Much has changed in Washington, D.C. in 2021. And there is talk of more change. The Biden administration recently released its “Green Book” of revenue proposals to fund the budget. This is just one step in the legislative process – an early step in a process that includes compromises. And while the Green Book proposals are a long way from law, they provide visibility into the administration’s potential plans related to tax law changes, which include focusing on raising revenue, improving tax administration, and, in the words of the text, making “the tax system more equitable and efficient.”
Of course, what is equitable and efficient when it comes to taxes depends on one’s perspective. A recent Wall Street Journal article discusses some of the varying viewpoints. In any event, as we emerge from a global health and employment crisis that has drained government coffers, we expect tax increases. We don’t know when or how much, but expect more taxes soon. The sky is not falling, but it’s getting cloudy.
There are a number of provisions in the Green Book proposals of particular interest to our clients. Following are a few of the highlights.
- Increase in the Corporate Income Tax Rate. One of the most significant changes under the Tax Cuts and Jobs Act (TCJA) of 2017 was the reduction of the corporate income tax rate for C-corporations from 35% to 21%. The current proposal would increase the rate to 28%, effective for taxable years beginning after December 31, 2021. We expect the final rate to be a point of compromise in the tax negation process.
- Increase in Top Marginal Rate for High-Income Taxpayers. The TCJA temporarily reduced the marginal ordinary income tax rate from 39.6% to 37%. Under current law, the rate is scheduled to revert at the end of 2025. The current proposal would accelerate the reversion to 2022, three years earlier than scheduled, which would be a relatively simple change to implement.
- Increase in the Capital Gain and Qualified Dividend Income Tax Rate. Ordinary income tax rates have long exceeded rates on long-term capital gain and qualified dividends, with disparate tax burdens on investment income and earned income. For taxpayers with adjusted gross income in excess of $1,000,000, the proposal would tax capital gains and qualified dividends at ordinary income tax rates, but only to the extent that a taxpayer’s income exceeds $1 million ($500,000 for married filing separately). In order to avoid a rush to sell, the proposal would be effective “after the date of announcement.” This is quite vague, to say the least, and ambiguity related to taxes reduces taxpayer confidence. Whether the effective date is considered to be the date of the President’s April 28 address or the May 28 release of the Green Book, it is behind us now.
- Taxing Gifts and Transfers at Death as Gain Recognition Events. We are accustomed to transfers by gift and at death being subject to gift and estate tax, but not to capital gains tax. The proposal would change this, and adopt a system similar to the “Gains on Disposition” regime our Canadian neighbors adopted 50 years ago. This would be a material change in the tax paradigm we are familiar with. The proposed gain recognition on transfers provision is one of the more complicated provisions and would require further regulations and guidance to implement. But recall, many provisions of the TCJA also required additional regulations and guidance to implement.
- The proposal includes gain recognition on certain transfers to and distributions of assets from some trusts, partnerships, and non-corporate entities and deemed recognition of otherwise unrealized gains every 90 years.
- There would be exclusions and deferrals in the case of transfers to spouse or charity and for transfers of certain types of property – tangible personal property (other than collections), principal residences, certain family owned and operated businesses, and small business stock. The proposal provides for a 15-year installment payment period for taxes on illiquid assets.
- There would also be a $1,000,000 exclusion, with portability, allowing a $2,000,000 exclusion for married couples.
- The gain on transfer provision would be effective at the earliest for transfers after December 31, 2021, so there is time to prepare.
- Like-kind Exchanges. The TCJA narrowed the applicability of Internal Revenue Code Section 1031 like-kind exchanges to real property. The proposal would further limit like-kind exchanges to $500,000 for each taxpayer ($1,000,000 for a married couple) per year for taxable years beginning after December 31, 2021.
- Carried (Profits) Interest. The TCJA imposed an extended holding period to qualify for capital gain tax treatment for carried interests. The proposal would tax carried interests in investment partnerships as ordinary income for holders with taxable income in excess of $400,000 who provide services to the partnership, effective for tax years beginning after December 31, 2021.
- Tax Collection. There are a number of provisions of the proposal directed toward increasing tax collection from existing sources. For example, expanded broker information reporting of cryptocurrency assets.
What is noticeably absent from the proposals are any changes related to the estate and gift tax. There are a few possible explanations for this omission. First, the gift and estate tax changes under the TCJA are scheduled to expire at the end of 2025, which is fast approaching. Also, while the burden of the gift and estate tax is very real for those who pay the tax, it is not a major source of revenue. We are concerned that the proposal does not clearly address the integration of the gift and estate tax and the proposed gain recognition on transfers by gift and at death – credits and deductions – although it is commonly understood that there would be a deduction to reduce the overlapping tax impact.
What do we expect and advise?
We expect that there will be rate changes, with actual rates being an area of compromise. Rate changes are simple to implement and have a near-term revenue impact. The taxation of gifts and transfers at death as gain recognition events would require more of a mind shift and be harder, but not impossible, to gather the requisite support. Gifts of appreciated assets to charity will continue to benefit the charitable causes and make tax sense, but the proposal would limit the tax benefit of gifts of appreciated assets to a charitable trust. Also, with the prospective effective date of the proposed trigger of gain recognition on gifts and the pending sunset of the increased gift and estate tax exclusion amount ($11.7 million this year, $5 million, adjusted for inflation in 2026), now is a good time to evaluate gifts and gift trusts.
Our clients’ circumstances and goals are varied. We encourage clients to prepare rather than react to potential changes, and we are available to discuss the changing tax landscape and its potential impact with you.