Increased taxes on the wealthy to fund plan to help American families

Following are highlights of the tax provisions in the AFP.

Extends or makes permanent enhanced tax credits for lower- and middle-income individuals. The plan extends or makes permanent key tax benefits enacted by the American Rescue Plan, including extending the enhanced child tax credit through 2025 and making full refundability of the credit permanent, making the earned income tax credit expansion for childless workers permanent, and extending the expanded child and dependent care tax credit and health insurance premium tax credit.

Raises taxes on the wealthy. The plan:

• Eliminates the rate preference for capital gains and other income:
• Increases the top tax rate from 37% to 39.6%
• Eliminates reduced rates for long-term capital gains and dividends for households making more than $1 million
• Treats carried interests for fund managers like ordinary income rather than capital gains, raising the current 20% basic rate to 39.6%
• Adds an income tax on most capital gains at transfer by gift or death as if they were sold just prior to the transfer to eliminate the so-called step up in basis that currently applies at death; includes a $1 million lifetime exclusion ($2 million for married couples with a tax-free transfer to spouses), an up to $500,000 exclusion relating to homes, and a deduction for the new income tax in determining the taxable estate of a decedent
• Applies the 3.8% Medicare tax consistently on high-income individuals making more than $400,000
• Eliminates like-kind exchange deferral for gains on real estate greater than $500,000
• Permanently restricts the ability to offset business losses in excess of $500,000 per year against other income

If all of the previously mentioned provisions are enacted, the highest federal tax rate on all types of income reported by certain wealthy individuals could be as high as 43.4%.

Reduces the tax gap. The AFP includes a number of provisions designed to reduce the tax gap, which generally is the difference between the taxes that are owed and the taxes that are paid on time. The plan includes roughly $80 billion in additional IRS funding for increased tax enforcement directed at corporations, partnerships, and wealthy individuals. It also includes a proposal to require financial institutions to annually report aggregate account outflows and inflows to the IRS and a renewed call for Congress to give the IRS authority to regulate tax return preparers, an initiative aimed at unlicensed professionals serving low- and middle-income communities. Part of the increased funding also would be directed to improve IRS technology and customer service.

Looking ahead

One of the interesting things about the AFP is what it does not include. For instance, the plan does not include a repeal of the 20% pass-through deduction that was part of the president’s campaign proposals. The deduction was created in the Tax Cuts and Jobs Act of 2017 (TCJA) to help equalize the difference between the newly enacted 21% corporate tax rate and the 37% individual tax rate. Likewise, the TCJA limit on the deduction of state and local taxes, a major issue for some Democrats in Congress, is not included in the plan. Both of these provisions are scheduled to expire at the end of 2025, which could be why they are not a focus of the president’s plan.

To date, few details have emerged regarding the president’s legislative proposals. For instance, no information about effective dates has been shared, though administration officials have indicated a preference against retroactive legislation. This provides little comfort to individuals who planned on a continued rate preference for capital gains and a stepped-up basis of assets at death. Hopefully, more information about how the initiatives will be translated into tax law, the effective dates, and other details will be forthcoming in the weeks ahead when the administration releases its budget request, which should include the “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals,” commonly known as the Green Book.

While similar, some of the president’s priorities differ from those of fellow Democrats in Congress. Given the slim majority that Democrats have in Congress, and the fact that Republicans so far have indicated little desire to adopt the president’s tax proposals, congressional managers will have to develop a package that can garner support from all Democrats in the Senate and most Democrats in the House. This legislation will take shape in the coming weeks and months. Taxpayers should consult with their tax advisers to keep abreast of the latest developments.