With the upcoming change in the federal administration on January 20, 2021, both individual and business taxpayers should be prepared for potentially major shifts in federal tax laws. A new administration often seeks to revamp federal tax statutes, but President-elect Biden’s objective for 2021 and subsequent years is to bring about a major overhaul of the federal tax code, not limited to repealing provisions enacted during the Trump administration. All of these changes would likely need the approval of Congress.
The most significant changes that President-elect Joseph Biden and his team have proposed during the last year (the “Biden tax proposals”) are summarized below.
The Biden tax proposals would increase the highest individual income tax rate from 37 percent to its pre-2017 level of 39.6 percent for taxpayers earning $400,000 or more. It is unclear if, or to what extent, tax rates for other income tax brackets may change. Individuals earning over $400,000 also may see limitations on itemized deductions and business-related deductions and credits.
The Biden team has discussed introducing a new Social Security tax for individuals earning over $400,000. It is not clear how this proposal would be implemented, but it likely would create a “donut hole” where earnings between $137,700, the current Social Security cap, and $400,000 are not subject to the new tax.
Under the Biden tax proposals, the capital gains tax rate for many taxpayers would remain at its current 20 percent, but there is a possibility that the rate could go as high as 39.6 percent (to equal the proposed highest ordinary income tax rate) for some high-income taxpayers. It is not clear what income thresholds would be affected, nor how this increased capital gains tax rate would operate in conjunction with other provisions governing an individual taxpayer’s income tax and deductions.
In connection with its proposed hike in the capital gains tax rate for high-income taxpayers, the Biden administration also proposes to repeal the preferential tax treatment for carried interest. We note, however, that previous administrations have tried unsuccessfully to bring about this change in the tax system.
Lower-income taxpayers—again with applicable thresholds not defined in the Biden tax proposals—could see an increase in dependent day care credits and potentially in other similar tax credits.
Three years ago, the Tax Cuts and Jobs Act (TCJA) significantly reduced the corporate tax rate from 35 percent to 21 percent. The intended result, when coupled with the reduction of the highest marginal tax rate for individuals to 37 percent, was to impose a similar burden on individuals conducting business through partnerships, LLCs and S Corporations and on C Corporations (the combined 21 percent corporate tax rate and 20 percent tax rate on earnings distributed to shareholders as dividends approximated a tax burden of 37 percent for C Corporations).
The Biden tax proposals would increase the corporate tax rate from 21 percent to 28 percent. This, with the increase in the highest individual income tax rate to 39.6 percent, would reinstitute a higher burden on investments through C corporations as compared to partnerships, LLCs and S Corporations. This difference will not be as extreme, however, as before the TCJA, when a C Corporation paid 35 percent in income tax plus a 20% tax on qualified dividends.
It is unclear whether the Biden tax proposals’ increase in the individual capital gains tax rate to 39.6 percent for high earners will mean a related increase in C Corporations’ tax on qualified dividends, currently at 20 percent as compared to non-qualified dividends that are taxed at the highest ordinary rate. If so, a higher corporate income tax rate coupled with an almost-doubled tax on dividends may result in a very large shift away from investment through C Corporations and back to LLCs, S Corporations, and partnerships.
In addition to a potential shift away from the corporate form, the proposed increase in the corporate tax rate may have an indirect effect on several international tax provisions, discussed below.
The Biden tax proposals also include a possible minimum tax rate of 15 percent, before book income, on corporations earning over $100 million per year. This proposal is still up in the air, with the actual tax rate and earnings threshold not yet determined. It does appear, however, that the Biden administration will try to impose some minimum tax on large corporations (although this may be mitigated for certain corporations by incentives to domestic production, as discussed below).
President-elect Biden’s focus on taxing large multinational corporations also is expected to result in specific taxes imposed on large banks. The Biden-Sanders Unity Tax Force Recommendations endorsed taxing “liabilities of ‘ultralarge’ banks to promote financial stability and fund investments in American productivity.” There is no current definition of what constitutes an “ultralarge” bank, however, nor specification of the proposed tax base or tax rate.
Finally, the Biden administration is expected to attempt to repeal the increase in the bonus depreciation percentage, from 50 percent to 100 percent, instituted by the Trump administration for qualified property acquired and placed in service after Sept. 27, 2017.
Domestic and International Tax Provisions Designed to Keep Wealth and Jobs in the United States
The Biden tax proposals relating to international corporate business are not as clear as those regarding individual and corporate tax rates, but they focus on the aim of bringing back and retaining jobs and wealth in the United States. One proposal in this regard would be to impose a 10 percent surtax on profits for goods manufactured, or for services rendered, outside the United by an overseas subsidiary of a United States company, which are then resold into the United States, which will result in an overall tax rate on such profits of 30.8 percent.
Consistent with President-elect Biden’s intent to bring jobs back to the United States, the Biden tax proposals include a 10 percent advanceable “Made in America” tax credit for companies making investments that will create domestic jobs. This credit will be available to companies with respect to a broad range of investments designed to create jobs in the United States, including, inter alia, for revitalizing closed facilities in manufacturing areas, for retooling existing factories to increase competitiveness and employment, and for expenses or new investments arising from bringing back to the United States production or service jobs. The credit will apply to the increment of increased wages—above a company’s pre-COVID baseline (with no precise date specified)—for manufacturing jobs paying up to $100,000. To consolidate the effect of this credit, companies that move business and jobs offshore could lose deductions to which they are currently entitled.
The Biden tax proposals would also increase the Global Intangible Low-Tax Income (GILTI) tax rate from the current minimum rate of 10.5 percent to 21 percent, although the exact mechanisms of how this increase would be effectuated are unsettled. The plan would change the calculation to a country-by-country minimum tax rather than the current approach, which in some circumstances allows businesses to blend foreign income taxed at a high rate with foreign income taxed at a lower rate. The plan would also eliminate GILTI’s exemption for deemed returns under 10 percent from qualified business asset investments.
Finally, the Biden tax proposals focus on tougher anti-inversion rules to prevent United States companies from moving their headquarters to other jurisdictions for tax reasons.
Real Estate-Related Proposals
The Biden tax proposals also target real estate investments. For example, the Biden team has discussed raising revenue by completely repealing IRC § 1031, which provides for deferral of capital gains tax on like-kind exchanges. A full repeal of section 1031 would affect real estate owners at all income levels, but there is an alternate proposal to limit section 1031 exchanges to taxpayers who earn less than $400,000.
More generally, investors in real estate who earn over $400,000 could see certain tax breaks, such as bonus depreciation, eliminated or scaled back. At the other end of the spectrum, first-time home buyers could enjoy a tax credit of up to $15,000, and there may be special credits for real estate renovations in certain distressed areas. There also may be a new low-income renters’ tax credit with the goal of reducing rent and utilities bills.
In addition, the Biden administration is expected to try to make changes to the statute providing tax incentives for investment in “Opportunity Zones,” which was enacted by the Trump administration. The main focus will be on scrutinizing whether benefits awarded to investors promote the welfare of communities located in these “Opportunity Zones.”
Estate and Gift Tax
The Biden tax proposals endorse significant amendments to estate and gift taxes. The most significant proposal is elimination of the step-up basis for inherited property or, in other words, carrying over the decedent’s basis to the heir(s). This change would be revolutionary and would affect taxpayers at all income levels.
Another proposal would reduce the estate tax/lifetime gift tax exemption from its current high of $11.5 million per spouse. President-elect Biden has proposed reducing the exemption to the pre-Trump level of $5.3 million per spouse, but there has also been discussion of reducing it even lower to its 2009 levels of $3.5 million for estate taxes and $1 million for lifetime gifts.
The Biden administration hopes to advance its policies by applying tougher taxes on industries such as pharmaceuticals and fossil fuels and by enacting tax incentives to encourage businesses to use clean energy. Specific details of these various plans have yet to be outlined.
One proposal would impose a tax penalty on pharmaceutical companies that increase prescription drug prices by more than the rate of inflation. Another would eliminate a deduction for consumer drug advertising.
The Biden tax proposals would eliminate fossil fuel subsidies, although they do not state whether this includes both direct and indirect subsidies. On the other hand, the Biden administration plans to incentivize investment in renewable energy, energy efficiency, and electric vehicles by reinvigorating the energy investment tax credit and the electric vehicle tax credit and by enhancing tax incentives for carbon capture, use, and storage.
It is difficult to predict how much success President-elect Biden and his administration will have in implementing the changes discussed above. There are, however, elements of the Biden tax proposals that appear more likely than others to take effect in the next year. For example, increases in the individual and corporate income tax rates are the most likely changes to be enacted in the near future (sooner than these rates’ expected natural “sunset” in 2025), even if the Senate is controlled by Republicans. In addition, tax sanctions on companies that move jobs and wealth offshore, and incentives for companies that keep jobs in America (and/or bring them back), are likely to move forward with bipartisan support.
Obviously no changes in legislation will take place before 2021. There have been discussions about whether changes could apply retroactively within 2021, however (for example, if legislation is adopted by December 31, 2021, will it take effect as of January 1, 2021?). Congress has the authority to adopt this kind of retroactive legislation, but it has rarely done so. Nevertheless, anti-abuse provisions could possibly be enacted in 2021 and applied retroactively to the beginning of the year, to prevent taxpayers from taking quick action to avoid new rules before they come into effect.