January 20, 2021
The Democrats’ “sweep” of the White House and both chambers of Congress means that it is all but inevitable that tax legislation will be introduced in 2021, but the razor-thin nature of the Democrats’ majority in Congress could mean that only a few of President Biden’s proposals will ultimately be enacted this year.  Because President Biden’s tax plan is unlikely to receive the support of the 60 senators needed to avoid a Senate filibuster, the Democrats will likely need to rely on the reconciliation process to pass tax legislation, and the reconciliation process limits the scope and duration of some legislation.  The Democrats will also likely need the support of more conservative Democrats, such as Senator Joe Manchin of West Virginia.  In addition, while President Biden has broadly proposed certain tax law changes, he has not released a technical explanation of his tax plan, and his proposals have not been fleshed out in detail.  It is, therefore, difficult at best to predict what changes will come this year.  This Client Advisory describes some of the Biden tax proposals.
 

Individual Income Tax Proposals

The Biden tax plan would make the following changes:
 
  • Increase in Tax Rate:  It would increase the top individual income tax rate from 37% to 39.6%, which would be the highest rate in effect prior to the 2017 enactment of The Tax Cuts and Jobs Act (“TCJA”).

  • Elimination of Capital Gains Tax Preference:  It would tax long-term capital gains and “qualified dividends” at the ordinary income tax rate of 39.6% for individuals with income above $1 million.

  • It would phase out the “qualified business income” deduction (under Code Section 199A) for individuals with taxable income above $400,000.

  • It would cap the tax benefit of itemized deductions at 28% of the amount of the deduction for individuals earning more than $400,000.

  • It would restore the PEASE limitation and reduce the value of itemized deductions by 3% of the amount by which a taxpayer’s adjusted gross income exceeds $400,000.

  • Removal of Social Security Tax “Cap”:  It would impose the 12.4% Social Security old age, survivors and disability insurance (“OASDI”) tax on income above $400,000.  Under current law, the Social Security OASDI tax, which is split equally between employers and employees, applies only with respect to income up to $142,800.

    • Removal of the Social Security tax cap would be especially costly for self-employed, high-income individuals, who bear both the employee and employer portion of the tax.  As a result of the elimination of the cap, individuals residing in high-tax states could be subject to a marginal tax rate exceeding 60%.

    • New York residents, and New York City residents in particular, could be hit especially hard.  New York Governor Cuomo has proposed increasing the top New York State income tax rate to 10.86%, up from 8.82%.  Elimination of the Social Security cap, combined with the proposed New York rate increase, could mean that some New York City residents will face a combined top marginal rate of almost 70%.

    • It seems doubtful that this proposal would be adopted, because it would require approval with 60 votes in the Senate, while the other Biden tax proposals could generally be approved with 51 votes (including the vote of Vice President Kamala Harris) in the Senate though the reconciliation procedure.  Under the “Byrd Rule,” changes to Social Security generally cannot be enacted through reconciliation.
 

Retirement Accounts

  • The Biden tax plan would eliminate tax deductions for contributions to IRAs, 401(k)s, and 403(b)s, and replace it with a new tax credit equal to a specified percentage of the amount contributed (which is currently expected to be 26%).

    • In explaining the rationale for this proposed change, the Biden website states:
       

      [C]urrent tax benefits for retirement savings provide upper-income families with a significant tax break while providing a limited benefit for low- and middle-income workers.  Biden will equalize benefits across the income scale so working families also receive substantial tax benefits when they put money away for retirement.

    • Individuals with a marginal income tax rate above 26% may be incentivized to avoid a traditional retirement account, and instead elect a Roth account.  While the taxpayer would forgo the 26% credit in the year he or she makes the contribution to the retirement account, he or she could receive tax-free distributions from the Roth account in the future.
 

Business Tax Proposals

The Biden tax plan would:
 
  • Increase the federal corporate tax rate from 21% to 28%;

  • Double the tax rate on Global Intangible Low Tax Income (“GILTI”) derived by foreign subsidiaries of U.S. multinational corporations, from 10.5% to 21%;

    • Under the TCJA, a U.S. shareholder of a controlled foreign corporation (a “CFC”) is required to include in income its share of the CFC’s GILTI.  A corporate shareholder is allowed a deduction equal to 50% of the GILTI.  Thus, the current federal tax rate with respect to GILTI is 10.5% (and 13.125% after 2025).

  • Impose a new corporate alternative minimum tax on any corporation with annual “book” profits of $100 million or more, at a rate equal to 15% of the corporation’s book income.  Book losses could be carried forward to offset book income in a succeeding year.

  • Impose a new 10% surtax on corporations that “offshore manufacturing and service jobs to foreign nations in order to sell goods or provide services back to the American market.”  The surtax would raise the effective federal corporate tax with respect to this activity to 30.8%.

  • Create a 10% “Made in America” tax credit for activities that restore production, revitalize existing closed or closing facilities, retool facilities to advance manufacturing employment, or expand manufacturing payroll.  This credit would be available when expenses are incurred, rather than when the tax return is filed.
 

Sector-Specific Proposals

The Biden tax plan would:
 
  • Eliminate the deduction for prescription drug advertising;

  • Create a financial fee for certain liabilities of large financial institutions with over $50 billion of assets;

  • Eliminate certain tax preferences for fossil fuels; and

  • Eliminate or substantially curtail a number of tax benefits currently enjoyed by real estate investors, possibly including (i) Section 1031 like-kind exchange tax-deferral, and (ii) the ability to offset real estate losses against other income under the “passive activity loss” rules.
 

Estates, Gifts and Trusts

Elimination of Basis “Step-up” at Death
  • Under current law, the income tax basis of property held by a decedent on the date of death generally is stepped-up to its fair market value as of the date of death.  President–elect Biden has proposed to eliminate the basis step-up.  It is unclear whether (i) built-in gain with respect to appreciated property would be taxable upon the owner’s death, or (ii) the beneficiary’s tax basis in inherited property would reflect the decedent’s carryover basis.

  • Previous government attempts to eliminate the basis step-up at death have been unsuccessful.
 
Estate and Gift Tax Increase
  • Under current law, the estate and gift tax exemption is $11.8 million per person and $23.16 million per married couple.

    • The TCJA doubled the exemption from prior levels, but the higher exemption is scheduled to “sunset” in 2026.

    • President Biden has proposed to reinstate the $5 million exemption in effect prior to enactment of the TCJA.

Of course, it is possible that none of the potential changes identified above will be enacted, and taxpayers should keep in mind that possibility in making financial decisions, but recent history suggests that at least some of the potential changes may be enacted.