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There’s One for You, Nineteen for Me: Biden Aims To Raise $1.5 Trillion by Raising Tax Rates and Eliminating Like-Kind Exchanges for Wealthy

In March, following the passage of the American Rescue Plan Act of 2021, President Biden announced the American Jobs Plan, an infrastructure spending plan, and the Made in America Tax Plan, a tax reform plan that seeks to raise corporate income taxes.
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In our client alert published on April 1, we analyzed the proposed tax increases introduced in the Made in America Tax Plan.

On April 28, President Biden announced a sister plan to the American Jobs Plan and the Made in America Tax Plan, known as the American Families Plan and outlined in a White House Fact Sheet. The American Families Plan includes additional tax reform proposals, as described below. We expect further information on these tax proposals in the coming weeks.

Increased Rates and Increased Enforcement

Increase Top Marginal Tax Rates. The American Families Plan proposes to restore the top income tax rate to 39.6 percent from the 37 percent that was introduced in 2017 in the Tax Cuts and Jobs Act. Arguably, the reduction from 39.6 percent to 37 percent in 2017 was in exchange for certain tradeoffs, including making state and local taxes no longer deductible above a small threshold. The American Families Plan does not mention adding back the deduction for state and local taxes.

Taxation of Capital Gains at Ordinary Income Tax Rates for Wealthy Individuals. The American Families Plan intends to tax capital gains at the same rate as ordinary income for households making over $1 million. It is unclear whether this threshold refers to gross income or taxable income. Taking into account the proposed increase in the marginal tax rate to 39.6 percent and the 3.8 percent Medicare tax on net investment income, the marginal US federal income tax rate for such gains would be 43.4 percent. Taking into account state and local taxes (and the current inability to deduct such state and local taxes for most taxpayers), the combined marginal tax rate could exceed 50 percent for wealthy individuals.

Limit Tax Basis Step-Up at Death. Presently, certain accumulated gains passed down at death are not taxed. Instead, the tax basis in these accumulated gains is “stepped up” to fair market value. The American Families Plan proposes to cap the basis adjustment to accumulated gains of $1 million ($2.5 million per couple when combined with existing real estate exemptions), meaning accumulated gains in excess of $1 million (or $2.5 million, as applicable) would not be transferred income-tax-free at death unless donated to charity. The American Families Plan also proposes to exempt family-owned businesses and farms under this proposal if such businesses are passed to beneficiaries who continue to run the business.

End Favorable Tax Benefits for Carried Interest. President Biden seeks to eliminate favorable tax treatment of carried interest so that investment fund managers will pay ordinary income tax rates on their income rather than the much lower capital gains rates. Presumably, this legislation would cover carried interest that is outside the scope of Section 1061, which was enacted in 2017.

Eliminate Tax-Free Section 1031 Exchanges. Presently, real estate investors are permitted to defer taxation when they exchange like-kind property under section 1031 of the Internal Revenue Code. The American Families Plan proposes to eliminate the tax deferral in instances where the gains are greater than $500,000. Given how common section 1031 exchanges are in the real estate industry, this proposal, if enacted, would be a blow to real estate investors.

Expansion of 3.8% Medicare Tax: Under current law, high-income earners are subject to a 3.8 percent Medicare tax on earned income. In addition, investors are generally subject to a 3.8 percent net investment income tax. However, neither tax may apply to certain types of income, such as income allocated by an S corporation to certain holders of S corporation stock who are active in the S corporation’s business. The American Families Plan proposes to apply the Medicare tax more consistently across investment types, presumably seeking to eliminate the Medicare and net investment income tax savings of investing through an S corporation.

Strengthen IRS Enforcement Resources. The American Families Plan proposes to substantially increase IRS enforcement resources, with a specific focus on underpayment of taxes by taxpayers with income over $400,000. The increased enforcement resources are projected to raise $700 billion in taxes that otherwise may go uncollected.

Extensions of Tax Credits for Individuals

Extend the Child Tax Credit. The American Families Plan proposes to extend the Child Tax Credit as temporarily expanded in the American Rescue Plan. The American Rescue Plan temporarily expanded the Child Tax Credit 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 temporarily makes 17-year-olds eligible for the credit and makes the credit fully refundable. Under the American Families Plan, the full refundability of the Child Tax Credit would be made permanent and the other expansions to the Child Tax Credit would be extended through 2025.

Make Permanent the Child and Dependent Care Tax Credit. The American Rescue Plan expanded the temporary Child and Dependent Care Tax Credit by allowing for a tax credit of up to 50% of a taxpayer’s spending on qualified child care for: (i) children under age 13, (ii) a spouse or parent who cannot care for themselves, or (iii) another dependent up to a total of $4,000 for one child or dependent. The tax credit can be claimed up to a total of $8,000 for two or more children or dependents. The American Families Plan would make permanent the Child and Dependent Care Tax Credit.

Make Permanent the Earned Income Tax Credit Expansion. The American Rescue Plan temporarily increased the Earned Income Tax Credit for childless workers. The American Families Plan seeks to make the increase permanent.

As we stated in our client alert published on April 1, any tax bill faces significant hurdles in the divided Congress.

“These tax proposals fairly reflect the ideological priorities of the Biden Campaign and the new Administration: expanding family tax credits, while pursuing greater progressivity," said former Congressman Phil English of Arent Fox. "The large tax increases in capital gains—reversing worldwide tax trends since the 1970's—are likely to be most controversial, because of their spillover impact on capital markets and unlikelihood to deliver the promised revenue. By proposing that high earners in the United States pay some of the highest capital gains taxes in the world, these proposals will invite a renewed debate over the taxation of capital income and its consequences for the economy.”

– Phil English, Former US Congressman

The American Families Plan is the latest installment of massive changes that have been proposed to the structure of the current U.S. tax system. We will continue to provide updates as new information is released. To discuss how these changes may affect your business, please contact the tax professionals at Arent Fox.

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