My earlier blog post addressed the issue whether retroactive tax legislation can constitutionally be enacted, in effect “setting back the clock” and making a law effective as if it had been enacted at an earlier point in time. In that post, I explained that the topic held special importance since it is no secret that the Biden Administration has a vast magnitude of tax increases in store. Taxpayers and professionals may have been wondering whether the inevitable tax increases will be retroactive not only to the date the bill may be introduced, but to an earlier date or perhaps to the very beginning of 2021. My blog post gave the skinny – yes, within certain parameters, retroactive tax laws can be enacted and have stood up to US Supreme Court scrutiny. Get ready for this as a distinct possibility especially, as discussed below with regard to capital gains tax rate increases.
The Greenbook is Here
On May 28, 2021 President Biden put forth the expected US$6 trillion budget for Fiscal Year 2022 (“Greenbook” proposal, available here). The President’s budget lays out the Administration’s proposals for spending, revenue, expected borrowing and generally opens Congressional communication that leads to
appropriations bills, tax expenditure and ultimately to revenue-raising legislation.
The Greenbook provides that for taxable years before January 1, 2026, the top marginal tax rate for the individual income tax remains at 37 percent. For taxable years beginning after December 31, 2025, the top marginal tax rate would be raised to 39.6 percent. For 2021, the 37 percent marginal individual income tax rate applies to taxable income over US$628,300 for married individuals filing a joint return and surviving spouses, US$523,600 for unmarried individuals (other than surviving spouses) and head of household filers, and US$314,150 for married individuals filing a separate return.
The Greenbook proposal sets out long-term capital gains and qualified dividends of taxpayers with adjusted gross income (AGI) of more than US$1 million (US$500,000 for married filing separately) would be taxed at ordinary income tax rates (see the above paragraph, with 37 percent generally being the highest rate through 2025 (40.8 percent including the net investment income tax if it applied) and after 2025, the rate rises to 39.6 percent (43.4 percent if the net investment income tax applies), indexed for inflation after 2022.
This proposal would be effective for gains required to be recognized after the date of announcement (generally understood to be April 28, 2021). If Congress agrees and the effective date of the law is made retroactive to April, then tax planning has already gone out the window for high-income investors to realize capital gains at the current lower tax rates.
A simplified example how the new rule would work – let’s assume the taxpayer has US$350,000 of long-term capital gains and US$850,000 in salary income. For simplicity, assume his total AGI is US$1.2 million. Under the proposal, the taxpayer would have US$200,000 of the long-term capital gains taxed at ordinary income rates (i.e., the excess over the AGI threshold US$1 million).
Gifting and Death – No Escape
President Biden’s plan would also change the tax rules for unrealized capital gains when assets are gifted or passed at death. Under current law, appreciation in asset value is not taxed when a gift is made of the asset (the recipient takes a “basis” in the asset that is called a “carryover basis”. It is the same as the basis held by the donor of the gift). Appreciation of the asset is also not taxed at the time of death. To make the parting a bit sweeter, heirs take a “basis” in the inherited assets in an amount that is “stepped up” to the fair market value at death.
Under the Greenbook proposal, gift donors and decedents would be taxed on capital gain upon a transfer to a donee-recipient or heir, as applicable. The tax would be based on the difference between the donor/decedent’s basis in the asset and asset’s fair market value at the time of gift transfer/death. A decedent would be permitted to use capital losses and carry-forwards to offset such capital gains.
Assets transferred to US citizen spouses and charities would be excluded. There would also be
a US$1 million per-person exclusion (US$2 million per married couple). The exclusion amount would be indexed for inflation.
Remember this new way of taxing gifts and bequests applies for income tax purposes. The separately imposed Gift and Estate tax rules will also apply to the transfers. Ouch! This proposal would not be retroactive, and would generally have an effective date commencing January 1, 2022.
All may not be lost. Let’s remember that Congress must still approve any changes in tax rates as well as any retroactive effective dates. There is already some pushback among some congressional Democrats concerning the President’s capital-gains tax plan.
Posted June 10, 2021
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