Recently, President Biden has proposed several tax law changes in his American Jobs Plan and American Families Plan. Outlined below are a few of the tax savings that could be significantly changed or eliminated under Biden’s plans.
Long-term capital gains and qualified dividends
Under current tax law, when an individual sells an appreciated asset that has been held for more than one year, the gain is taxed at a graduated rate. Generally, the highest tax rate is 20% provided the net investment income tax is not applicable. This rate also applies to qualified dividends.
Under the proposed tax law, long-term capital gains and qualified dividends would be taxed as ordinary income to the extent a taxpayer’s adjusted gross income exceeds $1 million ($500,000 for married filing separately). The effect would generally make the highest tax rate 37% provided the net investment income tax is not applicable.
1031 Like-Kind Exchanges
Under the current tax law, taxpayers that sell appreciated property used in a trade or business can defer paying capital gain tax on the sale if that property is exchanged for the same type or like-kind property. If certain requirements are met, the tax is deferred until a later recognition event.
Under the proposed tax law, taxpayers would still be permitted to defer the gain on a like-kind exchange up to an aggregate amount of $500,000 per taxpayer per year ($1 million for married filing joint returns). Gains in excess of $500,000 ($1 million for married filing joint returns) would be recognized in the year the real property subject to the exchange transfers.
A partnership is not subject to Federal income tax but instead passes the partnership’s income and losses to the partners. In addition, the items of income and loss retain their character when flowing through to the partners. The partners, in turn, must include the partnership items on their individual tax returns. One of the interests a partner can receive in exchange for services is an interest in future partnership profits, also referred to as “profits interests” or “carried interests.”
Under current tax law, income attributed to a profits interest is generally subject to self-employment tax, except to the extent the partnership generates income that is excluded from self-employment taxes.
Under the proposed tax law, generally, a partner’s share of income on investment services partnership interest (ISPI) in an investment partnership will be taxed as ordinary income regardless of the character of the income at the partnership level if the taxpayer’s taxable income from all sources exceeds $400,000. Additionally, the partner would be required to pay self-employment taxes on such income.
Stepped-up Basis Through Gift or Death
Under current tax law, when a taxpayer donates appreciated assets to a donee during life, neither the donor nor the donee recognizes gain on the gift. The donor’s basis is carried over to the donee and the donee recognizes the gain when the donee later disposes of the asset. In addition, when a donor dies owning appreciated assets, the donor’s heirs inherit the asset with an adjusted, or stepped-up, basis. The stepped-up basis inherited is the fair market value of the appreciated asset on the donor’s date of death.
Under the proposed tax law, a donor would realize the gain on the appreciated asset in the year of donation. The amount realized is the asset’s fair market value on the date of the gift over the donor’s basis. For a deceased owner who owns appreciated assets at death, the amount of gain realized is the fair market value on the owner’s date of death over the owner’s basis.
Social Security Tax Cap
Under current tax law, self-employment earnings and wages are subject to 12.4% social security tax and 2.9% Medicare tax on earnings either through the Self-Employment Contributions Act (SECA) or the Federal Insurance Contributions Act (FICA). The 12.4% social security tax is applicable up to a certain cap. In 2021, the cap is $142,800. An additional 0.9% Medicare tax is imposed on high-income taxpayers with income above certain levels. General partners and sole proprietors pay SECA on their net trade or business income. Limited partners are statutorily excluded from paying SECA on their distributive shares of partnership income but pay SECA on their guaranteed payments that are for services provided to, or on behalf of, the partnership. S-corporation shareholders are not subject to SECA tax. However, S-corporation shareholders must pay themselves a reasonable wage for services provided, which are subject to FICA.
Under the proposed tax law, all trade or business income of high-income taxpayers would be subject to the 3.8% Medicare tax. More specifically, for taxpayers with adjusted gross incomes above $400,000, the definition of net investment tax would be amended to include gross income and gain from any trade or business that is not otherwise subject to employment taxes. In addition, all revenue from net investment income tax, both raised under the current law and proposed expansion, would be directed to the Hospital Insurance Trust Fund. Further, limited partners and LLC members who materially participate in their respective companies and provide services would be subject to SECA tax on their distributive share of income, subject to certain threshold amounts. Further still, S-corporation owners who materially participate in the trade or business would be subject to SECA taxes on their distributive share of business income, subject to certain threshold amounts.
For additional questions related to how the potential tax changes may affect you, please contact BMD Tax Law Attorney Tracy Albanese at firstname.lastname@example.org or (330) 253-9195.