In 2020, Covid-19, the U.S. presidential election, the Tax Cuts and Jobs Act (the TCJA), and the Coronavirus Aid, Relief and Economic Security Act (the CARES ACT) dominated the estate planning landscape.
President Trump’s administration enacted the TCJA, overhauling the tax code in effect at the time. Generally, the TCJA reduced tax rates for the individuals, corporations, trusts, and estates. President-Elect Joe Biden is critical of the TCJA, having contended that the reductions favored those in the highest income tax brackets. In an effort to correct this perceived disparity, Biden has made the following proposals and has indicated the following intentions (collectively, the “Biden Plan”), aimed at raising taxes at the top levels. The key features of the Biden Plan from an estate-planning perspective are the increase in top individual income tax rates, the limitation on deductions, the taxation of capital gains as ordinary income, the repeal of stepped-up basis at death, and the reversion of the Federal exemption amount to pre-TCJA levels.
Individual Income Tax
The Biden Plan would restore the top individual income tax rate to its pre-TCJA rate of 39.6%. The Biden Plan would apply the same 39.6% rate to carried interest income, eliminating the special treatment of carried interest, and, for those with income of more than $1 million, capital gains and dividends (including the Medicare surtax, the top long-term capital gain and qualified dividend tax rate would be 43.4%). Taxpayers with income of more than $1 million might also face a mark-to-market regime for capital gains and dividends. Taxpayers with income under $400,000, however, should not see their individual income taxes raised.
The Biden Plan would make a number of changes to deductions under the current TCJA. Most significantly, it would cap the value of itemized deductions at 28% and would reinstate the Pease limitation on itemized deductions for higher-income taxpayers. Additionally, the Biden Plan would repeal the Internal Revenue Code Section 199A qualified business income deduction for taxpayers with income in excess of $400,000 and reinstate the state and local income tax deductions that were repealed under the TCJA.
Moreover, in an effort to close the income gap between wealthy and lower-income Americans, the Biden Plan would expand certain credits available to low- and middle-income taxpayers. Specifically, the Biden Plan proposes temporarily expanding the child tax credit to $3,000 per child for children ages six to 17 and to $3,600 for children under six during the pendency of Covid-19. It would also expand child and dependent care credit to $8,000 per child, making it refundable and payable in advance.
Biden also proposes forgiving student loan debt and not subjecting the forgiven debt to tax, expanding the work opportunity tax credit to include military spouses, enhancing access to 401(k) plans for workers, expanding the earned income tax credit for childless workers aged 65 and older, expanding access to ABLE accounts and providing renewable energy-related tax credits to individuals. The Biden Plan suggests creating a new refundable tax credit of up to $15,000 for first-time homebuyers, which would be paid when a buyer purchases a home (instead of on filing of the tax return following the purchase). He supports enacting a new renter’s tax credit to reduce rent and utility costs to 30% of income for low-income individuals and supports expanding the low-income housing tax credit.
For payroll taxes, the Biden Plan proposes a 12.4% Social Security Disability tax, split equally between employers and employees, on wages earned above $400,000. This tax would create a “donut hole,” where wages between $137,700, the current wage cap, and $400,000 would not be taxed for Social Security. In addition, Biden would create a $5,000 credit for long-term caregivers of elderly relatives or loved ones.
Property and Corporate Tax
The Biden Plan proposes eliminating or phasing-out Section 1031 “like-kind” exchanges. It is also possible that Section 1031 would apply only to individuals with taxable income under $400,000. Reform of Section 1031 in any capacity would raise significant revenue and could be seen as protecting small business. Biden’s proposals might also limit the ability of real estate investors with incomes of more than $400,000 to take losses as deductions against taxable income.
The Biden Plan would also eliminate the bonus depreciation rule for commercial property implemented under the TCJA, which defines internal improvements on commercial property as “qualified improvements,” reduces the depreciation life of qualified improvements to 15 years (from 30 years), and allows qualified improvements to have first year bonus depreciation of 100%. Biden’s proposal would revert the depreciation lives to 25 years for residential property and 39 years for commercial property.
The Biden Plan would increase the corporate tax rate from 21% to 28% with a 15% minimum tax on book income of corporations with income of $100 million or more. Biden also supports a repeal of the temporary net operating loss (NOL) provisions of the CARES Act, enacted in response to Covid-19, which allows NOLs incurred in 2018, 2019, and 2020 to be carried back for up to five years, while concurrently suspending the 80% taxable limit otherwise imposed for utilizing such NOLs.
In addition, Biden proposes increasing the global intangible low tax income (GILTI) rate on foreign income from 10.5% to 21% and imposing a 10% tax penalty on corporations that create jobs overseas and sell products back to America in order to avoid U.S. income taxes. He also supports a “claw-back” provision to force companies to return public investments and tax benefits when they eliminate jobs in the U.S. and send them overseas. There would also be an elimination of deductions for any expenses associated with sending jobs overseas.
On the other hand, Biden proposes tax credits for certain domestic business owners. For example, Biden supports a new manufacturing communities tax credit that would promote revitalization and renovation of existing or recently closed facilities. Projects receiving the credit would have to benefit local workers and communities. He also supports a new 10% “Made in America” tax credit for companies that invest in the U.S., in order to help revitalize the U.S. manufacturing industry.
The Biden Plan proposes creating tax credits for small businesses that offer retirement plans to employees, creating tax credits for employers who hire disabled workers and providing up to $30,000 in tax credits to businesses that improve the handicap accessibility of their workplace.
Estate, Gift, and Generation-Skipping Transfer Tax
President-Elect Biden has expressed an intention to decrease an individual’s Federal estate tax exemption amount either to $5 million per individual (and $10 million for a married couple) or to the pre-TCJA amount of $3.5 million per individual. This could be coupled with an increased top rate of 45%. Additionally, although Biden does not support a “wealth tax,” the Biden Plan might repeal stepped-up basis at death and, moreover, may cause unrealized capital gains to be taxed at death using the proposed increased capital gains tax rates.
Likelihood of Enactment of the Biden Plan
Whether any of the measures included in Biden’s proposals will become law has yet to be seen. The enactment of Biden’s proposals will depend in large part on the make-up of Congress. As of now, while the House appears to have a Democratic majority, the outcome of the Senate race is less clear. At this time, the Republicans have won 50 seats in the Senate and the Democrats have won 48 seats. The remaining two seats will be determined by the run-off elections in Georgia, which are to take place on Jan. 5, 2021. If one of these seats is won by the Republican candidate, it will prove very difficult for Biden’s Plan to become law, considering Biden will need at least 11 Republicans to cross the aisle to pass any measure that does not impact revenue or spending.
However, if both seats are won by Democrats, the President-Elect would be able to take advantage of “Budget Reconciliation,” which is a streamlined process for approving bills impacting revenue or spending and requires only a simple majority for passage. With a Senate divided 50-50, the tie-breaking vote would be in the hands of Vice President-Elect, Kamala Harris, and Biden’s Plan could be passed into law. Even were that the case, however, it is unclear that every measure in the Biden Plan would receive unanimous Democratic support in the Senate.
Finally, one needs to consider the effective date of any measures in the Biden Plan that may ultimately be enacted. Typically tax legislation is prospective and might not be effective until Jan. 1, 2022, or later (depending upon how long the enactment process takes). Sometimes, however, tax legislation is retroactive, in which case it would either be effective as of the date of introduction (which would in all events be sometime after the inauguration) or possibly even effective as of Jan. 1, 2021. Much remains to be seen.
Important Planning Considerations for 2020 and 2021
Given the changes implemented by the TCJA and the potential for the implementation of the Biden Plan in 2021, taxpayers should review their existing estate plans and consult with their tax advisors about how, where appropriate, best to take advantage of the higher exemption amounts while they are in all events available.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Joshua Rubenstein is national chair of Katten’s private wealth practice. Jonathan C. Byer is a partner in the private wealth practice, and Rebecca H. Lomazow is an associate.