Highlights

  • U.S. President Joe Biden in his address to a joint session of
    Congress on April 28, 2021, unveiled the American Families Plan,
    which focuses on “human infrastructure” and is the third
    part of his Build Back Better initiative.

  • The $1.8 trillion American Families Plan is composed of $1
    trillion in spending and $800 billion in tax cuts and credits for
    moderate/lower income families.

  • The spending in the American Families Plan is partially offset
    by income tax increases for wealthy Americans, an increased IRS
    budget for compliance, and notably does not include any of the
    estate and gift tax changes proposed during the campaign (other
    than the associated elimination of step up in basis).

  • The legislative pathway for enactment and effective dates are
    yet undetermined.

The American Families Plan is the third part of
the Biden Administration’s Build Back Better agenda, addressing
“human infrastructure” and containing proposals on free
education, direct support to children and families, and the
extension of tax cuts for families with children and American
workers. It was introduced by President Joe Biden in his address to
a joint session of Congress on April 28, 2021.1

The infrastructure portions of the Build Back Better plan amount
to approximately $4.1 trillion – $2.3 trillion under the American
Jobs Plan and $1.8 trillion and the American Families Plan – and
are among the most ambitious government agendas in decades.

Income Tax Increases on the Wealthy

The Biden Administration proposes to increase income taxes on
the wealthy and provide more resources to the IRS to enhance
compliance. The headline increases relate to taxing capital gains
and qualified dividends at the top ordinary income tax rates and
the elimination of the “step up” in basis rule.

  • Increase Top Income Tax Rate. The rate would
    be increased to 39.6 percent (from 37 percent) for taxpayers within
    the top 1 percent.2 Note, the 39.6 percent rate was the top
    rate in effect prior to the Tax Cuts and Jobs Act of 2017
    (TCJA).

  • Subject Long-Term Capital Gains and Qualified Dividend
    to Ordinarily Income Tax Rates.
    The rate applicable to
    long-term capital gains and qualified dividends would be increased
    to 39.6 percent for households earning more than $1 million. A
    long-term capital gain derives from assets that are held longer
    than a year. A “qualified dividend” is an ordinary
    dividend that meets specific criteria to be taxed at the current
    law lower capital gains rate rather than at the higher individual
    ordinary income tax rate.

  • Eliminate the Step Up in Basis. Generally
    under current law, the income tax basis of property acquired from,
    or passing from, a decedent is its fair market value at the
    decedent’s death rather than its original cost to the decedent.
    The benefit of this rule is that the economic gain of property that
    appreciated prior to death will not be subject to federal
    income tax upon a disposition by a heir. Under the proposal, the
    appreciation prior to death would become taxable upon a subsequent
    disposition by a heir. Significantly, legislation would be designed
    with protections that would exclude family-owned businesses and
    farms if the decedent’s heirs continue to run the
    business.

  • Eliminate the Carried Interest Rule. Income
    associated with “carried interests” would be taxable at
    the ordinary income tax rate rather than the current law
    preferential capital gains rate (20 percent). A “carried
    interest” is a contractual right that entitles a fund manager
    to a share of a partnership’s profits and under current law is
    taxable at the preferential capital gains rate, provided certain
    conditions are satisfied.

  • Eliminate “Like Kind” Exchanges for Gains in
    Excess of $500,000.
    A “like kind” exchange
    transaction is a swap of one real estate business or investment
    property for another that enables deferral of capital gains
    taxation. The proposal would eliminate that deferral for gains in
    excess of $500,000.

  • Permanently Extend Current Limitation that Restricts
    Large Excess Business Losses.
    This provision restricts the
    current deductibility of “excess business losses.” Under
    current law, noncorporate taxpayers (to include
    “pass-through” entities such as partnerships, limited
    liability companies (LLCs), and “S” corporations) are
    subject to a limitation for “excess business losses.” An
    excess business loss is the amount by which the total deductions
    attributable to all of a taxpayer’s trades or businesses exceed
    total gross income and gains attributable to those trades or
    businesses plus $250,000 (or $500,000 in the case of a joint
    return). The Coronavirus Aid, Relief and Economic Security Act
    (CARES Act) had removed the excess business loss limitation for
    2018, 2019 and 2020. However, beginning in 2020, the limitation
    returned and now is in effect.

  • Apply the 3.8 percent “Medicare” Tax to
    Taxpayers Making More Than $400,000.
    Under current law,
    the Medicare tax is a 3.8 percent tax imposed only on a portion of
    a taxpayer’s income. The tax is paid on the lesser of 1) the
    taxpayer’s net investment income or 2) the amount the
    taxpayer’s adjusted gross income exceeds the application of the
    adjusted gross income threshold ($200,000 for single taxpayers and
    $250,000 for married taxpayers). Under the proposal, the threshold
    for application of the 3.8 percent Medicare tax would be limited to
    taxpayers making more than $400,000.

  • Regulate Income Tax Preparers. The
    administration will ask for legal authority for the IRS to regulate
    tax return preparers and enact stricter penalties for unscrupulous
    preparers.

  • Increase IRS Enforcement Budget. The
    administration will ask for about $80 billion over 10 years to
    overhaul the tax administration and provide the IRS the resources
    and information it needs to investigate large corporations,
    partnerships and high-net-worth individuals. American households
    with less than $400,000 in annual income will not be targeted,
    according to the administration.

  • Additional Reporting by Financial
    Institutions
    . The administration will ask for enhanced
    reporting by financial institutions, which would require reporting
    on balances and account flows.

What Was Not Included

The Biden Administration did not include any of the estate and
gift tax changes that were proposed during the campaign. These
proposals included a reduction of a taxpayer’s unified
exemption from estate and gift taxes from the current $11.7 million
(inflation-adjusted) amount to as low as $3.5 million, as well as
an increase of the estate and gift tax rate from the current 40
percent rate to 45 percent. While these changes to the estate and
gift tax system are not included in the American Families Plan, the
proposed elimination of the step up in basis for income tax
purposes would have a significant impact on the estate and tax
planning of wealthy families. Further, the absence of any proposed
changes to the estate and gift tax system currently does not mean
that such changes will not be proposed at a later date. There
continues to be a strong interest among many leading Democrats to
expand the estate and gift tax as a means to target inherited
wealth.

The Way Forward

As noted in prior alerts, there are two ways to pass tax
legislation through Congress.3 First, through “regular
order,” which requires bipartisanship; viz., a
majority vote in the House and 60 votes in the Senate (to avoid the
filibuster). Second, through the budget reconciliation process,
which only requires passage through a simple majority vote in the
house and Senate (and bypasses the filibuster in the Senate).

In a consequential ruling in April of this year, the Senate
parliamentarian advised that the Senate budget rules would allow
the use of the budget reconciliation process more than once in a
fiscal year.4 The April 5 ruling creates additional
opportunities for the Democrats to approve a bill without GOP
support before the 2022 elections. 5 (See previous Holland
& Knight alerts, “Biden Administration’s Made in America Tax
Plan: Procedural Aspects
,” April 28, 2021; “Biden Administration’s Made in America Tax
Plan: Interaction with OECD Inclusive Framework
,” April
15, 2021.)

There are myriad possibilities for passage of the American
Families Plan, some of which are linked to the American Jobs Plan
and some of which are not so linked. The possibilities include:

  • A bipartisan agreement with Republicans on the America Jobs
    Plan or a smaller plan, as proposed by the GOP (and potentially
    without corporate tax increases that the GOP do not favor)?

  • If not, then the legislative pathway for the American Family
    Plan would be through the budget reconciliation process; in that
    case, would there be one bill or more than one bill?

In terms of the effective date of any individual tax legislation
enacted as part of the American Families Act, that also is
uncertain at this time. Although it appears that prospectivity is
preferred, the legislation could be effective as of the date of
introduction, enactment, or in 2022, depending on the
circumstances. It is important to closely monitored this item as
the legislation wends its way through Congress.

Key Takeaways

  • The tax increase proposals used to pay for the American
    Families Plan were presaged by then-candidate Joe Biden during the
    presidential campaign.

  • Of the income tax changes, the near doubling of the capital
    gains rate for wealthy individuals will be one of the most
    controversial proposals – essentially equating the taxation of
    income from wealth with that of work. Further, for those taxpayers
    subject to the “Medicare Tax,” the addition of the 3.8
    percent tax increases the federal rate of tax to 43.8 percent
    compared to 23.8 percent under current law.

  • The potential elimination of the step-up in basis at death is a
    big ticket item. Not only would the appreciation of assets prior to
    death become taxable in the hands of a deceased taxpayer’s
    heirs, but, depending on the circumstances, the rate of tax could
    be significantly increased if the top rate for capital gains is
    increased to 39.6 percent

  • All the proposals are silent with respect to effective
    dates.

  • The increased focus on and funding of compliance is intended to
    make the wealthy pay what they owe and is anticipated to be a
    significant revenue generator.

  • Finally, although not discussed herein, the $800 billion in
    changes to enhance tax credits should have a significant impact on
    working class families.

Footnotes

1. Build Back Better is President Biden’s
three-part agenda to rescue, recover and rebuild the country. It
includes three plans: the American Rescue Plan, the $1.9 trillion
economic stimulus bill passed by Congress and signed into law by
President Biden on March 11, 2021; the American Jobs Plan, which
proposes to increase investment in infrastructure, the production
of clean energy, the care economy and other priorities; and the
Made in America Tax Plan, which is the vehicle to pay for the
American Jobs Plan. The Biden Administration proposes to fund the
American Jobs Plan through increasing the corporate tax rate from
21 percent to 28 percent, adding a 15 percent corporate tax on book
income, modifying various international tax provisions and making
other changes.

2. It is not entirely clear whether that refers to
taxpayers earning less than or more than $400,000.

3. A potential third route would be for the
Democrats to override the filibuster, which is a tactic of
parliamentary procedure employed in the Senate to delay or entirely
prevent debate or vote on a specific proposal. At this time, there
does not appear to be an appetite to override this rule.

4. Technically, the Senate parliamentarian advised
that pursuant to Section 304 of the Congressional Budget Act of
1974, budget resolutions can be revised if updated prior to the end
of the fiscal year that they cover. The Democrats could go back and
amend the resolution for FY 2021 and include instructions for
another reconciliation bill.

5. To reopen the FY 2021 budget, both houses of
Congress would need to pass an amended budget with revised tax and
spending targets. The process would require debate time on the
floor of the Senate, taking up to 40 hours, followed by numerous
votes on amendments that could last into the early morning (the
so-called “vote-a-rama”).

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.



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