On May 28, 2021, the Treasury Department released the “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals.” These proposals are also known as the “Green Book” for both the American Jobs Plan and American Families Plan. These proposals are in the very early stages, and there is no guarantee they will become law. Business owners interested in tax planning should be mindful of a few of the proposals in the Green Book to determine if and how they might affect their plans if they do become law.
A summary of the key considerations and tax changes proposed in the Green Book for business owners to keep in mind is below:
Increase to Corporate and Individual Tax Rates
Under the Tax Cuts and Jobs Act of 2017 (TCJA), C-corporations are taxed at a flat rate of 21%, and individuals are taxed at a marginal rate that tops out at 37%. The Green Book proposes to increase the C-corporation flat tax rate to 28% and the top marginal tax rate for individuals to 39.6%. Please note that the proposed increases to the corporate and individual tax rates are still lower than the pre-TCJA rates. However, these increases and other proposed changes will dramatically change the fiscal landscape for business owners and individuals in 2021 and beyond.
Changes to Long-Term Capital Gains for Individual Taxpayers
One of the proposals in the Green Book is to eliminate the lower capital gains tax rate for individual taxpayers with an adjusted gross income of more than $1 million. Individuals who recognize income directly or through flow-through entities will pay different tax rates depending on whether the income is considered ordinary income or capital gain. Under current law, if an individual sells a capital asset that has been held for more than 12 months (i.e., a long-term capital gain), the sale is taxed at 20% on the excess over the individual’s tax basis in the asset. Under the proposals outlined in the Green Book, long-term capital gains would be taxed at ordinary income rates, with the top marginal rates for individual taxpayers set to increase from 37% to 39.6%.
Of greater concern to business owners looking to sell their business and individual taxpayers, the Green Book does not clarify when these changes to long-term capital gain taxes will become effective. The Green Book provides that the long-term capital gains tax increases would “be effective for gains required to be recognized after the date of announcement.” It is unclear if this retroactive effective date would be April 28, the date President Biden first announced the capital gain rate proposal, or May 28, the date the Green Book was released. Although controversial, retroactive taxes are generally considered legal, which could mean that business owners and individual taxpayers may not have the opportunity to effectively plan for these changes if signed into law.
Changes to Taxation of Gifts and Transfers at Death
Under current law, transferring an asset at death entitles the beneficiary to a stepped-up basis in the asset equal to the fair market value at the time of the transferor’s death. Put simply, all of the capital gains earned by the original transferor are wiped out and untaxed at death. The beneficiary then receives the asset with a fresh basis, so if they sell the asset in the future, they only have to pay capital gains tax on the gain in the asset’s value from the day it was received.
The Green Book proposes eliminating this step-up basis for beneficiaries at death and treats the transfer of an asset at death as a sale for fair market value. If passed into law, the beneficiary in the above scenario would have to realize a capital gain and pay taxes for the asset at the time it is transferred. The proposals do allow for a $1 million exclusion per person before these taxes apply, as well as certain excluded transfers to charities or family members. However, these changes could be detrimental to family-owned businesses that have not properly planned for these changes. If a married couple has grown a $12 million business, they could potentially be subject to tax on $10 million of gain when the second spouse dies. In this type of situation, if the business is the primary asset of the family’s estate, the family could be forced to sell the business to pay the capital gains taxes. Although the Green Book describes potential deferral options for family-owned businesses that could allow the family to defer the taxes due until the business is sold, it is not clear which businesses might qualify for such deferrals.
Start Planning Now
While the proposals outlined in the Green Book are sweeping and concerning for business owners, it is doubtful that the Green Book will be passed into law as currently written. Nonetheless, business owners with succession planning in mind should stay up to date with these changes and consult their professional advisors.
At Equinox, our team is experienced in helping business owners navigate a changing tax landscape. Speak with our corporate counsel attorneys to discuss your tax compliance and estate planning needs. Contact us at 425-250-0205 or firstname.lastname@example.org.
Legal Disclaimer: This article contains general information. Do not view this article as legal advice. Talk with counsel familiar with your unique business needs before taking or refraining from any action.