Yesterday, during his first address to Congress, President Biden formally announced the American Families Plan (“AFP”), a sweeping set of proposals that would be paid for in part by increasing taxes on high-income individuals by $1.5 trillion over the next decade, by increasing the top individual tax rate and tax rates on capital gains and dividends, and by changing the tax treatment of inherited assets. The plan, which the White House introduced by issuing a fact sheet earlier in the day, would use these tax increases to help offset the cost of $1.8 trillion of new investments and tax benefits intended to grow the middle class. The AFP, if enacted as proposed, would mark the biggest expansion of federal benefits in roughly 50 years. Similar to the international tax reform proposals discussed in our April 1 and April 6 alerts, there is a great deal of uncertainty surrounding some of the proposals. Nonetheless, we thought it would be helpful to highlight the Administration’s proposals and some of the questions we are eagerly anticipating clarity on.
Many of the revenue proposals included in the American Families Plan mirror proposals that candidate Biden advocated on the campaign trail. Revenue proposals of particular interest include:
- Increasing the top tax rate on ordinary income of individuals from 37 percent to 39.6 percent. The fact sheet suggests that the proposal would “apply only to those within the top one percent.” Today, the White House clarified that under the proposal, the highest income tax bracket for single and joint filers would begin at around $453,000 and around $509,000, respectively. These cutoffs are consistent with the IRS’ latest Statistics of Income, which suggest that to capture the top one percent of taxpayers, the cutoff for all individual tax returns would need to be set around $500,000.
- Taxing capital gains and dividends at the same 39.6 percent rate for households making over $1 million. The fact sheet does not state how the $1 million threshold is calculated. Further, the fact sheet indicates that the ARP would simply “equaliz[e] the rate paid on investment returns and wages,” which suggests the proposal may not recharacterize capital gains and dividends as ordinary income. This means that a future Republican-led Congress could simply lower rates to undo the proposal, as opposed to having to add back in provisions that were removed.
- Closing the “carried interest loophole,” beyond equalizing tax rates on ordinary income and capital gains. From the fact sheet, it is unclear whether the AFP proposes to merely change the rate or classification of carried interest, or whether the changes also extend to management fees. It seems that eliminating carried interest’s structural advantage, an aim of the proposal, might entail characterizing carried interest as ordinary income in all circumstances, regardless of an individual taxpayer’s income.
- Eliminating the step-up in basis at death for gains in excess of $1 million ($2.5 million for joint filers “when combined with existing real estate exemptions”) and taxing those gains except when the property is donated to charity. The AFP proposes to include “protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business.” However, it does not provide details on how those protections would operate. Interestingly, the AFP does not include President Biden’s campaign proposal to return the estate tax to 2009 levels, which would mean lowering the estate tax exemption to $3.5 million ($7 million for joint filers) and raising the estate tax rate to 45 percent.
- Repealing the deferral of gain in a like-kind exchange of real property under section 1031 for gains greater than $500,000. The TCJA amended section 1031 to apply only to like-kind exchanges of real property, which meant like-kind exchanges of personal property were no longer eligible for deferral. The AFP would take the TCJA amendments a step further by eliminating deferral of large gains on real property, defined to be those greater than $500,000.
- Making permanent the limitation on business losses in excess of $250,000 ($500,000 for joint filers) under section 461(l). This provision was originally enacted in the TCJA and recently extended through 2026 by the American Rescue Plan Act (“ARPA”).
- Making the 3.8 percent Medicare tax on earnings and net investment income applicable to all taxpayers earning more than $400,000. The fact sheet says the tax would be applied “consistently to those making over $400,000,” without providing further details. It is unclear whether that means eliminating the “lesser of” calculation for taxpayers making more than $400,000 or making other changes. Currently, the 3.8 percent Medicare tax applies to the lesser of a taxpayer’s net investment income or the amount by which the taxpayer’s adjusted gross income exceeds the applicable statutory threshold amount ($200,000 for single filers, $250,000 for joint filers).
Notably, the AFP appears to omit a number of President Biden’s campaign tax proposals, including reinstating the Pease limitation on itemized deductions and phasing out the 20 percent deduction for pass-through business income under section 199A, created by the TCJA.
Increased reporting, enforcement, and regulation
The AFP also proposes to increase revenue through enhanced reporting, tougher enforcement, and stricter tax preparer regulation. Notable proposals include:
- Requiring financial institutions to report information on account flows to increase tracking of earnings from investments and business activity. While details on this proposal are limited, to be effective it seems the proposal would likely have to apply to all accounts, regardless of size. Consistent with the general themes of the AFP, enforcement efforts could be targeted only at those taxpayers with income over $400,000. However, considering the significant privacy concerns the proposal is likely to present, it could be a bridge too far not only for Republicans, but also for centrist Democrats, such as Senators Manchin and Sinema.
- Increasing investment in IRS enforcement, with an emphasis on large corporations, businesses, estates, and higher-income individuals. With respect to individual taxpayers, the fact sheet states explicitly that the additional resources the AFP proposes would go toward enforcement against Americans with income of $400,000 or more.
- Giving the IRS the authority to regulate paid tax preparers. According to the fact sheet, the AFP calls on Congress to pass bipartisan legislation regulating tax return preparers. This reference is likely a nod to the Taxpayer Protection and Preparer Proficiency Act (H.R. 3330, 116th Congress), which enjoyed the support of a bipartisan group of House tax-writers in the last Congress.
Other noteworthy proposals
Also noteworthy are some of the AFP’s new investments and tax cuts, which include:
- Creating a national comprehensive paid family and medical leave program. Specifically, the AFP proposes the program guarantee 12 weeks of paid family and medical leave by its tenth year. According to the fact sheet, the program will provide workers with wage replacement of up to $4,000 per month, replacing 66 percent to 80 percent of wages depending on the worker’s average weekly wages. It is unclear whether the paid family and medical leave program being proposed is compulsory like that enacted in the Families First Coronavirus Response Act or voluntary like that program has subsequently become, or whether this program is designed to replace the Family and Medical Leave Act altogether.
- Extending tax benefits in the ARPA, including the child tax credit (“CTC”), earned income tax credit (“EITC”), the child and dependent care tax credit (“CDCTC”), and the expanded health insurance tax credits. The AFP proposes to extend the CTC, as enhanced by the ARPA, through 2025 and make the credit fully refundable permanently. It would also make permanent the expansions of the CDCTC and of the EITC for childless workers, both of which were enacted as part of the ARPA. Finally, the AFP includes a proposal to make permanent the ARPA’s subsidy for certain individuals who buy health insurance on their own.
A&M Tax says
President Biden’s American Families Plan will provide critical structure and direction to the current infrastructure talks. However, Democratic Senator Manchin has recently begun discussions with his colleagues across the aisle about what a scaled-down, bipartisan infrastructure plan ought to look like. It remains to be seen whether, in the process, Manchin may become a key obstacle to Democrats’ plan to pass the AFP quickly. Any reluctance on Manchin’s part to move forward will likely come down to whether centrist Republicans continue to negotiate in good faith and in sufficient numbers to make the exercise worthwhile. That said, because Manchin is expected to provide the 50th – and final – Democratic vote necessary to begin another filibuster-proof reconciliation process, Senate Majority Leader Schumer may not be able to bring legislation to the floor before Manchin’s bipartisan discussions have reached some sort of conclusion. The outcome of those discussions could ultimately determine which or how many of the President’s new proposals become law.
Please contact your trusted A&M Tax adviser if you have any questions regarding the proposed individual and estate tax reforms, including whether and how they apply to your particular situation.