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Changes to Individual Income Taxes: A look at President Biden’s Green Book Proposals

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As the House and Senate are in their last few weeks of legislative session prior to the August recess, it is a good time to look at proposed tax changes that may be enacted in 2021.  President Biden issued the “Green Book”, which included fiscal year 2022 tax and spending proposals, on May 28, 2021.  The President, through the “Green Book”, provided more details on the American Jobs Plan and the American Families Plan which had previously been announced.  The American Jobs Plan focuses primarily on business tax proposals while the American Families Plan (AFP) focuses primarily on individual tax proposals and this article focuses on the details of the AFP outlined in the “Green Book”.

The first area of focus of the AFP is increasing taxation of high-income taxpayers.  The administration plans to accomplish this through three main areas: increase the top marginal income tax rate, reform taxation of capital gains and “rationalize” net investment income and self-employment tax regimes.

The simplest proposal is to increase the top marginal tax rate from 37% to 39.6% in 2022.  This increased rate would apply to taxable income over $509,300 for married filing jointly filers, $452,700 for single filers, $481,000 for head of household filers and $254, 650 for married filing separately filers.  These tax brackets would be indexed for inflation.

The reform of the taxation of capital gains has the most dramatic changes to the taxation of individuals.  The first proposal is to apply the top marginal tax rate to long-term capital gains and qualified dividends for those with taxable income over $1 million. The current tax rates on long-term capital gains and qualified dividends are 0%, 15% and 20% depending on the taxpayer’s filing status and taxable income.  The proposal is to increase the top rate for capital gains to the top tax rate for ordinary income which is 37% currently but is proposed to increase to 39.6% in 2022.  With the current top income tax rate for long-term capital gains at 20% this would potentially almost double the taxation on this income.  For example, if you sold your business in January of 2021 for $10 million of taxable long-term gain, your income tax would be approximately $2 million.  If these tax proposals are implemented and you sell your business for $10 million of taxable long-term gain in January 2022, your income tax would be approximately $3.96 million. Notably, this Green Book proposal included an effective date as of the date of announcement which most agree would be April 28, 2021.  While most commentators do not anticipate Congress would enact legislation with this April 28, 2021 effective date, this change could still have an effective date in 2021, whether that is April 28th or later in the year.

The second significant proposed change to the taxation of capital gains is to tax the unrealized appreciation at time of gift or death.  The donor or deceased owner would realize a taxable capital gain at the time of transfer for the difference between the fair market value (FMV) of the asset transferred and the tax basis of the asset to the donor or the deceased owner.  Exceptions to this tax would include the transfer of assets to a U.S. spouse or a charity and the transfer of tangible personal property excluding collectibles.  The proposal includes a $1 million per person exclusion of recognition of gain, indexed for inflation, in addition to the current personal residence exclusion of $250,000 per person and the qualified small business stock exclusion.  Additionally, the payment of tax on appreciated family-owned and operated businesses would not be due until the interest in the business is sold or the business ceases to be family owned and operated. Finally, the tax due on illiquid assets would allow for a 15 year fixed rate payment plan.  The effective date of this proposal would be January 1, 2022.

The third income tax proposal included in the American Families Plan that could have a significant impact on the taxation on high-income taxpayers is the coordination of the Net Investment Income Tax (NIIT) with the Self-Employment Contribution Act (SECA).  The purpose of the change is to ensure that all pass-through business income of high-income taxpayers is subject to the 3.8% Medicare tax through either NIIT or SECA.  This would be accomplished by changing the definition of gross income subject to NIIT to include any gross income or gain from any trade or business that is not otherwise subject to employment taxes.  Additionally, limited partners and LLC members who provide services and materially participate in their partnerships and LLCs and S corporation owners who materially participate in the trade or business would be subject to SECA tax on their distributive shares of partnership, LLC or S corporation income.  Under this proposal, a high-income taxpayer is defined as one with adjusted gross income above $400,000.  This proposal would also be effective January 1, 2022.

The AFP also includes other provisions to increase income tax revenue such as taxation of carried interests at ordinary income tax rates, curtailing the deferral of gains from like-kind exchanges and making permanent the excess business loss limitation of noncorporate taxpayers.  These proposals would be effective January 1, 2022 and would include the following:

Carried interests – a partner’s share of all income from an “investment services partnership interest” (commonly referred to as a carried or profits interest) in an investment partnership, regardless of the character of income at the partnership level, would be taxed as ordinary income if the partner’s taxable income exceeds $400,000 and such income would be subject to self-employment taxes.

Like-Kind exchanges – the deferral of gain through a like-kind exchange of real property would be limited to $500,000 per taxpayer per year.

Excess business loss limitation – the 461(l) excess business loss limitation of noncorporate taxpayers would be made permanent.  The 461(l) limitation does not allow for a current net business loss to offset more than $262,000 per taxpayer ($524,000 for married filing jointly)(indexed for inflation) of nonbusiness income but instead converts such excess to a net operating loss to be carried forward to the next taxable year.

The American Families Plan is not all tax increases.  The AFP includes proposals to make permanent the expansion of the premium tax credits, the earned income tax credit and the child and dependent care tax credit.  Additionally, the AFP proposes to extend the child tax credit increase through 2025 and make permanent the full refundability.  See our, “What You Should Know About the Child Tax Credit Payments” article here for more information regarding the child tax credit.

The American Families Plan is primarily targeted at income tax changes.  Other proposed legislation has targeted gift and estate taxes.  Though not all of these proposals will be enacted into law as proposed, there does seem to be momentum for changes in individual and gift and estate taxation so we recommend that you contact your tax advisor to discuss how you might prepare for these potential tax law changes.

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