The American Jobs Plan and the American Families Plan (collectively the “Plan”) announced by President Biden on April 28, 2021, includes many tax proposals that have potentially significant tax changes to our readers. The following is a brief summary of certain provisions of the Plan that may be relevant to many readers. The provisions of the Plan are generally effective starting in 2022. However, there is one major exception for the changes to capital gain rates which is proposed to be effective at the Plan announcement date of April 28, 2021 (i.e., it is proposed to be retroactive notwithstanding the actual effective date of the Plan). Undoubtedly, there will be major changes to the Plan as proposed by the Biden Administration as it is negotiated in the legislative process. But, here are highlights as now proposed.
- Corporate Tax Rate. The Plan proposes an increase to the corporate tax rate from current 21% to 28%. For many readers business income is taxed on their individual income tax returns via pass- through entities such as LLCs and S corporations, and will not be directly affected by the change in the corporate tax rate.
- Low Income Housing Tax Credit (“LIHTC”). The LITHC has in the past been an important tax credit for taxpayers that invested in certain low-income housing projects. The Plan proposes an increase in the tax credit to incentivize investment in low-income housing projects by creation of an additional credit to be allocated to the states under a complicated procedure, but with the intent to increase the availability of the housing credit to more projects in underserved areas.
- Oil and Gas Tax Proposals. The Plan proposes several changes to the tax provisions related to oil and gas investments. The changes that most likely would affect our readers include elimination of the following; 1) Intangible Drilling Expense (“IDC”) which is the majority of expense to drill an oil or gas well and in most cases can be deducted in the year of drilling, 2) working interest exception to passive loss rules which allows passive investors in oil and gas projects to deduct losses in excess of income in the current year and 3) percentage depletion which allows a deduction for a certain proportion of production in excess of cost depletion. If these provisions are passed as proposed, they will have significant impact to the tax treatment for passive investors in oil and gas projects.
- Residential Solar Energy Credit. The Plan proposes that the current tax credit for residential solar panels and related equipment be increased to 30% of costs and expand qualification for the credit to certain storage battery equipment.
- Increase Marginal Tax Rate. The Plan proposes an increase in the marginal tax rate to 39.6%. The increase in the top marginal rates would be effective for married couples making more than $509,300 and individual taxpayers making more than $254,650.
- Capital Gains Tax Rate. In a major change to the manner in which capital gains are taxed, the Plan proposes an increase to a 37% rate for married couples making more than $1,000,000 and individuals making more than $500,000. The current capital gain rates are typically 20% and thus, this proposed change is very significant and taxes investment income similar to wage income. While this change may make the tax system more equitable for all taxpayers, it will likely negatively affect property sales. As currently written, the change in capital gains rates is also applicable to sales of residential property. Note again that the change to capital gain tax rates is proposed to be effective at the date of announcement of the Plan, April 28, 2021.
- Step up Basis. Currently, when a person transfers property by gift, the done of the gift takes a carryover basis for income tax purposes from the donor. However, at death, when property is transferred out of an estate, the basis is increased to the date of death fair market value (a “step up in basis”) tax-free. The step up in basis often times can be a major tax benefit because an inherited asset can then be sold largely free of capital gains tax. The Plan proposes a complicated system to treat transfers by gift or death as a deemed sale to tax the appreciation in the transferred asset. Although, there is an exemption for the first $1M value, this is a major change that will affect most taxpayers. In addition, determining basis of an asset held to death could be an accounting nightmare.
- Carried Interests. Many investments are set up in such a manner that the promotor or developer received what is known as a carried interest in the investment entity in exchange for creating the investment. Typically, this means that the promoter gets an additional interest in the investment after certain investment thresholds are met. When the investment is sold, the promoter may get capital gain treatment for its carried interest. The Plan proposes that all carried interests valued at more than $400,000 at sale, be taxed as ordinary income not capital gains.
- Tax Free Exchanges. For many years, investors in real estate projects have been able to defer tax on the “sale” of the real estate by using a technique known as a Section 1031 Exchange. In a Section 1031 Exchange, the proceeds of a sale would be exchanged into another property and there would be no capital gain until the property (or additional properties acquired by exchange) were sold and the proceeds not rolled into another property exchange. The Plan proposes elimination of all Section 1031 Exchanges starting in 2022. Although the language in the Plan proposal is unclear, it appears that any exchanges now in process, must be fully completed by the end of 2021. We suggest, unless there is further clarity in the legislative process that this means a sale and acquisition of replacement property completed by the end of 2021.
- Child Care Credit. The childcare credit is expanded for the next 4 years to $3600 annually for children under 6 and $3000 for children ages 6-17.
If you have any questions or concerns regarding taxation or estate planning, please feel free to contact Gary Kleiman, Steve Weiser or Mark Boscoe at 303-333-9810.