bipartisanship; viz., a majority vote in the House and 60 votes in the Senate (to avoid the filibuster). Second, through the budget reconciliation process, which only requires passage through a simple majority vote in the house and Senate (and bypasses the filibuster in the Senate).
In a consequential ruling in April of this year, the Senate parliamentarian advised that the Senate budget rules would allow the use of the budget reconciliation process more than once in a fiscal year.4 The April 5 ruling creates additional opportunities for the Democrats to approve a bill without GOP support before the 2022 elections. 5 (See previous Holland & Knight alerts, "Biden Administration's Made in America Tax Plan: Procedural Aspects," April 28, 2021; "Biden Administration's Made in America Tax Plan: Interaction with OECD Inclusive Framework," April 15, 2021.)
There are myriad possibilities for passage of the American Families Plan, some of which are linked to the American Jobs Plan and some of which are not so linked. The possibilities include:
- A bipartisan agreement with Republicans on the America Jobs Plan or a smaller plan, as proposed by the GOP (and potentially without corporate tax increases that the GOP do not favor)?
- If not, then the legislative pathway for the American Family Plan would be through the budget reconciliation process; in that case, would there be one bill or more than one bill?
In terms of the effective date of any individual tax legislation enacted as part of the American Families Act, that also is uncertain at this time. Although it appears that prospectivity is preferred, the legislation could be effective as of the date of introduction, enactment, or in 2022, depending on the circumstances. It is important to closely monitored this item as the legislation wends its way through Congress.
- The tax increase proposals used to pay for the American Families Plan were presaged by then-candidate Joe Biden during the presidential campaign.
- Of the income tax changes, the near doubling of the capital gains rate for wealthy individuals will be one of the most controversial proposals - essentially equating the taxation of income from wealth with that of work. Further, for those taxpayers subject to the "Medicare Tax," the addition of the 3.8 percent tax increases the federal rate of tax to 43.8 percent compared to 23.8 percent under current law.
- The potential elimination of the step-up in basis at death is a big ticket item. Not only would the appreciation of assets prior to death become taxable in the hands of a deceased taxpayer's heirs, but, depending on the circumstances, the rate of tax could be significantly increased if the top rate for capital gains is increased to 39.6 percent
- All the proposals are silent with respect to effective dates.
- The increased focus on and funding of compliance is intended to make the wealthy pay what they owe and is anticipated to be a significant revenue generator.
- Finally, although not discussed herein, the $800 billion in changes to enhance tax credits should have a significant impact on working class families.
1. Build Back Better is President Biden's three-part agenda to rescue, recover and rebuild the country. It includes three plans: the American Rescue Plan, the $1.9 trillion economic stimulus bill passed by Congress and signed into law by President Biden on March 11, 2021; the American Jobs Plan, which proposes to increase investment in infrastructure, the production of clean energy, the care economy and other priorities; and the Made in America Tax Plan, which is the vehicle to pay for the American Jobs Plan. The Biden Administration proposes to fund the American Jobs Plan through increasing the corporate tax rate from 21 percent to 28 percent, adding a 15 percent corporate tax on book income, modifying various international tax provisions and making other changes.
2. It is not entirely clear whether that refers to taxpayers earning less than or more than $400,000.
3. A potential third route would be for the Democrats to override the filibuster, which is a tactic of parliamentary procedure employed in the Senate to delay or entirely prevent debate or vote on a specific proposal. At this time, there does not appear to be an appetite to override this rule.
4. Technically, the Senate parliamentarian advised that pursuant to Section 304 of the Congressional Budget Act of 1974, budget resolutions can be revised if updated prior to the end of the fiscal year that they cover. The Democrats could go back and amend the resolution for FY 2021 and include instructions for another reconciliation bill.
5. To reopen the FY 2021 budget, both houses of Congress would need to pass an amended budget with revised tax and spending targets. The process would require debate time on the floor of the Senate, taking up to 40 hours, followed by numerous votes on amendments that could last into the early morning (the so-called "vote-a-rama").
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