Article byPosted Featured AuthorSeptember 2021
Federal tax law has remained uncharacteristically stable since the passage of the Tax Cuts and Jobs Act of 2017, known formally as “TCJA” and colloquially as the “Trump Tax Cuts.” Among other things, the TCJA cut the corporate tax rate, cut the capital gains rate, rearranged the individual income tax brackets, doubled the standard deduction for individuals, and doubled the estate tax exemption. With the election of a Democrat President and a Democrat-held Congress, rumors have swirled for some time about the inevitable roll-back of provisions of the TCJA. Democrats have argued that the TCJA cuts unfairly favor large corporations and wealthy individuals. Until now, though, little headway has been made in changing its provisions.
“Now” is September 2021, and President Biden has proposed a $3.5 trillion infrastructure bill as part of his “Build Back Better” agenda. Such magnitude of spending begs the question: how are we going to pay for this? Proposed answers were unveiled recently in a document released by the House Ways & Means Committee, where all good tax bills originate. Bear in mind that, as of the writing of this article, none of these measures have made it out of committee, much less passed the House or Senate. However, it does appear that sufficient momentum exists to enact at least some of the proposed measures.
Unsurprisingly, the proposal will raise the long-term (assets held more than one year) capital gains rate. The TCJA scaled back the top capital gains rate to 20%, with preferential rates of 15% and even 0% for lesser earners. The proposal will increase the top rate to 25%, although it is unclear whether the preferential rate will be changed. Note that this is not as drastic a measure as originally proposed by President Biden, who has suggested that the top rate should be increased to 39.6%, effectively treating capital gains the same as ordinary income for higher earners.
In 2021, the federal estate tax exemption stands at $11.7 million (indexed for inflation) for individuals. This means that, in the case of married couples, estates valued at up to $23.4 million are not subject to the estate tax. Under the terms of the TCJA, the increased estate tax exemption will sunset on December 31, 2025, and the exemption will revert to $5 million per person, indexed for inflation. The proposal will accelerate this sunset to the end of 2021, effectively cutting the estate tax exemption in half at the end of the year.
Speaking of the estate tax, President Biden has threatened in recent months to eliminate the so-called basis “step-up” to fair market value on the date of a decedent’s death. This would have led to more gain recognition events when appreciated assets were sold or transferred from a decedent’s estate. The real estate industry was particularly unhappy with this provision, and it was nowhere to be seen in the Ways & Means proposal. The proposal also mentions clamping down on estate planners’ use of defective grantor trusts and discounted valuation transfer techniques.
For years the corporate level income tax rate was a flat 35%. The TCJA reduced this rate to 21%. President Biden has proposed raising the level to 28%, but the proposal splits the baby (unevenly) and proposes a top corporate rate of 26.5%. Note that the corporate-level tax rate only applies to Subchapter “C” corporations. These typically include very large companies and very old companies which have not made an S election.
One of the most notable features of the TCJA was the adjustment of individual income tax brackets. Following passage of the TCJA, many middle-class Americans saw an almost immediate increase in their paychecks as withholding for federal taxes was decreased. The highest bracket earners saw their income tax rate decreased from 39.6% to 37%. The proposal will not upset this bracket shift… until individual earners reach $400,000, and couples filing jointly reach $450,000. Those taxpayers will see their tax rate revert to 39.6%. The proposal will also add a tax “surcharge” of 3% for individuals who earn $5 million or more. My speculation is that, if this “surcharge” is enacted, it will likely never go away.
The proposal restricts contributions to IRAs for individuals who earn $400,000 or more. Additional contributions from savings will be prohibited after an IRA balance reaches $10 million. Some of the restrictions on Roth IRAs will return, in an attempt to curb so-called “Mega-IRAs”. 1
Assuming, arguendo, that the proposal emerges from committee, it still faces roadblocks, particularly in the Senate. The senate is currently split 50–50, and, in theory, can pass the bill with a simple majority using the deciding vote of the Vice President. However, Senator Joe Manchin (D – WV), has already indicated that the $3.5 trillion spending proposal is too high. It is likely that he will prevent a simple majority vote on the spending or taxing provisions proposed until changes have been made. Stay tuned!