President Biden Announces his Proposed Tax Changes under the American Families Plan
On April 28, 2021, President Biden announced the American Families Plan (the “Plan”), which continues many tax provisions of the American Rescue Plan signed into law by President Biden in March of 2021, and reverses many provisions of the Tax Cuts and Jobs Act (TCJA) signed into law by former President Trump in December of 2017.
Child Tax Credit. First, the Plan extends the Child Tax Credit (CTC) increases in the American Rescue Plan through 2025 and makes the CTC permanently fully refundable. The American Rescue Plan expands the CTC from $2,000 per child to $3,000 per child for six-year-olds and above, and $3,600 per child for children under six. It also makes 17-year-olds eligible and makes the credit fully refundable permanently. The credit will be delivered regularly throughout the year, rather than when the federal tax return is filed.
The Plan also makes permanent the temporary Child and Dependent Care Tax Credit (CDCTC) expansion enacted in the American Rescue Plan. The CDCTC allows for a tax credit for as much as half of a family’s spending on qualified childcare for children under age 13, up to $4,000 for one child or $8,000 for two or more children. A 50% reimbursement will be available to families making less than $125,000 a year, while families making between $125,000 and $400,000 will receive a partial credit. The credit can be used for expenses such as full-time care, after-school care, and summer care.
Individual Income Tax Rates. The Plan seeks to reverse many of the tax law changes created under the TCJA. First, the Plan will return the top income tax rate to 39.6% (under the TCJA, the top rate was reduced to 37%). Second, it increases the capital gains tax rate for households making over $1 million from the current 20% to 39.6%, so those households will pay the same 39.6% rate on all their income.
The Plan also seeks to treat carried interest as ordinary income. Carried interest is a share of a private equity or fund’s profits that serve as compensation for fund managers. Because carried interest is considered a return on investment, it is taxed at capital gains rates, and not at ordinary income tax rates. This treatment has long been criticized, with critics arguing that carried interest should be taxed at ordinary income rates since it reflects payment to a fund manager for his or her services.
Step-Up in Basis. The Plan will eliminate the “step up” in basis on death for certain inherited property. Federal tax law allows the basis of property inherited from a decedent to be “stepped up” to its fair market value as of the decedent’s death. The “step up” in basis rule therefore allows any unrealized gain that existed in the inherited property before the decedent’s death to escape taxation. Under the Plan, the “step up” in basis rule will be eliminated for gains over $1 million ($2.5 million per couple when combined with existing real estate exemptions). The gains will be taxed unless the property is donated to charity. According to the Plan, there will also be protections for family-owned businesses and farms when given to heirs who continue to run the business.
Loss Limitations. The Plan also calls for making permanent the existing limit on excess business losses under Section 461(l) of the Internal Revenue Code. That limit disallows excess business losses of noncorporate taxpayers if the loss is over $250,000 ($500,000 in the case of a joint return), adjusted for inflation. The disallowed amount is carried forward as a net operating loss to the following tax year.
Like-kind Exchanges. The Plan would eliminate the deferral of taxation for 1031 like-kind real estate exchanges for gains greater than $500,000. Section 1031 of the Code provides that, when real property used for business or held as investment is exchanged for other business or investment property of the same type, the taxpayer does not have to recognize a gain or loss. The Plan will instead require that gain be recognized if the gain is over $500,000.
Corporate Tax Rates. The Made in America Tax Plan, also announced by President Biden, would reverse part of the TCJA tax cuts to the corporate income tax rate. The corporate tax rate would be increased to 28%, up from the current 21%, but not as high as the 35% top rate that existed before the TCJA. Large, profitable companies with large discrepancies between income reported to shareholders and that reported to the IRS would be required to pay a 15% minimum tax. The Plan would also impose a global minimum tax for U.S. multinational corporations.
No SALT Deduction Changes. Absent from the Plan is any mention of a repeal of the state and local tax deduction limitation created under the TCJA. Section 164(a) of the Internal Revenue Code generally allows a deduction for certain state and local taxes paid or accrued during the taxable year. However, Section 164(b)(6), as added by the TCJA, limits an individual’s deduction under Section 164 to $10,000 ($5,000 in the case of a married individual filing a separate return) (the “SALT deduction limitation”). The SALT deduction limitation applies to taxable years beginning after December 31, 2017 and before January 1, 2026. Many Democratic lawmakers from high-income tax states, including New York and New Jersey, had hoped President Biden would repeal the SALT deduction limitation, with New York Governor Andrew Cuomo going so far as justifying proposed state tax increases as a net reduction in taxes when combined with the anticipated repeal of the SALT deduction limitation.
No Estate and Gift Tax Changes. Notably, unlike some other legislation recently proposed in Congress, such as the “For the 99.5% Act,” the Plan does not modify estate, gift, and generation-skipping transfer taxes. Before the enactment of the TCJA, the unified estate and gift tax exemption and the generation-skipping transfer tax exemption were equal to $5,000,000 per person, indexed for inflation. The TCJA doubled the exemptions through 2025, so that, for 2021, the exemptions are equal to $11,700,000 per person. The exemptions are set to expire at the end of 2025, and thus be reduced to pre-TCJA levels in 2026. President Biden, during his campaign for President, proposed increasing the top federal estate tax rate from 40% to 45% and reducing the exemptions to $3.5 million, with no adjustment for inflation. With such proposals absent from the Plan, President Biden seems to have chosen to allow the current exemption levels to expire in accordance with the TCJA, rather than reduce the exemptions further or sooner than is scheduled.
Planning for the Proposals. While the Plan includes dramatic changes to the tax code and is silent on other changes expected to be included, the Plan is merely a proposal. It is likely there will be changes to the Plan before the tax revisions are enacted, if at all, and we may see some integration of the Plan with legislation proposed by other lawmakers. Nevertheless, it is important to understand the proposals that exist to properly advise clients about how these changes may affect them and to consider whether planning opportunities.