Top 3 Tax Considerations for Business Owners in the American Jobs Plan and American Families Plan
On Friday, May 28, 2021, the Treasury Department released the “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals,” otherwise known as the “Green Book” for both the American Jobs Plan and American Families Plan. Generally, the Green Book provides more detail regarding the Biden administration’s tax proposals than the initial announcements. While none of these proposals are law—or anywhere close to law—they are a good indication of what the Biden administration will seek to implement and business owners engaged in tax planning should consider how—and when—these proposals might impact their plans.
The Green Book is over 100 pages and contains significant details about dozens of proposals, but here are three considerations for business owners, particularly family business owners in the midst of succession planning:
1. Taxation of Gifts and Transfers on Death. At present, transfers at death are entitled to a treatment known as a “step up in basis” whereby the asset’s basis is “stepped up” or increased to fair market value on the transferor’s date of death. Essentially, this “step up in basis” regime allows the transferor to eliminate all gain acquired during their lifetime, and the recipient takes the asset with a fresh basis, meaning that if they sell the asset in the future, they only have to pay tax on the gain in value of the asset from the day it was received. Put simply, all the gain the original transferor acquired is eliminated and is never taxed.
The American Families Plan eliminates the step up in basis and treats a transfer of appreciated property by gift as if it were a sale for fair market value, requiring the transferor to realize a capital gain at the time of transfer. This is a significant change in current tax policy. The Green Book softens this change by providing a $1 million exclusion per person before the tax kicks in, and allowing certain transfers, such as those to a spouse or a charity, to carry over the transferor’s basis. These exclusions allow small transfers, certain intrafamily transfers, and charitable gifts to escape the immediate tax realization.
For family-owned businesses, this could be a crippling tax. For example, a $10 million business owned and founded by a married couple would be potentially subject to tax on $8 million of gain at the death of the second spouse, which, if the business is the primary asset of the estate, could force a “distressed” sale of the family business to pay the taxes due. The Green Book includes certain deferral options, however, for family-owned and operated businesses, which might allow the family to defer the tax due on the $8 million of gain until the business is sold or ceases to be family operated. The Green Book does not provide sufficient detail for businesses to determine whether they might qualify for the family-owned and operated deferral option.
Currently, this proposal would be effective only for property transferred by gift or owned at death after December 31, 2021; however, business owners seeking to avoid application of this treatment should be prepared to complete all transfers well in advance of December to avoid a year-end crush.
2. Application of Ordinary Income Tax Rates to Capital Gains. One of the more controversial proposals detailed by the Green Book is the elimination of beneficial long-term capital gains rates for taxpayers with an adjusted gross income of more than $1 million. Currently, long-term capital gains are taxed at a 20% federal rate (23.8% including the net investment income tax, if applicable), but under the proposal they would be taxed at ordinary income rates, which are set to increase from 37% to 39.6%. Combined with the net investment income tax of 3.8%, long term capital gains could be subject to a combined rate of 43.4%.
However, what is most concerning to business owners who might be looking to sell their company is the proposed effective date, which is the “date of announcement.” No one is quite sure what that might mean, but it could be as early as April 28, 2021, meaning most planning opportunities have already been lost. While retroactive taxes are controversial and disfavored, they are generally considered legally possible, even if politically problematic.
3. Increase in Corporate and Individual Tax Rates. The Green Book has proposed an increase in the corporate income tax rate from the current flat 21% back to a flat tax of 28% for years beginning after December 31, 2021. Although lower than the pre-Tax Cuts and Jobs Acts of 2017 rates (which taxed most corporate income at 35%), this rate increase, combined with additional proposed restrictions, such as restricting interest deductions, and the scheduled expiration of R&D incentives and bonus depreciation, may dramatically change the fiscal picture for corporations in 2021 and beyond.
The American Families Plan would also increase the top marginal rate for individual taxpayers from 37% to 39.6% for couples with taxable income over $509,300, rather than the current $628,300.
It remains to be seen what the ultimate legislation will look like, and it almost certainly will not be identical to the current proposals in the Green Book. Business owners considering succession planning should be aware of these changes and factor in additional time to work with their advisors.