What could a change in administration and a shift in Senate majority mean for taxes? Frazier & Deeter tax experts LeighAnn Costley and Bryce Nations discuss potential tax changes by the Biden administration.
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Untangling the Technical: Biden’s Tax Plan: What to Expect
This transcript was assembled by hand and may contain some errors.
It has been edited for readability.
Adelle Starr Hello everyone. Welcome to Untangling the Technical, Frazier & Deeter’s podcast in which we take a look at complex topics to break them down for people navigating today’s ever-changing business environment.
This is Adelle Starr. Today, we’re excited to have two of our tax partners here to take a look at the possible tax implications of a Biden administration. Both of our guests provide tax advice for closely held businesses, corporate executives and other high net worth individuals.
First, let me welcome LeighAnn Costley to the podcast.
LeighAnn is one of the leaders of Frazier & Deeter’s high net worth and closely held business tax practices. She has degrees from the University of Michigan and Walsh College, and she was named one of Atlanta’s Women Who Mean Business in 2019.
LeighAnn, welcome to the podcast.
LeighAnn Costley Thanks, Adelle. Happy to be here.
Adelle Excellent. We also have with us Bryce Nations.
Bryce is one of the leaders of Frazier & Deeter’s Real Estate and Closely Held Business Tax practices. He has degrees from the University of Mississippi, Kennesaw State University and Georgia State University.
Bryce, welcome to the podcast.
Bryce Nations Thanks for having me.
Adelle Well, today we want to talk about some of the possible tax changes that lie ahead under the Biden administration. Given the shift in the majority in the Senate, it seems likely that there indeed will be changes ahead.
So why don’t we start off with just some general discussion of the timing of changes? What are we looking at in terms of seeing anything actually take effect?
LeighAnn That’s a really interesting question, Adelle, I’ve given a couple talks on this particular topic, but it was either before the original election in November or before the runoff election in January, so we didn’t really know what the situation was going to be. Now we do know that the Democrats are going to control both houses of Congress and the presidency.
What I have said on multiple occasions is when Trump took office in 2017, he also had control. The Republicans had control of the House and the Senate. At that time, a tax cut was his highest priority. They hit the ground running with a potential tax cut in January and they didn’t get it passed until December. It took them nearly a full year in a wholly Republican controlled environment to do that tax cut. So, I think we can look at that as sort of a standard for what a Biden administration has to look at from a timing standpoint.
That being said, I don’t think raising taxes is Joe Biden’s highest priority. There’s obviously much more going on in the world. We’ve got a pandemic, we’ve got vaccine distribution.
Biden has talked a lot about infrastructure, he’s talked a lot about climate change. Do I think there’s going to be some tax changes? Yes, I do. And we’ll get into what those might be here in a little bit.
But, I don’t think we can look at something taking place in twenty, or at least not before the very end of 2020 such that they would be effective for 2021 or 2022.
I think it’s much more likely that a tax law change is going to get pushed into 2022 before those mid-term elections next November with a potential change in control. They would be effective either in the latter half of 2022 at the earliest or 2023 if something were to happen. That is what I’ve been reading and seeing, and from historic precedent of other tax law changes, things could likely happen. Bryce, what do you think?
Bryce Yeah, I would generally agree with that. In my mind, the logic to what would most likely happen would be the first priority would be some sort of pandemic stimulus bill, which would probably get passed in the spring or February – March timeframe.
Second, I think what we’re likely to see is probably more along the lines of administrative rulings coming out of both the Treasury and the IRS, either clarifying or possibly changing some prior guidance on some of the 2017 Trump tax changes and maybe giving them a little more of a Democrat flavor, if you will.
But I would agree with you, to push through major tax reform, I think the overall consensus seems to be the earliest they probably start to talk about that would be towards the end of end of this year, the end of 2021, and then try to make it effective the earliest 1/1/2022. It could happen sooner, but I think there’s just such a tight control of Congress by the Democrats right now that it just makes it difficult to kind of rush through a big full tax package like that, especially given the fact that we’ve got still a recovering economy.
Now, maybe we get one or two tax provisions throughout the year that get tacked on to some of these other bills. I think that’s a possibility, but it’s hard to say which ones might garner enough attention to actually get passed.
The other big question that I’ve kind of had from clients is, if there’s any chance that this stuff is retroactive? So maybe they do wait until the end of the year to pass it and what’s the risk of them making it retroactive? Back to when? I think the answer to that is that is not likely.
I think history will show that there’s been very few tax bills that have actually been made retroactive, although there have been probably two or three in the last 30 years that have been. Usually what happens is Congress gives a heads up on those and as they’re debating them for several months, it’s written into those bills or those laws that they would, in fact, be retroactive. People know already if you’re planning on trying to sell a bunch of stock or property at the end of the year, not to even bother because it would be a retroactive rule.
LeighAnn You made a couple of good points that I want to elaborate on as well. I think you’re right – we could absolutely get some tax provisions linked with other legislations.
The last major tax bill that occurred was a corporate and individual bill. I think what might happen is they would bifurcate those two types of taxes and quite possibly raise the corporate rate, say, in conjunction with the funding of an infrastructure bill. That might be something that would get passed pretty easily by this Congress, because we’ve been talking about infrastructure for years and nothing has happened. Raising the corporate rate from 21% where it stands now back up to 28 or something around there as a mechanism for funding infrastructure is something I think that could likely happen.
The other point you made, which I think is really important, is around retroactivity. I got asked that question several times, and I agree with you, it’s highly unlikely for anything to be retroactive. Someone actually told me at one of the presentations I gave, an attorney so I have to take that they know what they’re talking about, that it is not allowed under the statute for a capital gains rate change to be retroactive because people make transactional decisions around asset sales based on the law, on the data that they make that sale.
There have been estate tax changes that were retroactive and only once in my career – and I’m enough older than Bryce to maybe have this one leg up on him. There was a year, I think it was 1997 where there were two capital gains rates. Sales up until like May 5th or August 5th – I don’t remember what the date was – there was one rate, and there was a different rate for the sales after that date and that’s because the law change was signed on that particular day. It wasn’t retroactive to the beginning of the year, but rather than taking effect the beginning of the next tax year, it took effect the day the law was signed. So, that is a possibility. But I think it’s much more likely that any future rate changes will take effect 2022 at the earliest or sometime in 2023.
Adelle Okay, so we’re looking at something that’s a bit down the road, and it’s hard to say what might get folded into some piece of legislation along the way. But you already mentioned one of the things that I’ve heard talked about, which is the corporate rate moving from 21% to 28%. What are some of the real headline news things that are under discussion that we could already talk about?
Bryce Well, I think when you look at business tax changes, especially, I think the overall theme is that taxes are going up. I mean, that’s just how it’s going to be. The question is when and by how much.
I think the thing that’s on the table right now is to raise that corporate rate back up. I think politically, it’ll probably be pretty easy for them to do. Most of the talk right now is to raise that rate back up from 21% to 28%. So, it’s not going to go all the way back up to what it was before the tax cuts, but it’s still going to be elevated from where it is now.
Another thing that’s also been in the media a fair amount has been imposing some type of minimum tax on corporations with one hundred million or greater in income. And this is kind of like a book income tax. They’d like it to be a flat rate, like a 15%. This is really to kind of go after all those media stories that you hear about that the Amazons or the Apples that don’t, “pay their fair share of tax”. And so this is a way to kind of get around some of the tax magic, if you will, on the tax returns that that helps to maybe artificially deflate their tax liabilities, although most of those differences are timing differences. But this would still, at least according to the Democrats, make those high income and high revenue corporations pay something, so that’s on the table.
The big one, which we’ve already sort of alluded to is, is the capital gains. For the most part, there seems to be universal support across the Democrats to raise the capital gains rates up to ordinary income rates. With the logic being, wealthier taxpayers are able to take advantage of capital gains tax rates and in effect, pay a lower tax rate than what an ordinary worker might pay on their income.
I think that’s going to be fairly popular. I think the mechanics of that, though, are going to be more difficult to actually implement. We’ll have to see what that actually looks like.
There’s also talk along the lines of raising the capital gains rates to actually converting capital gains to some type of unrealized mark to market tax, where at the end of the year you would mark all of your assets, your stocks or bonds, your real estate to market to fair market value, and you pay the tax on the difference. That would be a major change in our tax system, because that’s there’s nothing else that really works that way right now unless you’re like a day trader.
I think that could affect a lot of businesses, especially the real estate industry. Obviously, that’s meant to target Wall Street, to target hedge funds, things like that. Those are the guys that are kind of in the crosshairs right now but I think there’s going to be some fallout into some other folks in other industries as well.
LeighAnn That approach to taxation is akin to the old intangibles tax that a lot of states imposed, you know, a couple of decades ago, around every year filing an intangible tax return that showed the value of your stocks and bonds, especially from states that didn’t assess income tax.
It also is a little bit of a flavor and a nod to what we would call the far-left portion of the Democratic Party, the Elizabeth Warrens and the Bernie Sanders of the world who want to impose a wealth tax on the upper 1%, which is all about asset value and less about transactional nature of income tax.
It will be interesting to see whether this raising capital gains rates that’s been proposed, what shape that takes, in what form. So, it will be what we faced at the end will be, what, we just abolish capital gains rates and grade them with the normal marginal rates? Because obviously now we have three different buckets or four different buckets of capital gains rates, depending on which marginal tax rate you fall into. Will that just align then with your marginal rates? Or will there still be a 0% capital gains rate for those sort of lower marginal rate people? Or are we just going to get rid of the 20% and go up to 39 or 37 or wherever the upper tax bracket ends up?
Bryce Right, and if you’re bouncing in between the income ranges, where this applies with them doesn’t apply in another year, how are you tracking your assets, your fair market value? There’s a lot of unanswered questions along those lines.
There’s also been talk of getting rid of Section 1031. That’s the tax code section that allows you to swap property, with the idea being if you’re economically in the same spot that you were. So if you sell a piece of real estate, for example, as long as you buy another piece of real estate that has that same value, you can ultimately defer the gain that you generated on that first piece of property. The logic being you don’t really have the wherewithal to pay that tax because you didn’t get any cash – you reinvested all of that cash into the new piece of property. So, that code section there has been talk of abolishing that, which would have a major effect in the real estate industry.
And then just to wrap up on the business side, there’s several mentions of some international tax hikes, like trying to increase the GILTI tax from some 10 and a half percent to 21% and an offshoring penalty of roughly 10%. So that’s basically if you could manufacture in the US, but you don’t, you manufacture outside the US but then you sell back to the US there could be a penalty on your company of up to 10%.
I think outside of that, there’s a couple other rumors that are out there, I don’t know if they’re worth mentioning. There was one trying to raise all tax rates, especially individual marginal rates, up to 59%. I think that was that extreme group of the Democrats, as LeighAnn mentioned. I don’t know how much traction they could get with a 59% tax rate, but you never know.
LeighAnn Biden’s proposal has just been to reinstate the 39.6%, so I don’t think that’s going to get very far.
Bryce I’ve also seen where a financial transaction tax has also been mentioned above a certain value of assets, an extra half a percent is added on to each stock sale or something like that as a transaction tax. So those are some of the hot issues right now in business tax and potential changes.
So, yeah, there’s a lot on the table right now and a lot of moving pieces. We’ll just have to wait and see.
Adelle So, LeighAnn, what are some of the things that are getting batted around as far as individual tax changes?
LeighAnn Well, we’ve mentioned one of them in terms of raising the highest rate from the current 37% back to what it was prior to the Trump tax cuts, to 39.6, actually. Joe Biden has said repeatedly on the campaign trail that taxes are not going to increase for people who make less than $400,000. So, by just taking the top rate and raising it, that would certainly fulfill that campaign promise.
Some of the other aspects from an individual standpoint are to reinstate the what we call the Pease limitation, which is a haircut on the itemized deductions that are allowable to individuals who itemized deductions on their tax return. It’s a phased in pro-rata calculation. But it’s basically if you make over a certain amount of money, you look at all of your itemized deductions, take 80% of them and then take 3% off of that, that’s the general way it works. Again, that would only affect people who make a certain amount of money. They would raise that Pease limitation threshold to $400,000 so that it only impacts those individuals.
The one that I think it would be interesting to see if it takes hold is a cap on itemized deductions. Currently, you know, if you itemized deductions, if you have more deductions than the standard deduction amount, you deduct those at whatever your marginal rate is. So, if you’re in the 33% bracket, you get the benefit of a deduction against your 33% income. If you’re in the 37% bracket, you get that deduction. It’s at that rate.
The proposal is to cap itemized deductions for anyone earning over four hundred thousand dollars at 28%, regardless of which bracket you’re in. If they raise the upper rate to 39.6, and you make five million dollars and you have a million dollars of deductions because of your very charitable nature, and you only get $280,000 of tax benefit from that million-dollar deduction when you are paying 39.6% on the income that you earn. That’s a big disconnect between the income tax you’re paying and the benefit of the deductions that you are claiming. So that one will be an interesting one to watch.
Adelle Okay, what about estate taxes? What do we think will happen in that area?
LeighAnn So that’s also an interesting one to watch, and it kind of circles back to our discussion earlier about intangibles tax and wealth tax and value tax. The current estate exemption or lifetime exemption that you have available to you is sitting at 11.7 million dollars per person, it gets indexed for inflation each year. It just went up at the beginning of 2021 and it used to be five million dollars until the Trump tax law change, when it doubled and was indexed for inflation for the time being.
So, what that means is every individual can give away, either during lifetime or death, 11.7 million dollars of value if they die in 2021. The current highest tax rate for estate purposes is 40%. What the Biden campaign has said is that they are going to reverse the current estate tax structure to 2009 levels, which would allow an exemption of only 3.5 million dollars per person and take the rate up to 45% as the highest rate. That’s a big loss of value.
When you die, your assets are valued at the fair market value on the date of death. Currently when you die, your heirs get what’s called a step up in basis. So, if you have one hundred shares of Coca-Cola in your estate and you bought it at $5 a share and it’s currently worth one hundred and fifty dollars a share, your estate reports the value at $150 a share pays tax on that amount or that amount is subject to your annual your lifetime exclusion.
But then your heir takes that asset, those hundred shares of Coca-Cola stock and holds them at $150 a share. So, if they turn around and sell them the next day at $151 a share, they only report a dollar gain on each share as opposed to $146 of gain between in terms of the basis that you had when you purchased it.
They’re talking about eliminating that step up. And it’s a little bit unclear because if you eliminate the step up from an estate tax purpose, are you saying then that your heir takes that five dollar basis in your Coca-Cola stock, which could be a huge administrative tracking nightmare depending on the asset. Especially if it’s real estate or something not tradable on the New York Stock Exchange or the Nasdaq. And also, are you just kicking the can down the road in terms of what the tax impact of holding that asset is? Or, are you eliminating the step up and making the heir pay a capital gains rate as opposed to the estate paying an estate tax on the value? It’s really sort of muddy in what I have read about how that might be treated.
Bryce, have you seen anything on that?
Bryce I’ve seen some on it. I’ve also seen where they are going to allow for certain levels of exemption. So like, in the past, when you died and you had a family home, like you could exempt up to two million dollars in value of that home, then anything above that would fall into this formula. Same thing for a farm – I feel like I heard five million dollars for a farm tossed around. I think there are there are some exceptions there so it’s not just going to be a flat tax rate. It’s going to be a huge effect and an absolute nightmare to track if you have to carryover that basis.
LeighAnn What’s always so interesting to me about the estate tax discussion is that there is a large percentage of members of Congress who would be the percentage of individuals who might be subject to the estate tax, which is admittedly a very small percentage of taxpayers in the United States.
And so, the discussion is always a little bit self-serving, I guess is the right word, is self-interested in terms of what they decide to do, because so many members of Congress fall into the upper high net worth taxpayer profile.
Adelle Well, that’s fascinating. I heard about that step up in basis, but I didn’t really understand what it meant and what a complete nightmare it might be to try to figure out the original value of an asset.
Well, before we close, are there any other topics or parting thoughts that either of you wanted to share with our audience?
Bryce I mean, I would just say overall I think it’s going be a lot of tax changes over the next 12 to 24 months. I think the primary focus will be, as LeighAnn said, for incomes at $400,000 or above. That seems to be kind of the threshold of what the Biden Administration seems to be trying to target. I think other than that we’ll just have to see how the rest of the year goes.
I think if the economy starts to kind of come back, I think if the if the vaccine kind of takes hold, I think you’re going to see a possibility of a bunch of this stuff happening towards the end of this year, especially when they start to do the year end fiscal budget for the government. I think that’s when a lot of this will pop up in terms of how do we pay for stuff.
LeighAnn The only other thing I would add to that is that I also think because of this razor thin margin in Congress, I think you’re going to see a lot of things done much more quickly than they have been done in the past because the Biden administration doesn’t have four years. They have 18 months before the midterm election campaigning really when the Congress goes out to hit the pavement again to get reelected. There’s going to be a lot that the administration wants to accomplish before the 2022 elections. I think you’re going to see a lot of things in process, that’ll be interesting to watch as well.
Adelle Bryce, LeighAnn, thank you both for taking the time to be on the podcast today. And for our listeners, please subscribe to our podcast so you don’t miss the next edition of Untangling the Technical.