President Biden has released a description of his American Families Plan, which is designed to provide far-reaching economic benefits to lower and middle-income families. The $1.8 trillion cost would be funded by increasing individual taxes on higher-income taxpayers, including a reinstatement of a 39.6% top rate and elimination of the special capital gains rate. (Biden’s earlier infrastructure bill, the American Jobs Plan, would be funded by corporate tax increases and is still pending.) Elements of the latest proposal include expanded family and medical leave, an extension of tax cuts enacted by the American Rescue Plan, free community college, universal pre-school and reduced-price daycare.
Individual Tax Increases
The White House fact sheet on the plan explains the individual tax increases this way: “The President’s tax agenda will not only reverse the biggest 2017 tax law giveaways but reform the tax code so that the wealthy have to play by the same rules as everyone else.” What exactly does this mean?
Biden says the increases will only fall on those with over $400,000 in income, but the exact effect is hard to gauge.
Specifically, the plan would:
- Give the IRS extra funding to focus its enforcement on large corporations, businesses, estates and individuals with incomes above $400,000.
- Increase the top tax rate from 37% to 39.6% and apply it to those with incomes in the top one percent, which roughly equates to those with income above $450,000.
- End the lower 20% maximum long-term capital gains and dividend tax rates for households making over $1 million. Those taxpayers would have a tax rate on capital income that is the same as the rate on earned income—39.6%.
- End the step-up in basis to fair market value for assets passed through an estate for gains in excess of $1 million ($2 million per couple). Taxpayers would still get the exclusion of gain from the sale of a principal residence of $250,000 for single taxpayers and $500,000 for married couples for residences held at death. Gains would not be taxed if estate property is donated to charity. Also, family-owned businesses and farms will not have to pay taxes if given to heirs who continue to run the business.
- Eliminate the carried interest provision completely so that hedge fund partners will pay ordinary income rates on their income. Currently, carried interests are taxed at the lower capital gains rate if held for three years.
- End like-kind exchanges for real estate gains greater than $500,000.
- Permanently extend the current limitation on excess business losses. The CAREs Act delayed the effective date of the limitation until 2021. For 2021, inflation adjusted limits are $262,000 for single taxpayers and $524,000 for joint filers.
- Impose a 3.8% Medicare tax on those making over $400,000, including on business income from partnerships and S Corporations.
- Require financial institutions to report information on account flows so that earnings from investments and business activity are subject to reporting in the same way wages are.
Family and Medical Leave Extension
The plan would create a national comprehensive paid family and medical leave program that would guarantee twelve weeks of paid parental, family and personal illness/safe leave by year 10 of the program, and also ensure workers get three days of bereavement leave per year starting in year one. The program would provide workers up to $4,000 a month. It appears the plan contemplates the federal government paying for the benefit, but employers would be required to allow the leave.
Extension of Tax Cuts
The American Families Plan also would extend the following tax cuts enacted as part of Biden’s earlier stimulus legislation:
- Child tax credit, with full refundability, through 2025
- Child and dependent care tax credit, permanent extension
- ACA premiums tax credits
- Earned Income Tax Credit, permanent extension
Unemployment Insurance Reform
The plan would automatically adjust the length and amount of unemployment benefits workers receive depending on economic conditions. No other details are available at this time.
Regulating All Tax Preparers
The plan also would give the IRS authority to regulate all paid tax preparers. Currently, CPAs, enrolled agents and attorneys are regulated by state boards, courts and professional organizations and the IRS if they practice before the agency, but unlicensed preparers are not. The IRS attempted to regulate these uncredentialed preparers a few years ago but that effort was struck down by the courts as needing Congressional approval.
Outlook
The Administration and congressional Democrats can use the budget reconciliation process to pass the tax bill without Republican support. Only a simple majority would be needed. Both Republicans and Democrats have used this process to pass legislation in a sharply divided Congress. However, the slim Democratic majority in the Senate requires the Vice President to act as a tiebreaker. Thus, the Administration may need to compromise on some tax provisions to gain the support of some of the more conservative Democratic senators.
Observations
The tax increases in the Biden plan could have some immediate effects. Elimination of the favorable capital gains rate could lead to investors holding onto their assets longer. The same thing could happen with appreciated real estate if the like-kind exchange option that offered tax deferral is eliminated. Higher dividend rates exacerbate the double taxation of corporate income.
With no favorable capital gains rate on carried interests, fund managers’ compensation would likely be adjusted to include more tax-favorable types of income, like deferred compensation. Estate assets would be subject to not only estate tax, but also income tax on the appreciation.
Other tax proposals from the Biden administration include a plan to increase the corporate tax rate from 21% to 28% and a plan to impose the 12.4% social security payroll tax on income earned above $400,000, evenly split between employers and employees. These proposed changes would fund a variety of federal programs, but taxpayers should look at the various changes in their totality to understand the overall tax impact for an individual or an organization.