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On May 28, 2021, the U.S. Department of the Treasury released its “Greenbook,” which are explanations of the Biden Administration’s 2022 Revenue Proposals. This book provides additional information on proposals previously announced as American Families Plan and the Made in America Tax Plan.   Many of these proposals center on improving tax compliance and tax administration through provisions which modify , expand or add to existing tax expenditures and revenue raising measures. However, these legislative proposals may undergo changes before being passed into law, as this is the first step in the budget and reconciliation process.

The Greenbook provides revenue estimates generated by the Treasury’s Office of Tax Policy, which are used to support the proposals.  The most notable proposals are as follows:

Additional Funding for the Internal Revenue Service

There will be an additional $80 billion in funding for IRS over the next decade.  This funding is primarily for enforcement and operations.  The Administration has indicated that this additional funding will be utilized towards enforcement against those with the highest incomes rather than against Americans with income less than $400,000.

High-Earners Lose Preferential Capital Gains Rates

To the extent that an individual’s gross income exceeds 1 million ($500,000 for married filing separately), taxpayers long-term capital gains and qualified dividends will be taxed at ordinary income tax rates.  For clarification, this application of ordinary income tax rates applies to the individual’s income over 1 million and the tax treatment is not changed for income below that amount.  Capital gains have long received preferential treatment dating back more than 90 years (with a brief exception as to the Tax Reform Act of 1986).   This may cause taxpayers to defer or avoid recognition events.  Alternately, the tax incentive to hold capital assets for more than one year in contrast to several months will no longer be appealing.

This proposal is said to be effective for gains recognized after the date of the announcement, which was April 28, 2021.  This effective date may very well change during the Budget Reconciliation process.

Deemed or Forced Realization Event for Gifts, at Death and for Certain Partnerships and Trusts

Generally, taxpayers account for increase and decreases in the value of their assets only at a realization event. Currently, gifts and transfers upon death are not treated as taxable events.  For transfers that occur at death, the individual who inherits the asset takes a stepped-up fair market value as to the Decedent’s date of death.

Under the Greenbook, effective January  1, 2022, donors and decedents will now recognize capital gains upon the transfer of an asset, to a donee or an heir.  The asset will be valued as of the fair market value as to the date of transfer.  However, the proposal does permit the use of capital losses carry-forwards to offset the capital gains tax where the asset is from a decedent.

Assets transferred to spouses and charities would be excluded.  Individuals would have a 1 million dollar exclusion and married couples a 2 million dollar exclusion.

In addition, other transfer events will trigger a capital gains tax.  For example, upon the transfer of an appreciated asset to or from a partnership, trust, and other non-corporate entity, this transfer will be deemed to be a recognition event for tax purposes.  This provision would apply to otherwise unrealized appreciation where no prior recognition event had occurred in the preceding 90 years.  The look-back period begins January 1, 1940. This aspect of the proposal will not become effective until December 31, 2030.

The operational details of this proposal were not specified.  It is unclear what property would be taxed, who would bear the tax, and the extent of any adjustment in basis. The proposal would need to be further developed. The proposal also states that tax-deferred contributions to or from partnerships, trusts, or other non-corporate entities are also taxable events.

For family owned and operated businesses, payment of the tax would be deferred until the business is sold or ceases to be family owned and operated.

Corporate Income Tax Rate Raised to 28%

A increase in the federal income tax rate to 28% is proposed on C Corporations, effective for taxable years beginning 2022, with a phase in rule for taxpayers on a non-calendar year.  The existing rate is 21% on corporations, and it remains possible that a compromise will put this rate at closer to 25%.  Regardless, this rate change may encourage the use of pass-through entities instead of a C-Corporation status.

199A Deduction

The entire Greenbook makes no reference to repealing or modifying the 199A deduction nor its expiration in 2025.

The 199A deduction is also known as the Qualified Business Income Deduction, which allows owners of pass through businesses to claim a tax deduction worth up to 20% of their qualified business income.  This deduction was introduced as part of the 2017 Tax Cuts and Jobs Act.  Qualified business income is the business’ net income with some exceptions, such as excluding investment income, such as capital gains or losses, dividends, or interest.   This deduction is only available to owners of pass-through businesses, and for those businesses identified as a specified service trade or business, the deduction may disappear entirely depending on the businesses income.

Top Marginal Rate for Individuals Raised to 39.6%

Under current law, the rate is 37% for individuals but would revert to the 39.6% for taxable years beginning on or after January 1, 2026 (before accounting for the additional 3.8% tax rate on net investment income).

The Greenbook also proposes that beginning in 2022, the new 39.6% rate would apply (before accounting for the 3.8% tax rate on net investment income) as the top marginal income tax rate to taxable income that exceeds $509,300 for married couples filing jointly and for single filers the amount of $452,700.  The amounts would be adjusted annually for inflation.

State and Local Taxes

Prior to the 2017 Tax Cuts and Jobs Act, taxpayers who itemized their deductions were generally able to subtract most of the state and local taxes they paid (if not all) from their federal taxable income. However, the 2017 Tax Cuts and Jobs Act sets the limit of that deduction at $10,000, referred to as the SALT cap.  This limit is far below what New Jersey taxpayers are currently paying in state and local taxes, such as real property taxes.  The SALT cap disproportionally harms New Jersey taxpayers resulting in higher tax bills for residents.  The proposal does not address a repeal of the limitation on deductibility of the SALT cap nor an increase in the SALT cap.

In sum, the Greenbook provides a substantial amount of detail in many areas as to how revenue changes would be implemented, although deemed realization would require more development and clarity.  As a final note, the proposals of the Greenbook will undergo some reform and possible changes by Congress.