To keep you informed on the latest tax negotiations from Washington, we will be issuing a weekly blog with the current news. Our first installment covers details of the proposed tax increases drafted by House Democrats and released on September 13. The plan falls short of the outline presented by President Joe Biden earlier this year, but still contains significant tax increases. Some highlights from the summary include:
- Corporate tax: Increase the corporate tax rate from 21% to 26.5%, less than the 28% included in President Biden’s outline. The proposal reinstates a graduated rate structure. Firms would face an 18% rate on income up to $400,000, 21% on income up to $5 million and 26.5% on any income above that. The benefits of the graduated rate would phase out for firms earning more than $10 million a year.
- Qualified business deduction: Pares back the 20% qualified business deduction many owners of partnerships, S Corporations and trusts currently receive by instituting a cap on the deduction of $500 thousand for joint filers, $400 thousand for single filers, and $250 thousand for a married person filing separate.
- Medicare tax: The proposal also subjects active trade or business income in excess of $500 thousand for a joint filer, $400 thousand for single filers, to the 3.8% Medicare tax. Currently this tax is only imposed on passive income such as interest, dividends, and capital gains.
- If this proposal passes, capital gains arising from the sale of a pass-through business would be subject to this additional 3.8% Medicare tax. Under the current tax system, this tax is not assessed on such gains.
- Individual income tax: Increase the top individual income tax rate to 39.6% and enforce a 3% surtax on individuals with adjusted gross income of more than $5 million.
- Capital gains tax: Increase the top capital gains tax rate from 20% to 25%, instead of the 39.6% included in President Biden’s proposal. Including the 3.8% Medicare surtax on high earners, the top capital gains tax rate could be as high as 31.8% for persons with adjusted gross income over $5 million.
- It is important to note the proposal contains language that makes this increase effective as of Monday, September 13, 2021, with special transition rules for deals with binding contracts that haven’t been completed yet.
- Estate and gift tax exemption: Cut in half the $23.4 million estate and gift tax exemption for married filers on December 31, 2021, four years earlier than set to roll back under the 2017 Tax Cuts and Jobs Act. Interestingly, the document does not include President Biden’s proposal to impose capital gains taxes on appreciated assets transferred at death. The proposal also limits certain estate-planning techniques, including some uses of grantor trusts and asset transfers with discounted values. The language surrounding this has not been released.
- Cryptocurrency: Include cryptocurrency in general tax rules, to treat it the same as other financial instruments and prevent taxpayer abuse of the rules.
- Carried interest: Increase the holding period for carried interest from three years to five years, rather than eliminate the tax break entirely.
- Research & experimental expenses: The measure delays the required amortization of research and experimental expenses until tax years beginning after December 31, 2025. This requirement is currently slated to go into effect for tax years beginning after December 31, 2021.
Major spending portions expected to be included in legislation have already been introduced and include a multi-year extension of the expanded child tax credit, set to expire at the end of the year, paid family medical leave, universal Pre-K and two free years of community college.
The slimmed down proposals, compared to those proposed by President Biden, are meant to appeal to more moderate Democrats. While the proposal is only a starting point for further negotiations, it appears Democrats are working hard to ensure full support within their own party.
Democrats intend to pass this legislation using a process called budget reconciliation that allows them to bypass Republican support. With narrow majorities in both chambers of Congress, Democrats can only afford three defections in the House and none in the Senate. Senator Joe Manchin, a moderate Democrat whose vote is crucial in the Senate, has continued to object to the originally proposed $3.5 trillion tax-and-spend plan and has floated a roughly $1.5 trillion headline number for the package.
The House Ways and Means Committee is expected to meet soon to debate the tax portion of the broader economic package. We will provide insight into what changes those debates bring in next week’s addition of Insights from Washington. If you have any questions, please contact us.