The Biden Administration tax increase proposals are working their way through Congress with some unanticipated resistance from Democrats but should these proposals pass, massive changes to our economy can certainly be anticipated. Some of the changes are being suggested to be retroactive.
Long-term capital gains and qualified dividends of taxpayers with adjusted gross income of more than $1 million will tax that income at ordinary income tax rates.
The proposal increases the tax rate to 39.6% (43.4% including the net investment income tax and Medicare Surcharge, plus any state taxes pushing the overall increase to well over 56.7% in states such as California), but only if the taxpayer’s income exceeded $1 million (or $500,000 for taxpayers who are married filing separately), indexed for inflation after 2022.
The Biden proposal would be effective for gains recognized after the date of announcement, however, that announcement could be interpreted as the date when the American Families Plan was first announced on April 28, the date being unclear but President Biden stated that he would like to see the effective date be April 28.
Biden in making the statement is attempting to prevent taxpayers from executing transactions now as happened with earlier tax reforms, and thereby avoiding the new higher taxes.
Step up in Basis
The administration also wants to eliminate the step up in basis on inherited assets from a decedent allowing an exclusion of $1 million on capital gains, indexed for inflation, and also excluding transfers by a decedent to a U.S. spouse or charity. The capital gain would not be recognized until the surviving spouse disposes of the asset or dies, and appreciated property transferred to charity would not generate a taxable capital gain.
The $250,000 per-person exclusion under current law for capital gain on a principal residence would apply to all residences and would be portable to the decedent’s surviving spouse, making the exclusion effectively $500,000 per couple. The exclusion under current law for capital gain on certain small business stock would also apply.
In addition to the above exclusions, the proposal would allow a $1 million per-person exclusion from recognition of other unrealized capital gains on property transferred by gift or held at death.
The per-person exclusion would be indexed for inflation after 2022 and would be portable to the decedent’s surviving spouse under the same rules that apply to portability for estate and gift tax purposes (making the exclusion effectively $2 million per married couple).
The recipient’s basis in property received by reason of the decedent’s death would be the property’s fair market value at the decedent’s death.
Historically, Congress passed a comparable change in the Tax Reform Act of 1976 but found it was unworkable in that it was considered administratively unworkable as very few taxpayers had the records, and therefore the law was impossible to apply. That law was repealed.
Elimination of IRC 1031
The Biden proposal also includes the abolishment of Internal Revenue Code 1031 wherein properties can be exchanged tax free.
The elimination of this IRC section will have extreme negative effects on the economy chilling trillions in real estate sales, and increasing the cost of transacting property transactions, and ultimately increasing the cost to business in increased rents that will be required by property owners to recover their costs.
This proposal alone will increase inflation on a dramatic and unprecedented scale. While the other proposals affect both the stock market and real estate sales, this proposal alone will have disastrous effects to the US economy. Hopefully, Congress will see the dangers thereto, but historically Congress fails miserably in seeing the implications of their actions, the worst of which was the passage of the 1986 Tax Reform Bill which again attacked real estate transactions, and then caused the economy to spiral into recession for almost 10 years.
Opportunity Zones
Changes in capital gains tax treatment could also negatively affect investors who have or will invest in Opportunity Zone (OZ) funds in that the proposals as to those investments are unclear but with the proposed rate changes OZs will be negatively affected unless specifically exempted from the changes. To date it appears that OZ’s will be impacted and how they would be impacted.”
It appears that IRC 1202 stocks, small-business stocks, have not been addressed, and the White House has stated they will be leaving that alone. Under IRC 1202 one can set up an enterprise and qualify as a 1202 small-business stock with the first $10 million of gain when sold will continue to not be recognized.
Peter Muffoletto is with Peter Muffoletto & Company and may be reached at (818) 346-2160, or you can visit www.petemcpa.com.