On May 28, 2021, President Biden released new details about the administration’s tax proposals. We have provided below a brief overview of 7 key takeaways from the proposals that could have an impact on entrepreneurs and investors. We encourage you to continue to monitor these developments as they could have a significant impact on your structure and the amount of tax you will be paying in future years.
Notably, President Biden did not include a proposal to reduce the estate tax exclusion amount. However, the administration has proposed a new tax on gifts and transfers of appreciated assets during life or upon death.
President Biden has also not addressed reinstating the SALT deduction which remains limited to $10,000. We expect Democrats from high tax states, such as New York and California, to continue to push for removing the cap on the SALT deduction.
1. Capital Gains Tax Increase
President Biden is proposing to increase the capital gains tax rate from 20% to the top ordinary income rate for individuals with income over $1M. This would result in a federal effective tax rate of 43.4% on capital gains [39.6% individual rate + 3.8% net investment income tax].
The effective date of this increase is set for April 2021, when the original proposal was released.
2. Corporate Tax Rate Increases
President Biden has proposed to increase the corporate tax rate from 21% to 28%. Some moderate democrats prefer to limit the increase to 25%.
3. Individual Tax Rate Increases
The top individual tax rate would increase back to 39.6% beginning in 2022. This proposal is not receiving significant pushback and is expected to pass.
4. Self-Employment Tax Increases
Self-employment taxes would be imposed on the distributive share from all pass-through entities, including S Corporations and partnerships for individuals with income over $400,000.
5. Apply 3.8% Net Investment Income Tax to Active Income
The proposal contains an extension of the 3.8% net investment income tax to all business income for taxpayers with income over $400,000 to the extent that the income was not subject to employment taxes. This would effectively impose an additional 3.8% tax on all allocations of profits from LLCs, S Corporations, and partnerships that are not treated as a salary.
6. Elimination of 1031 Like-Kind Exchanges for Real Estate
The proposal includes a limit on the amount of gain that can be deferred under a 1031 like-kind exchange to $500,000 per individual or $1M for a married couple filing jointly.
7. Tax on Gifts of Appreciated Assets
President Biden has proposed a tax on gifts of appreciated property or transfers of appreciated assets upon death on the donor or decedent. Each taxpayer has a $1M exclusion from the tax. Certain exemptions apply, such as transfers to qualified charitable organizations and some transfers of small business stock. This tax would be in addition to any gift tax or estate tax that was owed with respect to the transfer, although a deduction against any estate tax due is permitted for transfers of appreciated property at death. The tax would apply for gifts or transfers made after December 31, 2021.
If enacted, this new tax would have a significant impact on estate planning techniques and may reduce the ability to use certain trusts to defer or eliminate estate taxes upon death. We expect significant pushback from moderate Democrats on this aspect of President Biden’s plan.