The Biden administration and Democrats in Congress are developing legislation that would raise taxes for corporations and persons with higher income. This demographic is being targeted in response to the tax cuts of the 2017 tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA), which primarily benefited these same taxpayers. Part of the call for tax increases is an effort to change the nation’s distribution of wealth, a topic we addressed during the presidential campaign. The most pressing reason for these proposed tax increases is to raise funds for President Biden’s “Build Back Better” infrastructure plan, which envisions as much as a $3.5 trillion investment in new government programs such as expanded education access and expanded Medicare benefits, among other things.
But if the intent of this initiative is to increase taxes only for wealthy individuals, the question then becomes, how does the initiative define wealthy? The answer, interestingly, depends on the particular tax proposal. This article describes who might be affected if the changes in the Build Back Better plan are enacted.
The Biden administration stated that there would be no tax increases for those earning less than $400,000, making this the baseline for wealthier individuals. In 2010, this baseline was established at $250,000 in the Affordable Care Act, passed when President Biden was Vice President. But this is not necessarily the threshold for all of the proposed tax increases.
Individual Tax Rate Increases
Under the House Ways and Means Committee’s current discussion draft, the increase in the top individual income tax rate to 39.6% would affect single taxpayers with taxable income more than $400,000, married taxpayers with taxable income more than $450,000, and heads of households with taxable income more than $425,000. For married taxpayers filing separately, the threshold for tax increases would actually be $225,000 (significantly less than $400,000). Under the President’s proposals,, these levels would be $452,700 (single), $509,300 (married filing jointly), $481,000 (heads of household), and $254,650 (married filing separately). It is notable that any of these income thresholds are lower than the current income thresholds for the current top rate of 37%.
Capital Gains Tax
The next proposed tax increase for individuals would affect the fewest taxpayers. This is a proposed increase in the top capital gains rate. The House Ways and Means Committee’s current discussion draft would raise the capital gains rate from 20% to 25%, while the President’s proposal would raise the capital gains rate to 39.6%. While the House Ways and Means Committee did not provide details for the income level at which these rates would apply, the President’s proposal indicated that the threshold is set at $1 million for individuals, heads of household, and married couples filing jointly. For taxpayers filing as married filing separately, the threshold is $500,000.
It is notable that both of the proposed tax rate increases carry a significant “marriage penalty.” For either of these rates, a married couple could experience a tax rate jump if their combined incomes exceed the new thresholds, even though their separate incomes (considered hypothetically as single filers) would not be enough for the new higher rates.
Qualified Business Income Deduction
These two proposals are not the only tax hikes on the table for the wealthy. Senator Ron Wyden (D-OR) also proposed phasing out the qualified business income (QBI) deduction for those with income in excess of $400,000. This would amount to a significant tax increase for many “wealthier” owners of pass-through businesses. Presently, the QBI deduction provides those in the current 37% maximum rate bracket with an effective rate of 29.6% on their qualifying income. Thus, a phase-out of the QBI deduction concurrent with the other proposals could mean an increase of 10 percentage points in the tax rate on pass-through income for those that would be subject to the proposed 39.6% rate.
State and Local Tax Deduction Limit
On the other side, wealthier taxpayers could see a benefit under the proposed reconciliation bill. The Senate specifically called for consideration to reduce the burden imposed by the $10,000 state and local tax deduction limit (the SALT cap). This cap generally affects wealthier taxpayers more, as they are more likely to incur higher property taxes on valuable real estate or income taxes on pass-through business income. The SALT cap adversely affects these taxpayers the most. Currently, neither the President’s proposal nor the House Ways and Means Committee’s discussion draft address the SALT cap.
There are just two proposed domestic tax increases for corporations. However the first would affect nearly all corporations.
Corporate Tax Rate
The House Ways and Means Committee’s discussion draft proposes an increase from the current 21% rate to a maximum rate of 26.5% for corporations making more than $5 million. Corporations would see a tax rate reduction to 18% on the first $400,000 of income, and would maintain the current 21% rate on income up to $5 million. The benefit of the lower rates would also be recaptured for corporations making more than $10 million. On the other hand, the President’s proposal would simply increase the current 21% flat rate to 28%.
Moderates in the Senate, most prominently Senator Joe Manchin (D-WV), have stated that the President’s proposed rate is too high and that he favored a maximum 25% corporate tax rate. But because the President’s corporate rate is a flat rate, it would affect all corporations with a nonzero amount of taxable income. And combined with the President’s proposed capital gains increase, it could result in a significant tax increase on corporate shareholders. For instance, the new effective rate for shareholders could be as high as 56.51% (28% paid by the corporation and 39.6% paid by individuals on the remaining 72% in dividend distributions); and that does not include the 3.8% net investment income tax.
Book Income Tax
The other proposed domestic corporate tax increase would truly only affect the largest and wealthiest corporations. The House Ways and Means Committee’s discussion draft does not make a provision for this other corporate tax increase, but the President’s proposal includes a 15% minimum “book income tax” that essentially reinstates the repealed corporate alternative minimum tax (AMT). The President’s proposal would apply to corporations with net income of $2 billion or more, and the Department of Treasury estimates that only 180 firms meet this threshold (and of these, only 45 would actually owe the book income tax).
There are many other nuances included in the House Ways and Means Committee’s discussion draft, but the few provisions we highlighted demonstrate who will be considered “wealthy” for the purpose of suffering tax increases. Congress is moving towards tax increases for these wealthier taxpayers, with the passage of the budget resolution in the Senate and passage of a similar measure in the house (see our previous coverage, here). For the most part, it appears that they will hold to their promise of not raising taxes on those earning less than $400,000, with the notable exception of the marriage penalty that may affect certain couples. Because these measures are likely to change as they proceed through Congress, stay tuned for further updates. And if you have further questions about how these proposals may impact you or your business, please contact us.
Published on September 14, 2021