Tax breakdown: President Biden’s capital gains tax proposals
On May 28, 2021, the U.S. Treasury issued the “Green Book” that describes President Biden’s tax proposals as connected with the 2022 budget.
Of concern to many taxpayers, and of course, tax preparers, are the proposed changes to capital gains. This article examines the five proposed changes and the implications of each potential change on tax planning purposes. Let’s dive in!
4 proposed changes to capital gains tax
1 . Tax capital gains at ordinary rates for high-income taxpayers
The long-term capital gains and qualified dividends of taxpayers with adjusted gross income (AGI) of over $1 million ($500,000 MFS) would be taxed at ordinary rates with this change, with 37% generally being the highest tax rate. Adding the 3.8% Net Investment Income Tax (NIIT) results in a combined rate of 40.8%. Additionally, the $1M/$500K thresholds would be indexed for inflation after 2022. It seems that for sales after 2021, the top rate for capital gains would be 39.6%, which comports with the top individual rate under the new plan.
The proposal would be effective for gains recognized after the date of announcement. The date of announcement could be considered April 28, 2021, which was when the American Families Plan was first announced. It also could be considered May 28, 2021, which is when the Green Book was released. The date could change as this law makes its way through Congress, at which point it may be too late for affected clients to sell appreciated assets and enjoy the current lower capital gains rates.
2. Treat transfers of appreciated property by gift or upon death as taxable events
A donor or deceased owner of appreciated property would have to realize a capital gain at the time of the transfer with this change. The gain would be considered taxable income to the decedent on the Federal gift or estate tax return or on a separate capital gains return. Capital losses and carryforwards could be used to offset the capital gains on the decedent’s final tax return. Taxes paid upon death would be allowed as a deduction on the decedent’s estate tax return.
Certain exclusions would apply, such as:
- Transfers by a decedent to a spouse or charity would carry over the basis.
- Capital gains would not be recognized until the surviving spouse dies or disposes of the property.
- Gains on personal property such as household furnishings and personal effects (excluding collectibles) would not be recognized.
- The $250,000 per person exclusion of gain on a principal residence would continue. With portability to the surviving spouse, the total exclusion would be $500,000.
- The section 1202 exclusion on qualified small business stock would apply.
Also, the proposal would allow a $1 million per-person exclusion from recognition of gains on property transferred by gift or at death. This threshold would be indexed for inflation and would be portable to the surviving spouse. The donee’s basis in gifted property would be the donor’s basis to the extent the unrealized gain on that property counted against the donor’s $1 million exclusion from recognition.
The proposal would be effective for gains on property transferred by gift, and on property owned by decedents dying after December 31,2021.
3. Some unrealized appreciation recognized
Gain on unrealized appreciation would also be recognized by a trust, partnership or other non-corporate entity that is the owner of the property, if that property has not been subject of a recognition event within the past 90 years.
Special relief would be provided for family owned and operated businesses. Payment of tax on the appreciation of assets would not be due until the interest in the business is sold or the business ceases to be family owned and operated.
A special 15-year fixed-rate payment plan is allowed for the tax on appreciated assets other than liquid assets. This can include publicly traded securities and family owned businesses for which the deferral election is made.
4. Repeal of deferral of gain on certain like-kind exchanges
Since the Tax Cuts and Jobs Act, only real property may be exchanged tax-free. The proposal would tax any real property gains in excess of $500,000 ($1 million MFJ). The proposal would be effective for exchanges completed in taxable years beginning after December 31, 2021.
Observations – Opportunity zone funds
Will opportunity zone (OZ) funds become more attractive should these capital gains changes be made? If a proper election is made, capital gains invested in OZ funds are excluded. Further, a taxpayer who invests capital gains in an OZ fund could permanently exclude 10% to 100% of the invested gains (depending on how long the investment is held).
It’s clear that if even some of these changes are implemented, there will be implications for both taxpayers and tax preparers. Tax practitioners need to alert their clients to the potential changes in case clients need to act quickly to protect their interests. By understanding these proposed changes, you can better serve your clients and prepare for tax planning changes as soon as possible.