American Families Plan: What Does it Mean for Your Taxes?

The Biden Administration has announced its American Families Plan, with a focus on tax breaks for lower- and middle- income individual taxpayers and tax increases for higher income individuals. Proposals also involve the reversal of some of the provisions of the Tax Cuts and Jobs Act.

A number of commentators are looking at fall of 2021 as a likely timeframe for a combined bill to be enacted. The proposed tax changes are detailed below.

Tax breaks for middle-class taxpayers
The tax breaks proposed in the American Families Plan are primarily just extensions of the tax breaks contained in the American Rescue Plan passed earlier this year. The American Families Plan proposes these extensions:

– The enhanced and fully refundable Child Tax Credit would be extended through 2025, although some Democrats want to make it permanent.

– The enhanced and fully refundable Child and Dependent Care Credit would be made permanent.

– The enhancements for childless individuals to the Earned Income Tax Credit would be made permanent.

– Enhanced health insurance tax credits and premium tax credits under the Affordable Care Act would also be made permanent. Enrollments under the Affordable Care Act have picked up significantly since enactment of the American Rescue Plan and the administration’s extension of the enrollment deadlines.

Increases to individual tax rates
To help pay for these tax breaks, the American Families Plan proposes a series of tax increases. The proposal would reverse the reduction in the individual tax rates in the Tax Cuts and Jobs Act and return the top rate to 39.6 percent. The Administration has stated that there will be no tax increases for those with incomes under $400,000, leaving the possibility that there could be changes to the size of the 39.6 percent bracket, or other brackets down to the $400,000 level may also be adjusted. It is also not clear if the $400,000 level applies to single taxpayers and would be doubled for joint filers.

Increase in the capital gains rate
The American Families Plan also proposes raising the top capital gains tax rate for taxpayers earning over $1 million from 20 percent to the top ordinary income tax rate, proposed to be 39.6 percent. This would be the first time the differential between ordinary income and capital gain tax rates has been eliminated since the Tax Reform Act of 1986. The administration has indicated that they would like to make this tax increase retroactive to its announcement date.

Ordinary income for carried interests
Owners of private equity funds and hedge funds have long had a perceived advantage of being able to obtain capital gains treatment for their management of the funds. The Tax Cuts and Jobs Act increased the holding period for capital gains treatment from greater than one year to greater than three years. The American Families Plan would propose eliminating capital gains treatment completely. With the capital gain tax rate and ordinary income tax rate being proposed to be the same for those earning over $1 million, this change would primarily affect only those earning more than $400,000 but less than $1 million.

No more “stepped-up” basis for some
The American Families Plan proposes ending stepped-up basis at death for gains in excess of $1 million. In 2010, the year that the estate tax was eliminated for that year only, stepped-up basis was replaced by carryover basis. This proposal, however, appears to be focused on taxing gains in excess of $1 million at death. Those gains would therefore be potentially subject to both an income tax and an estate tax at death.

Although not included in the American Families Plan, President Biden had also campaigned on lowering the estate and gift tax exemption amount. There are discussions about excluding family-owned businesses and family farms to avoid forced liquidation of illiquid assets. Realization at death would avoid the carryover basis problem of having to track basis back to the basis in the hands of the prior generation or even earlier. It appears that not all Democrats are on board with this provision, and some would prefer carryover basis rather than taxing gains at death.

An end to like-kind exchanges on real estate
The Tax Cuts and Jobs Act ended like-kind exchanges for personal property but retained it for real property. The American Families Plan proposes to also end like-kind exchange deferral for gain on real property in excess of $500,000. This also creates issues of taxing gain when there may be no realization event providing liquid funds to pay the taxes.

Expand Medicare tax to business owners
During the campaign, President Biden proposed phasing out the 20 percent qualified business income deduction for passthrough businesses, which was enacted as part of the Tax Cuts and Jobs Act and set to expire in 2026. While that proposal did not make it into the American Families Plan, the new plan does propose expanding the 3.8 percent Medicare tax to passthrough business owners earning over $400,000. This would limit one of the perceived advantages of the S Corporation structure—the ability to have both compensation subject to employment taxes and return on investment not subject to employment taxes.

Limitation on excess business losses
The American Families Plan proposes making permanent the existing provision imposing a limit on excess business losses, which under current law is scheduled to expire in 2026.

Increase in IRS funding
An important projected revenue raiser in the American Families Plan is an increase in IRS funding by $80 billion over a 10-year period. This becomes a revenue raiser from projections that the increase funding could help the IRS increase tax revenues by over $700 billion through greater enforcement activity and upgraded technology. The proposal would also expand the ability of the IRS to regulate tax return preparers. To further enhance third-party reporting, which also improves compliance, financial institutions would be required to report to the IRS business and investment activity, inflows and outflows, in the accounts of taxpayers held at that institution.

Planning for these changes and their effective dates
In planning for these possible tax changes, the likely effective date can be important. At this point, we do not have legislative language, so the effective date for these proposed changes is unknown, but the administration is in general pointing to an effective date of January 1, 2022 for many of the provisions.

Congress generally does not impose tax increases retroactively, but there have been exceptions. Tax changes involving transactions are more likely to have an earlier effective date than tax rate increases, sometimes as of the enactment date, but sometimes effective back to the date the change was first proposed, as is being suggested for capital gains changes. It is not clear at this point how much room there might be for taxpayers to try to make anticipatory changes, such as realizing capital gains or doing like-kind exchanges of real property, before these proposed changes would become effective.

There will likely be some version of tax legislation enacted this year, but the compromises that might be needed to achieve passage, even under budget reconciliation, may force changes to many of these proposals.

For questions about these proposed changes or any other related manner, contact your Weiss tax professional at your convenience.