Biden Administration Provides Effective Dates and Other Details on Its Pending Tax Plan – Selected Highlights
June 03, 2021
By Richard Shapiro
In its General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, just released, the Biden Administration has filled in many of the details of the tax proposals contained in its American Jobs Plan and American Families Plan. Following is a summary of selected highlights.
We note at the outset that the proposals, including their effective dates, may be revised, perhaps substantially, during consideration by Congress, and there is no certainty that some or all of the Administration’s tax proposals will ultimately be adopted in the same or altered form or that new provisions will not be substituted or added. We also note that the proposal to tax capital gains of high earners at ordinary income tax rates is intended to apply retroactively.
Corporate Income Tax Rate Increase
The corporate income tax rate for C corporations would be increased from 21% to 28%. It would be effective for taxable years beginning after December 31, 2021. For non-calendar taxable years beginning after January 1, 2021 and before January 1, 2022, the tax rate would be equal to 21% plus 7% times the portion of the taxable year that occurs in 2022.
Individual Income Tax Rate Increase
The top marginal individual income tax rate would be increased to 39.6%. The proposal would be effective for taxable years beginning after December 31, 2021. In 2022, the top marginal tax rate would apply to taxable income over $509,300 for married individuals filing a joint return, $452,700 for unmarried individuals (other than surviving spouses), $481,000 for head of household filers and $254,650 for married individuals filing a separate return. After 2022, the thresholds would be indexed for inflation.
Taxation of Capital Gains
Taxation of Capital Gains for High Earners at Ordinary Rates
Long-term capital gains and qualified dividends of taxpayers with adjusted gross income (“AGI”) of more than $1 million would be taxed at ordinary income rates (generally 37% plus 3.8% net investment income tax (“NIIT”)), but only to the extent that the taxpayer’s AGI exceeds $1 million ($500,000 for married filing separately), indexed for inflation after 2022. Note: The individual income tax rate increase proposal, if adopted, would increase the top ordinary income tax rate to 39.6% plus 3.8% NIIT, or 43.4%.
The General Explanations contains the following example: A taxpayer with $900,000 in labor income and $200,000 in long-term capital gain income would have $100,000 of capital gain income taxed at the current long-term preferential tax rate and $100,000 taxed at ordinary income tax rates.
This provision would be effective for gains required to be recognized after the “date of announcement.” (This reference is not entirely clear, but may be the date of announcement of the American Families Plan – April 28, 2021.)
Transfers of Appreciated Property by Gift or on Death as Realization Events
Under this proposal, the donor or deceased owner of an appreciated asset would realize a capital gain at the time of “transfer.”
Gain on unrealized appreciation also would be recognized by a trust, partnership, or other non-corporate entity that is the owner of property if that property has not been the subject of a recognition event within the prior 90 years, which such testing period beginning on January 1, 1940. The first possible recognition event for any taxpayer under this provision would therefore be December 31, 2030.
A transfer would be defined under the gift and estate tax provisions and would be valued using the methodologies used for gift or estate tax purposes. However, for purposes of the imposition of this tax on appreciated assets, the following rules would apply –
- A transferred partial interest would be its proportional share of the fair market value of the entire property.
- Transfers of property into, and distributions in kind from, a trust, partnership, or other non-corporate entity, other than a grantor trust that is deemed to be wholly owned and revocable by the donor, would be recognition events. The deemed owner of such a revocable grantor trust would recognize gain on the unrealized appreciation in any asset distributed from the trust to any person other than the deemed owner or the U.S. spouse of the deemed owner, other than a distribution made in discharge of an obligation of the deemed owner. All of the unrealized appreciation on assets of such a revocable trust would be realized at the deemed owner’s death or at any other time when the trust becomes irrevocable.
The proposal would be effective for gains on property transferred by gift, and on property owned at death by decedents dying, after December 31, 2021, and on certain property owned by trusts, partnerships, and other non-corporate entities on January 1, 2022.
A number of exclusions to the proposed capital gain rules would apply –
- Transfers by a decedent to a U.S. spouse or to a charity would carry over the basis of the decedent. Capital gain would not be recognized until the surviving spouse disposed of the capital asset or dies; appreciated property transferred to charity would not generate a taxable capital gain.
- The transfer of appreciated assets to a split-interest trust would generate a taxable capital gain, with an exclusion allowed for the charity’s share of the gain based on the charity’s share of the value transferred as determined for gift or estate tax purposes.
- The proposal would exclude from recognition any gain on tangible personal property such as household furnishings and personal effects (excluding collectibles).
- The $250,000 per person exclusion under current law for capital gains on a principal residence would apply to all residences and would be portable to the decedent’s surviving spouse (making the exclusion effectively $500,000 per couple).
- The exclusion under current law for capital gain on certain “small business stock” would apply. (It would appear this is a reference to IRC Sec. 1202 “qualified small business stock.”)
- In addition to the above exclusions, the proposal would allow a $1 million per person exclusion from recognition of other unrealized capital gains on property transferred by gift or held at death (indexed for inflation after 2022), which would be portable to the decedent’s surviving spouse (making the exclusion effectively $2 million per married couple). The recipient’s basis in property received by reason of the decedent’s death would be the property’s fair market value at the decedent’s death. The same basis rule would apply to the donee of gifted property to the extent the unrealized gain on that property at the time of the gift was not shielded from being a recognition event by the donor’s $1 million exclusion. However, the donee’s basis in property received by gift during the donor’s life would be the donor’s basis in that property at the time of the gift to the extent that the unrealized gain on the property counted against the donor’s $1 million exclusion from recognition.
- Payment of tax on the appreciation of certain family-owned and family-operated businesses would not be due until the interest in the business is sold or the business ceases to be family owned and operated.
“Rationalization” of Net Investment Income and Self-Employment Contributions Act (“SECA”) Taxes
To better coordinate the application of the NIIT and SECA tax, a proposal would make the following changes –
- All trade or business income of high-income taxpayers would be subject to the 3.8% Medicare Tax, either through the NIIT or SECA tax. Specifically, for taxpayers with AGI in excess of $400,000, the definition of net investment income tax would be amended to include gross income and gain from any trades or businesses that is not otherwise subject to employment taxes.
- Limited partners and LLC members who provide services and materially participate in their partnerships and LLCs would be subject to SECA tax on their distributive shares of partnership or LLC income to the extent that this income exceeds certain threshold amounts. The exemptions from SECA tax provided under current law for certain types of partnership income (e.g., rents, dividends, capital gains, and certain retired partner income) would continue to apply. The statutory exception to SECA for limited partners would not exempt a limited partner from SECA tax if the limited partner otherwise materially participated.
- S corporation owners who materially participate in the trade or business would be subject to SECA tax on their distributive shares of the business’s income to the extent that this income exceeds certain threshold amounts. The exemptions from SECA tax provided under current law for certain types of S corporation income (e.g., rents, dividends and capital gains) would continue to apply.
This proposal would be effective for taxable years beginning after December 31, 2021.
Taxation of Carried (Profits) Interests as Ordinary Income
A proposal would generally tax as ordinary income a partner’s share of income on an investment services partnership interest (“ISPI”) in an investment partnership, regardless of the character of the income at the partnership level, if the partner’s taxable income (from all sources) exceeds $400,000. Thus, such income would not be eligible for the reduced rates that apply to long-term capital gains. Further, partners in such investment partnerships would be subject to self-employment taxes on such income. The proposal also assumes that the gain on the sale of an ISPI would generally be taxed as ordinary income, not as capital gain.
The proposal would repeal IRC Sec. 1061 (“Partnership Interests Held in Connection with Performance of Services”) for taxpayers with taxable income (from all sources) in excess of $400,000 and would be effective for taxable years beginning after December 31, 2021.
What is an ISPI? According to the proposal, an ISPI is a profits interest in an investment partnership that is held by a person who provides services to the partnership. For this purpose, a partnership is an investment partnership if substantially all of its assets are investment-type assets (certain securities, real estate, interests in partnerships, commodities, cash or cash equivalents, or derivative contracts with respect to those assets), but only if over half of the partnership’s contributed capital is from partners in whose hands the interests constitute property not held in connection with a trade or business. To the extent (i) the partner who holds an ISPI contributes “invested capital” (which is generally money or other property) to the partnership, and (ii) such partner’s invested capital is a “qualified capital interest” (which generally requires that (a) the partnership allocations to the invested capital be made in the same manner as allocations to other capital interests held by partners who do not hold an ISPI and (b) the allocations to these non-ISPI holders are significant), income attributable to the invested capital would not be recharacterized. Similarly, the portion of any gain recognized on the sale of an ISPI that is attributable to the invested capital would be treated as capital gain. “Invested capital” would not include contributed capital that is attributable to the proceeds of any loan or advance made or guaranteed by any partner or the partnership (or any person related to such persons).
In addition, any person who performs services for any entity and holds a “disqualified interest” in the entity would be subject to tax at ordinary income rates on any income or gain received with respect to the interest, if the person’s taxable income (from all sources) exceeds $400,000. A “disqualified interest” is defined as convertible or contingent debt, an option, or any derivative instrument with respect to the entity (but does not include a partnership interest, stock in certain taxable corporations, or stock in an S corporation). According to the proposal, this rule is intended as an anti-abuse rule designed to prevent the avoidance of the provision through the use of compensatory arrangements other than partnership interests.
The proposal is not intended to adversely affect qualification of a real estate investment trust (REIT) owning a profits interest in a real estate partnership.
Repeal of Deferral of Like-Kind Exchanges
The proposal would allow the deferral of gain up to an aggregate amount of $500,000 for each taxpayer ($1 million in the case of married individuals filing a joint return) each year for real property exchanges that are like-kind. Any gains from like-kind exchanges in excess of $500,000 ($1 million in the case of married individuals filing a joint return) during a taxable year would be recognized by the taxpayer in the year the taxpayer transfers the real property subject to the exchange.
The proposal would be effective for exchanges completed in taxable years beginning after December 31, 2021.
Excess Business Loss Limitation of Non-Corporate Taxpayers Made Permanent
The proposal would make permanent the excess business loss limitation on noncorporate taxpayers, effective for taxable years beginning after December 31, 2026 (the existing limitation currently expires in 2027).
Improved Compliance and Tax Administration
A major emphasis is placed on improved compliance and tax administration. The Administration plans would, in part, do the following –
- A comprehensive financial account information reporting regime would be created. Financial institutions would report data on financial accounts in an information return. The annual return would report gross inflows and outflows with a breakdown for physical cash, transactions with a foreign account and transfers to and from another account with the same owner. This would apply to all business and personal accounts from financial institutions, including bank, loan, and investment accounts, with the exception of accounts below a de minimis gross flow threshold of $600 or fair market value of $600. Similar reporting requirements would apply to crypto asset exchanges and custodians. Other accounts with characteristics similar to financial institution accounts (e.g., payment settlement entities) would also be covered. Also, reporting requirements would apply in cases in which taxpayers buy crypto assets from one broker and then transfer the crypto assets to another broker; businesses that receive crypto assets in transactions with a fair market value of more than $10,000 would have to report such transactions. This proposal would be effective for tax years beginning after December 31, 2022.
- The Treasury/IRS would have explicit authority to regulate all paid preparers of federal tax returns, including by establishing mandatory minimum competency standards. This would be effective on the date of enactment. The penalty on “ghost preparers” (paid preparers who fail to identify themselves on tax returns) would be increased. This proposal would be effective for returns required to be filed after December 31, 2021.
- A proposal would expand the Treasury/IRS authority to require electronic filing for forms and returns. Electronic filing would be required for returns filed by taxpayers reporting larger amounts or that are complex business entities, including (i) income tax returns of individuals with gross income of $400,000 or more, (ii) income, estate, or gift tax returns of all related individuals, estates and trusts with assets or gross income of $400,000 or more in any of the three preceding years; (iii) partnership returns for partnerships with assets or any item of income of more than $10 million in any of the three preceding years; (iv) partnership returns for partnerships with more than ten partners; (v) returns of REITs, REMICs, RICs and all insurance companies; and (vi) corporate returns for corporations with $10 million or more in assets or more than ten shareholders. Also, electronic filing would be required for specified IRS forms. Return preparers that expect to prepare more than ten corporation income tax returns or partnership returns would be required to file such returns electronically.
- A proposal would expand the scope of information reporting by brokers who report on crypto assets to include reporting on certain beneficial owners of entities holding accounts with the broker. This proposal would require brokers, including entities such as U.S. crypto asset exchanges and hosted wallet providers, to report information relating to certain passive entities and their substantial foreign owners when reporting with respect to crypto assets held by those entities in an account with the broker. This proposal would be effective for returns required to be filed after December 31, 2022.
- A proposal would address noncompliance with certain listed transactions by extending the statute of limitations.
- A proposal under the centralized partnership audit regime would allow reviewed year partners to receive the full benefit of any reductions in tax as a result of partnership adjustments.
EisnerAmper will continue to keep you informed as new developments warrant with respect to the Biden Administration tax proposals.