President Biden recently outlined the American Families Plan extends the tax breaks of the American Rescue Plan for lower- to middle-income taxpayers. If you are making over $400,000 a year, an increase in your taxes along with the closing of some of your loopholes will make this tax break possible.
The Plan is not finalized yet, but we expect that some congressional democrats will want to add their own provisions as well, and it may require adjustment to keep every democratic senator on board. It may also include repeal or modification of some state’s local tax deduction limitation enacted by the Tax Cuts and Jobs Act. Democrats in high-tax states will be pushing for this type of relief.
The passage of proposals is likely not to be approved until August, and it is assumed that the extension of tax breaks for lower- to middle-class will be effective in 2022.
Here are some of the potential changes on the horizon:
An Increase of the Top Individual Tax Rate
The top rate may jump back up to 39.6%, where it was before the Tax Cuts and Jobs Act of 2017. President Biden has said that he would not raise taxes for anyone earning under $400,000. At this point, if you file single and earn over $400,000, you fall into the 37% – 35% tax brackets. Right now, we aren’t sure if a new 39.6% bracket would start at the $400,000 mark. Although we don’t know the effective date of the new provisions, we know that Congress has been hesitant to impose tax increases retroactively. With that knowledge, people earning over $400,000 may want to minimize the impact of their tax increase by considering a plan to accelerate income or arranging for a Roth conversion during the current year.
An Increase Capital Gains Rate
The new plan looks to raise the capital gains rate to 39.6% for high earners, representing a big increase in the current top tax rate of 20% for those earning over $1 million. This would mean that both ordinary income and capital gains would be taxed at the same tier.
If you seek to minimize the impact of this potential change in rate, you may want to look into accelerating capital gains realizations sooner rather than later. As it now stands, the plan will also end capital gains treatment even under the $1 million level for carried interests, which are still eligible for capital gain treatment if a three-year holding period is met. If this provision is enacted, hedge funds and private equity funds may use a deferred compensation strategy.
Ending Stepped-Up Basis for Some
Although President Biden campaigned on lowering the exclusion rate for gifts and estates, the proposed Plan only addresses a reduction in the availability of a stepped-up basis. There is ongoing analysis about how these rates will affect holders of non-liquid assets such as family farms and family-owned businesses. The concept of permitting taxes to be paid over several years is also being discussed. This would help to ease the financial burden for families by avoiding a rapid liquidation. It will, however, require a historical tracking of the basis of assets in the hands of the deceased. It would also likely violate a tax law principle which only imposes taxes on realization events when there are more likely to be funded to pay the taxes.
The End of Like-Kind Exchange Deferral for Gain Over $500K
The Tax Cuts and Jobs Act eliminated like-kind exchanges for personal property but retained it for real property. Now, Biden’s plan will also restrict it to real property. The 1986 act had eliminated deferral of gain on the reinvestment of profit on a principal residence into another principal residence. In effect, this provided a gain exclusion of up to $250,000 for single taxpayers and $500,000 for joint filers. The principal residence exclusion would be retained.
The Medicare Tax
One proposal would expand the 3.8% Medicare tax to pass-through entity owners earning over $400,000. One of the advantages of the S corporation is the ability to limit payroll taxes by differentiating funds between the owner and employees. This proposal would potentially limit that advantage based on the entity’s structure. The American Families Plan does not include eliminating the cap on Social Security taxes, which has also been discussed.
A Limitation on Excess Business Losses
One provision would make permanent the limitation on excess business losses. Under current law, the limitation on excess business losses would expire in 2026.
Tax Breaks for Lower- and Middle-Income Taxpayers
The American Rescue Plan Act provided enhancements to the Child Tax Credit, the Child and Dependent Care Credit, the Earned Income Tax Credit, health insurance tax credits, and the premium tax credits under the Affordable Care Act. They included dollar limits, income limits, and increasing refundability and were only effective for 2021. The new plan promises to extend the Child Tax Credit through 2025 and make the other enhancements permanent.
Funding for the IRS to Audit
The American Families Plan plans to raise revenue by increasing IRS funding by $80 billion to permit the agency to increase its auditing of wealthy taxpayers, estates, and large corporations. Some commentators suggest that the estimated $700 billion in revenue from expanding audits is overly optimistic. Financial institutions would have new reporting requirements to help the IRS track earnings from business and investment activity.
As Dylan sang 57 years ago…
For the wheel’s still in spin
And there’s no tellin’ who
That it’s namin’
For the loser now
Will be later to win
For the times they are a-changin’
–Bob Dylan, “The Times They Are a-Changin”
Remember, if you have questions about any of these tax changes, please reach out to me. I’m here to help you maximize your tax deductions while minimizing your tax pain.