As a presidential candidate, Joe Biden put forth a comprehensive tax plan that significantly differed from the status quo. Today, President Biden and his administration have revealed several tax proposals as part of the $3.5 trillion Build Back Better (BBB) Agenda. If implemented, how would the BBB Agenda affect you and your business? In this article we will delve into the proposed tax plan’s implications for individuals and businesses.
What Are the Key Aspects of the BBB Agenda?
First, let’s review the key aspects of the proposed BBB Agenda as it relates to individuals, businesses (including pass-through entities and corporations), and gifts and estates. While not all of the proposed changes may make it through Congress, we have outlined some that would have the greatest impact.
Raise the top individual income tax rate to 39.6% from 37% for single filers making more than $400,000 and for joint filers making more than $450,000.
Prohibit contributions to Individual Retirement Accounts when balances reach $10 million and taxable income exceeds $400,000 for single filers or $450,000 for joint filers. Under these same thresholds, taxpayers would have to take a required minimum distribution (RMD) equal to 50% of the value that exceeds $10 million, plus 100% of any amount exceeding $20 million.
Increase the top capital gains tax rate from 20% to 25%, and adjust the top capital gains tax bracket to $400,000 plus for single filers and $450,000 plus for joint filers. The increase is lower than candidate Biden’s original proposed increase in the capital gains rate to as high as 39.6%.
Tax long-term capital gains as ordinary income for taxpayers with Adjusted Gross Income (AGI) above $1 million.
Create a 3% surcharge or tax on individual taxpayers with AGI in excess of $5 million.
Pass-Through Entities and Corporations
Return to a progressive corporate tax rate structure, with the top rate increasing from 21% to 26.5% for corporate income above $5 million.
Limit the qualified business income (QBI) deduction to a maximum of $500,000 for taxpayers filing jointly or $400,000 for single filers. While there is currently no limitation on the deduction, the new proposal would impose a cap once QBI exceeds $2.5 million for taxpayers filing jointly or $2 million for single filers.
Impose an alternate minimum tax of at least 15% on companies with profits of $100 million or more. This proposal is still working its way through negotiations.
Combine the global intangible low-tax income (GILTI) rate with the increased corporate tax rate, which would result in an effective tax rate of 16.6%.
Seek to eliminate Section 1031 “like-kind” exchanges (a change hinted at by Biden, although it is not a part of his plan). A Section 1031 exchange is a swap of one investment property for another, with no or limited taxes due at the time of the exchange. It allows an investment to continue to grow tax-deferred.
Estates and Gifts
Increase the estate and gift tax to up to 45% from the current progressive rate scale that tops out at 40%.
Reduce the estate and gift tax exemption level to $6.02 million beginning in 2022. The current estate and gift tax exemption is $11.58 million for individuals and $23.6 million for married couples.
Create a 3% surcharge or tax (similar to the one for individuals) on trust and estate income in excess of $100,000.
No longer exclude grantor trusts from estate tax if the decedent is the deemed owner of the trust. Also, sales between an individual and their grantor trust would be taxable even if the individual is deemed the owner of the trust.
Eliminate the ability to claim a valuation discount for estate and gift tax purposes on transfers of entities holding nonbusiness assets.
Past proposals have suggested an elimination of the step-up in basis for inherited assets of estates. Current tax law allows for a stepped-up basis at the date of death, which results in beneficiaries receiving an appreciated asset that is not subject to a capital gains tax. According to the Tax Foundation, the elimination of the step-up in basis for inherited assets would almost exclusively affect taxpayers in the top 20% bracket, with a distributional effect almost four times larger for those in the top 1% bracket relative to those in the top 20% bracket.
How Will the BBB Agenda Affect the Stock Market and the Economy?
Stock prices may decline. The value of a security is calculated as expected future earnings divided by the investor’s discount rate (i.e., required rate of return). The Biden administration’s plan would reduce corporate income, thereby decreasing the numerator. Simultaneously, due to higher effective taxes among investors, the investor’s discount rate would increase. The net effect would be that stock prices decrease.
According to Savita Subramanian, head of U.S. Equity Strategy at Bank of America Securities, the administration’s tax plan could reduce S&P 500 earnings by approximately 7%, mostly due to higher corporate taxes.
Based on an analysis by Benchmark Wealth Management, median effective corporate tax rates could increase from 19% to 24% and the median decrease in earnings would be 7%.
According to the Tax Foundation, the administration’s plan could shrink the economy by roughly 1.5% but would raise roughly $3.5 trillion in revenue over the next decade.
What Are the Implications for You and Your Company?
As it pertains to estate planning, this may be a good time to make gifts before changes are made to the tax code.
If you are planning to sell a company sometime in the future, it might be a good idea to consider selling it before taxes go up. This could be especially true for owners of pass-through entities that are worth more than $1 million. However, if the effects of COVID-19 have significantly and adversely affected your company’s value and recovery has been slow, then selling it in the near term may not be advisable.
If you hold stock options, it may be beneficial to exercise the options before changes are made to the tax code.
If your company has the ability to defer expenses, then it might be advisable to do so. For example, if you don’t take bonus depreciation, more depreciation would be pushed to years when tax rates may be higher.
Do You Still Have Time to Act?
Depending on which media outlet or opinion piece you regularly review, there are advantages and disadvantages that will result from passage of the BBB Agenda as legislation. Many of the above-mentioned proposals were passed by the U.S. Senate in August, and the final version remains in limbo as Democrats squabble about the size and cost of follow-on social investment packages. Even though it took President Trump and a Republican Congress one year in office to pass the Tax Cut and Jobs Act, Democratic party leaders hope to pass their follow-on social investment package with budget reconciliation rules that are not subject to a Republican filibuster. Bickering Democrats will likely need to reach a compromise on the reconciliation package soon, or further delays and changes could ultimately impact the final bill.
Time appears to be running out, but there is a short window of time to act. Many of the proposed changes will not take effect until 2022, so year-end planning will be important if you hope to benefit from existing tax laws.