President Biden’s American Families Plan - what it means for you

A new top tax rate of 39.6%

A key takeaway is the proposed increase to the top rate of tax from 37% to 39.6%. Prior to the change, the top rate of tax has been 37% since 2018. The new 39.6% rate is expected to apply only to the top 1% of taxpayers. It is yet to be confirmed what level of income the new rate will apply to, and the start date. 

A doubling of the capital gains tax rate

The American Families Plan will also change how high earners pay tax on their investment returns, which will include capital gains and dividends. These are currently taxed at 20% for qualified dividends and long-term capital gains, plus the 3.8% Net Investment Tax, giving a total of 23.8%.  

Under Biden’s proposal, the top rate for long-term capital gains and qualified dividends will raise to 39.6%, plus the 3.8% Net Investment Tax, giving a total 43.4% top tax rate. The new rates will apply to taxpayers with annual income of more than $1m. The date this increase will apply from has not yet been announced. 

Capital gains at death

The proposal will also change how large estates will pay tax on appreciated assets at death. Currently an asset’s unrealised gain is not subject to capital gains tax at death. The asset gets a step-up in basis, meaning the heirs obtain a basis in the inherited asset of the market value at the date of death. Heirs could then sell their inherited assets immediately, and not pay any capital gains tax. 

Under Biden’s proposal, the step-up in basis for capital gains purposes at death will no longer apply for any gains of more than $1million. The unrealised gains in excess of $1million (or $2million per married couple) would be subject to a capital gains tax upon the deceased owner’s death. This could be at a rate of up to 43.4% as above.  

There are, however, relief measures being proposed for the passing on of family owned businesses and farms to heirs who continue to run the business, and the charge will not apply to charitable donations. The existing real estate exemption of $250,000 per spouse can also be factored in.

It has not been confirmed when the tax will apply, either at death or eventual sale. It’s also unclear if it will apply to lifetime gifts. Surprisingly, at the current time there is no proposal to reduce the current $11.7million estate tax exemption. 

More IRS audits

IRS audit rates have fallen over recent years, however the American Families Plan will allocate additional resources to the IRS so that they can increase tax audits for taxpayers with the highest incomes. Together with focus on large corporations, businesses and estates, it’s hoped that this will raise over $700billion revenue over the next decade. 

Closure of loop holes

There are also proposals to tax carried interest at ordinary income rates, as opposed to the current capital gains rates. This could increase the top rate of tax on carried interest from 20% to 39.6%. The like-kind exchange rules which allow investors to defer capital gains tax when they exchange assets for similar real estate, are also proposed to be changed where gains are greater than $500,000. 

What should you do?

Currently the American Families Plan is only a proposal, and it will be discussed and debated over the coming weeks. We will update you when we have more detail, including when the new rules will be effective. While no immediate action needs to be taken, if you hold assets with high unrealised gains, you could consider disposing of these before the proposed regulations are enacted. Likewise, it is a good time to review your estate planning, especially if you’re intending to pass on assets with large unrealised gains.