President Biden’s $1.8 trillion American Families Plan (AFP) represents the second installment of his “Build Back Better” campaign plan, and would more prominently position the government’s role in society. While his $2.3 trillion American Jobs Plan (AJP) would finance infrastructure spending primarily through additional taxes on corporations, the AFP has “wealthy” individual taxpayers footing the bill for child care and education spending. Congress must first agree on a strategy to formalize both the AFP and the AJP in legislation before it hones in on negotiations over the provisions from these two plans. But before the prospects are explored for the AFP becoming law, an analysis of its key components is in order.
The $1.8 trillion price tag on the AFP consists of several new government programs primarily designed to support the child care and educational needs of families. The AFP would invest $309 billion to provide “free” public education, consisting of $200 billion for pre-school to benefit three- and four-year olds, and $109 billion for two years of community college to benefit adults. The AFP would invest $225 billion in child care to subsidize its cost for low and middle-income families and to fund enhancements to the child care workforce. Another $225 billion would be invested in a federal paid leave program for sick and family leave, to cover situations ranging from maternity to military deployment and recovery from traumatic events. The AFP would also invest $200 billion to make permanent certain temporary enhancements to the premium tax credit, which is a subsidy for health insurance purchased on a “marketplace” exchange (such as HealthCare.gov). $197 billion would also be invested into educational initiatives that include Pell Grants, and strategies to bolster community college completion and retention rates among disadvantaged communities. And $45 billion would be invested to supplement programs that support the nutritional needs of children, including various school meal programs.
The remainder of the spending measures pertain to an extension of recent enhancements to three individual tax credits – the child tax credit, the child and dependent care tax credit, and the earned income tax credit. The extension to these tax credits will be explored later.
Individual Income Tax Increases
The new or enhanced government programs under the AFP would be fully funded, together with a surplus from the AJP, over the next 15 years. Unless otherwise noted, all of the individual income tax provisions under the AFP would be permanent. Concerning its headline individual income tax provisions, the AFP would:
Increase the Top Individual Tax Rate to 39.6%
This would reverse the cut to 37% under the tax law commonly known as the Tax Cuts and Jobs Act (TCJA), which is set to expire after 2025. Although the tax bracket income ranges are not disclosed, the AFP notes that “no one making $400,000 per year or less will see their taxes go up.” It is unclear how the maximum tax brackets would apply to single filers and married couples.
Increase the Long-Term Capital Gains Tax Rate to 39.6%
This would apply to “households making over $1 million,” and would apply to capital gains and dividends. Presently, the long-term capital gains rate is 20%, plus a 3.8% net investment income tax that also applies. The new combined rate on long-term capital gains would therefore be 43.4% (higher than the maximum rate on wage earners), and would actually exceed 50% when state taxes in certain jurisdictions are added.
Eliminate the Step-Up in Basis to Inherited Assets
Presently, Internal Revenue Code (IRC) Section 1014 generally allows the heirs to an estate to treat the fair market value of their inherited assets as the cost of those assets. This means that the heirs can subsequently sell the inherited property without paying tax on so much of the sales price that does not exceed this value. The AFP would eliminate any step-up in basis that exceeds $1 million (or $2.5 million per couple when combined with existing real estate exemptions). However, donations to charity would not be subject to this rule, nor would family-owned businesses and farms that are passed on to heirs who continue to run those family businesses.
Expand the Reach of Special Tax Rates on Carried Interests
Presently, IRC Section 1061 treats certain partnership interests received in exchange for the performance of services as a “carried interest” that is subject to taxation at short-term capital gains (i.e., ordinary) tax rates. The special tax rate generally applies when the holder does not satisfy a three-year holding period. Under the AFP, indicators are that provisions would “close the carried interest loophole” permanently, to equalize tax rates on the sale of carried interests with those applicable to wages. Presumably, this would be implemented by eliminating the exception for the three-year holding period or by significantly narrowing the scope of the exception.
Curtail Like-Kind Exchange Tax Deferral Benefits
Presently, IRC Section 1031 permits real estate investors to sell real estate and re-invest the proceeds into new real estate without paying tax. The AFP would limit the ability to defer gains in excess of $500,000 on such exchanges.
Make Permanent the Excess Business Loss Limitation
Presently, IRC Section 461(l) limits the amount of excess business losses that non-corporate taxpayers may deduct to $250,000 ($500,000 for joint filers) per year. The limitation presently applies to tax years beginning after 2020 and before 2027. The AFP would eliminate the expiration date of this provision.
Consistently Apply the 3.8% Net Investment Income Tax to High-Income Workers
The 3.8% net investment income tax generally applies to investment income (interest, dividends, capital gains, etc.) for taxpayers with incomes that exceed $200,000 ($250,000 for joint filers). The AFP states that “the application is inconsistent across taxpayers due to holes in the law,” and that this tax would be consistently applied to “those making over $400,000.” It is unclear what change the AFP would make to the 3.8% net investment income tax, but a possibility is a change to the treatment of non-passive business or rental income.
Other Income Tax Changes
As previously noted, the AFP would extend through 2025 recent enhancements to the child tax credit, the child and dependent care tax credit, and the earned income tax credit. Earlier this year, the child tax credit was temporarily expanded and increased (for 2021 only) to $3,600 for each child ages 0-5 and $3,000 for children 6-17, while also making the credit fully refundable (even if eligible taxpayers have no earned income). Compared to previous levels, those are increases of $1,600 and $1,000, respectively. Again, the AFP would extend the $3,600 and $3,000 levels through 2025.
Furthermore, the credit for child and dependent care expenses was temporarily expanded and increased earlier this year (for 2021 only) so that $8,000 of qualifying expenses ($16,000 for more than one child) are eligible. Compared to previous levels, those are increases of $5,000 and $10,000, respectively. Certain increases to the credit rates were made as well. As noted, the AFP would extend these enhanced levels through 2025.
Lastly, the AFP would increase IRS enforcement on “wealthy” individual taxpayers. Although it was not reported as part of the AFP, a press release from the U.S. Treasury department indicated that the Biden administration will direct “…roughly $80 billion to the IRS over a decade to fund an array of priorities…” that pertain to IRS enforcement “…against those with the highest incomes, rather than Americans with actual income of less than $400,000.” An increase in IRS enforcement on corporations was also part of the AJP. By comparison to present-day levels, this would represent nearly a 65% increase in the budget for the IRS.
Notably, the AFP does not mention any planned modification to the $10,000 deduction limitation on state and local taxes (SALT cap). The AFP also does not mention any planned modification to restore caps on itemized deductions (the so-called “Pease” limitation), or to impose limitations on the ability to deduct qualified business income deductions for certain higher-income taxpayers.
As noted initially, the prospects for passage of the AFP – and of the AJP – depend on the strategy that Congress chooses to formalize these plans into legislation. It is possible that the Senate may turn to its “Budget Reconciliation” rules to pass both of these measures. Our previous article detailed how these rules require only a simple majority vote in the Senate.
However, including both of these plans in one large Budget Reconciliation bill may be problematic. A massive reconciliation bill (which would total $4.1 trillion on a combined basis) could lead to opposition from those wary of government expansion, and could introduce uncertainty over garnering the support needed from all Senate Democrats in order to pass such a measure. For example, Senator Joe Manchin (D-WV) presently favors a 25% corporate tax rate over the AJP’s proposed 28% corporate tax rate.
The legislation must also clear the House, but universal support from Democrats is not guaranteed there either. For instance, Thomas R. Suozzi (D-NY) and Bill Pascrell Jr. (D-NJ) are leading an initiative to potentially block the AJP if the SALT cap is not also addressed. Further, Rosa L. DeLauro (D-CT) is leading an initiative to make permanent this temporary expansion of the child tax credit (together with the earned income tax credit), where the AFP would only extend these credits through 2025.
Because of these political dynamics, consolidation into a single reconciliation bill would be a complicated proposition that is potentially less certain to pass. As an alternative, the AFP and the AJP may be passed using two or more rounds of legislation. One proposal that was recently reported includes paring down the AJP to cover initiatives involving roads, bridges, and airports (which have Republican support) and pass that smaller bill using “regular order” in the Senate as a five-year surface transportation reauthorization bill. Then, the other remaining parts of the AJP would be included in an amendment to the fiscal 2021 reconciliation bill, where the AFP would be advanced as part of a fiscal 2022 reconciliation bill.
All of these strategies could theoretically be accomplished during 2021, but there are many complicated and moving parts. For instance, the revenue measures under the AFP will not offset the spending measures until 15 years later, which is outside of the 10-year window required under the Senate’s Budget Reconciliation rules. This could mean that parts of the AFP may not be eligible for that type of legislation.
The AFP and the AJP propose a combined $4.1 trillion expansion to government spending. Significant increases to individual income tax rates would be imposed under the AFP, while a significant corporate tax rate increase would be imposed under the AJP. All told, those wary of tax increases in general may want to begin thinking about pre-emptive moves to mitigate the impact of these increase, such as accelerating income or deferring deductions. Certain decisions may not have to be made until the time a 2021 tax return is filed in 2022, so there may be time to “wait and see” before engaging in these unique tax planning strategies. For more information about the AFP, please contact us.
Bill Smith is a Managing Director for CBIZ MHM’s National Tax Office. He can be reached at 301.907.2412 and email@example.com.
Nate Smith is a Director for CBIZ MHM’s National Tax Office. He can be reached at 727.572.1400 and firstname.lastname@example.org.
Copyright © 2021 CBIZ & MHM (Mayer Hoffman McCann P.C.). All rights reserved. CBIZ and MHM are separate and independent legal entities that work together to serve clients. CBIZ is a leading provider of tax and consulting services. MHM is an independent CPA firm providing audit and other attest services. This article is protected by U.S. and international copyright laws and treaties. Use of the material contained herein without the express written consent of the firms is prohibited by law. Material contained in this alert is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their business.