There's an iron rule for customers trying to abide by proposed federal tax law through Congress: Don't do it!
Most proposed tax laws never make it past the congressional hall of Congress, and whatever survives the order and hideout of the tax committee surgeons is often very different from the original. It therefore makes little sense to devote time, effort and memory cells to learning information that is very likely to become completely irrelevant. After all, your brain is already clogged with useless information about the six wives of Henry VIII and the War of the Spanish Succession. At least this stuff might show up as a question on Jeopardy one day! But tax laws never passed are as worthless as your old BlackBerry charger, your college dorm key, or the gamblers who got the Boston Red Sox for trading Andrew Benintendi.
The far better approach – proven and true – is to wait for bogus tax legislation to become actual tax legislation. Then you can pick up on the new law, read it carefully, inhale deeply all new ideas, and then exhale them again in the next breath for clients and friends.
So why write this article about the Biden Administration's pending federal tax proposals? For one thing, it's pretty much the only thing anyone talks about. On the other hand, there is probably still time to do something about it. As a tribute to the Titanic, consider changing the navigation before the icebergs appear.
Biden Income Tax Proposals
The White House has developed an ambitious income tax change agenda aimed at U.S. corporations and individuals making more than $ 400,000 a year.
Several administrative proposals were published in the US Treasury Department's “Green Book” on May 27 this year. One of them was that the US corporate tax rate would increase from its current 21% to 28%. An average state corporate tax in the range of 7 to 9% would raise the combined corporate tax rate to 35% or more, putting the US at the top of the list when compared to other countries.
The individual income tax rate would be increased from a maximum of 37% to 39.6% for those earning $ 400,000 under the proposals.
The Old Age, Survivor, and Disability Insurance (OASD) component of Social Security taxes, which currently expires at $ 142,800 of wage income in 2021, would resume at $ 400,000 (and count pass-through income as well). The 2.9% hospital insurance component would increase to 3.8% for incomes above $ 250,000. This gives the federal effective marginal tax rate on income 39.6% + 12.4% + 3.8% = 55.8% for income over $ 400,000. Add a state income tax (say, the Massachusetts one, which is 5%) and the total tax would be 60%.
The Biden government also suggests making death a taxable event – which means that taxpayers' estate recognizes an assumed sale of any valued assets they own when they die, with an appropriate deduction for federal estate tax purposes.
Biden suggests limiting the tax benefit of individual deductions to 28% for those whose income is more than $ 400,000, even if their marginal tax rate is (far) higher.
The administration would also tax long-term capital gains and qualified dividends at the ordinary income tax rate of 39.6% for individuals who earn income greater than $ 1 million. If you apply net investment income tax (3.8%) and state capital gains tax rates (which are 13.3% in California), the effective rate could be over 50%.
Similar exchanges under Section 1031 of the Internal Revenue Code would be limited to a profit of $ 1 million per annum per taxpayer.
However, the deduction for unlimited state and local taxes (SALT) would be restored under the “Green Paper”. Carried interest, a common arrangement among hedge funds, would, however, be treated as ordinary income rather than capital gain.
Inheritance and gift tax proposals
The administration has decided not to push ahead with any increase in inheritance and gift taxes, at least during the first round of tax increases. Instead, the President is proposing what is known as a “Canadian” alternative, in which all valued assets a taxpayer possesses on the day of his death are taxed as if they had been sold at market value.
However, inheritance tax “reform” (ie increases) is far from dead. President Biden tabled four proposals during his 2020 presidential campaign.
The first was to abolish the tax base increase on a person's wealth in the event of death. Next, the lifetime credit equivalent (for tax-exempt gifts and inheritance transfers) was reduced from its current $ 11.7 million per person to $ 3.5 million. (The credit for couples would drop from $ 23.4 million to $ 7 million.) The third proposal was to reduce the lifetime gift tax exemption to $ 1 million and make it exempt from inheritance tax decouple.
Finally, Biden proposed increasing the inheritance tax rate for larger taxable estates from 40% to 45% (as a result of lowering inheritance tax and gift tax exemptions).
When is the iceberg coming?
The immediate question – and the justification for this current, albeit guesswork – article is, "When will this legislation, if enacted, come into effect?"
First, a frightening observation: The Wall Street Journal published an article on May 27, 2021 that revealed that the Biden administration intends to raise the state capital gains tax to 43.4% … retroactive to April 28, 2021.
Can you do this?! The short answer is yes, you can. In 1993, on August 3, 1993, the Clinton administration signed a dramatic increase in income tax from 31% to 39.6% for individual taxpayers, which was also retroactive for the entire calendar year. The US Supreme Court later upheld the idea and the tax census began on January 1, 1993.
Many proposed tax changes go into effect the day the proposal is reported by the tax committee. So by the time you find out about the change, it will be too late to plan for it.
But if taxes are retroactive, you may not even have time until the end of 2021 to get your estate and wealth plans in order.
Today is the first day of the rest of our tax lives, and it can make sense to do things right away that would be helpful in all cases and that may not be allowed later. The planning options discussed here are practical strategies that work today – and are likely to be respected even if Congress later passes some or all of the Biden tax agenda.
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