On April 28, 2021, President Biden introduced The American Families Plan (the Families Plan). The Families Plan is estimated to cost $1.8 trillion according to a White House summary. The Families Plan sets forth the administration’s initiatives that they believe will grow the middle class, expand the benefits of economic growth to all Americans and leave the US more competitive. The Families Plan initiatives focus on the following broad areas:
- Adds two years of free access to preschools and two years of community college as well as other investments in education
- Provides direct support to children and families so that low and middle-income families will spend no more than 7% of their income on child care
- Creates a national comprehensive paid Families medical leave program
- Expands access to healthy meals to our nation’s students
- Extends certain tax cuts in the American Rescue Plan
- Extends the expanded health insurance tax credits in the American Rescue Plan
To pay for the Families Plan, President Biden proposed numerous tax changes. At a high level, the Families Plan would be offset with $1.5 trillion in revenue raisers that would primarily impact high-income individual taxpayers: Those revenue provisions would include:
- Increase the top marginal tax rate to 39.6%
- Increase the capital gains rate to match the top tax rate of 39.6% on all income for households making more than $1 million
- Expansion of the 3.8% ‘Medicare Tax’
- Treating death as a recognition event subject to certain exceptions
- Eliminate the preferential rates for carried interests
- Elimination of most of the remaining like-kind exchanges
- Permanent extension of excess business loss limitation
- Increase investment in the IRS for enforcement
- Give the IRS authority to regulate paid tax preparers
Washington National Tax has summarized the key tax provisions of the Families Plan.
Increase in the top marginal rate
The President’s proposal would increase the top marginal rate on ordinary income from 37% to 39.6%. According to the White House summary, this rate increase would only affect the top 1% of taxpayers, and would apply to income such as interest, wages and income from flow through investments and other businesses.
Increase in capital gains tax rates for incomes over $1 million
Capital gains and qualified dividends are currently taxed at a maximum preferential rate of 20%. The administration’s proposal would eliminate these preferential rates for taxpayers with incomes of greater than $1 million, and instead subject this income to ordinary income tax rates. The White House summary indicates that this change would impact the top 0.3% of taxpayers.
Expansion of the 3.8% ‘Medicare Tax’
Under current law, certain types of income earned by high-income workers and investors are subject to an additional 3.8% tax. This generally takes the form of either the self-employment tax, additional Medicare tax or the net investment income tax, depending on the nature of the income. But these regimes do not capture all income. The President’s proposal appears aimed at eliminating the exceptions in order to ensure that taxpayers earning more than $400,000 would incur this 3.8% tax on all income – regardless of the source. For taxpayers already in the proposed 39.6% bracket, this proposal would push the nominal marginal federal tax rate on all income to 43.4%.
Treating death as a recognition event
To eliminate a taxpayer’s ability to avoid the increase in capital gains rates noted earlier by holding assets until death, the proposal would require taxation of all unrealized gains in excess of $1 million as of the date of death. The only exception to recognition would be for appreciation attributable to assets donated to charity. The summary indicates that the reform will be designed to ensure that Families owned businesses and farms would be protected and that no tax would be triggered when those businesses are transferred to heirs that continue to run the businesses.
Elimination of preferential rates for carried interests
Specifically calling out the hedge fund industry, the administration called for closing the ’carried interest loophole.’ Under current law, fund managers are sometimes able to enjoy preferential capital gains rates on their share of income from the fund, despite the fact that the income may effectively represent compensation for the manager’s services.
Elimination of most remaining like-kind exchanges
The tax law currently allows for the deferral of gains on transfers of real estate in situations where the taxpayer exchanges into other like-kind property. The proposal calls for an elimination of this deferral mechanism in circumstances where the gain exceeds $500,000. This would effectively eliminate the like-kind exchange in most circumstances.
Permanent extension of excess business loss limitation
In 2017, the Tax Cuts and Jobs Act limited the ability of taxpayers to deduct ‘excess business losses’ against other types of income – capping the allowable net deduction to $500,000 per year. This provision was originally set to expire. Under the President’s plan, this provision would be made permanent.
Increase investment in the IRS for enforcement
President Biden’s office estimates that the overhaul of tax administration will generate approximately $700 billion in tax revenue over the course of a decade, net of investments made. The key components of the American Families Plan proposals include:
- Provide resources to the IRS by way of multi-year stream of funding. The proposal directs approximately $80 billion to the IRS over a decade to fund an overhaul of technology, hire and train auditors to focus on complex investigations of large corporations, partnerships and global high-wealth individuals. The President’s proposal specifically directs allocation of resources for the enforcement against those with highest incomes, over $400,000. The resources will also be used to go after high wealth non-filers.
- Provide the IRS with information from third parties. This proposal is triggered by the need for the IRS to be able to verify income distributed to taxpayers by opaque sources, such as partnership and proprietorship income. The IRS needs mechanisms to cross check the accuracy of tax filings and improve compliance, similar to income streams such as wage, pension and employment income. This proposal will not impose additional burdens on taxpayers; instead, the proposal will require financial institutions to add certain information to their annual reports about aggregate account outflows and inflows.
- Overhaul outdated technology to help the IRS identify tax evasion. Antiquated IRS IT systems need to be modernized to be able to respond to the needs of the compliant taxpayers, as well as unpack complex structures, like partnerships, where income is not easily traced.
- Improve taxpayer service and deliver tax credits. This improvement to customer service will allow the IRS to communicate with taxpayers promptly and securely and provide accurate and timely answers to questions. This proposal also includes allocation of resources to efficiently deliver tax credits to taxpayers, including Child Tax Credit and Child and Dependent Care Tax Credits.
- Regulate Tax Preparers. This proposal will give the IRS the legal authority to implement safeguards in the tax preparation industry to protect taxpayers from tax preparers who lack the ability to provide accurate tax assistance. This will also include higher penalties against dishonest preparers who fail to identify themselves on tax returns and who defraud taxpayers.
The provisions outlined above would undoubtedly have profound implications for high-income taxpayers and business owners. The journey from proposal to legislation to law can be a long one – and it is reasonable to expect that there will be significant negotiations regarding many of these proposals once the legislative process begins. But it should be apparent that if even a handful of these proposals are enacted, particularly when one also considers the corporate tax provisions outlined in the American Jobs Plan, the changes would have a profound impact on the tax landscape.