"You can’t always get what you want…you get what you need."
-The Rolling Stones
The Biden Administration’s three-point Build Back Better (BBB) initiative aims to bolster the post-pandemic economic recovery (a recovery that already has momentum in our opinion) and institute broad changes. In order to fund this goal, the initiative looks to raise taxes on corporations and select high income taxpayers. Though the BBB is being applauded by those who embrace fiscal spending and more social programs, it is unwelcome for those who fear higher tax rates. As we reminisce about prior first-term administrations and their ambitious tax plans we are reminded that they seldom get what they want – but usually get what they need. These plans are still proposals and must work their way through Congress – most likely through the process of budget reconciliation given the Democrats’ slim majority. Furthermore, the fears of individuals and corporations regarding – "how, and by how much" – these ambitious plans will affect them is usually overblown or misguided in hindsight. Let’s break the proposals down and, as we do, remain aware that it’s conjecture to think any or all will be passed, with or without modification.
The American Rescue Plan passed in March of this year was the first major bill to pass in the narrowly held Democratic majority in Congress and contained a few temporary tax provisions.While the bill’s primary focus was COVID-19 stimulus, the newly introduced American Jobs Plan and American Family Plan seek to make those tax provisions permanent. They also seek to extend the child tax credit and the child and dependent care tax credit through 2025, rather than expiring at the end of the year. This will have little to no effect for investors. Overall, the $1.9 trillion American Rescue Plan did not include any tax increases to pay for the stimulus; however, these two new proposals look to self-fund through corporate and individual tax rate hikes. Here’s where it gets interesting…
Infrastructure – a positive for discerning investors
In an overhaul of the nation’s neglected infrastructure, the American Jobs Plan directs more than $2 trillion towards the rebuilding of roads, bridges, and airports. Hundreds of billions of dollars baked into the plan would also fund long-term care access under Medicare. In order to pay for these expenses, the proposal would increase the corporate income tax rate from 21% (established under the Tax Cuts and Jobs Act of 2017) to 28%. It also would impose minimum taxes on multinational corporations and promote a global minimum tax in an effort to keep foreign countries from serving as tax havens. While these tax changes will not affect you, the individual taxpayer, it will certainly have an impact on corporate profits. Our investment team employs sector management, so that we can take advantage of those sectors that stand to benefit the most from increased infrastructure spending. On balance a positive for discerning investors.
Individual Tax Rates– Earned annual income of over $400,000 beware!
The third prong of the BBB initiative is the American Family Plan. The plan contains ambitious goals including providing Americans with two years of free pre-kindergarten and community college, as well as paid family and medical leave and will require major tax changes to do so. It is worth noting however that the tax increases are designed only to affect individuals earning more than $400,000 a year. The first major change would revert the top tax bracket to 39.6% from 37% for individual filers making $452,700 or more and married couples earning $509,300 or more. This change is likely and is not significant considering the change would have gone into effect anyway when Tax Cuts and Jobs Act of 2017 expires in 2025.
Capital Gains Rates –Annual earned income of over $1,000,000 beware!
In this proposal the BBB seeks to nearly double the highest long-term capital gains rate from 20% to 39.6% for taxpayers whose incomes exceed $1 million (at this time we do not know if the limit would be increased to $2 million for married couples filing jointly). This is significant for high income earners and we will be watching this proposal closely.
Inherited Wealth – More costly
In a change to inheritances, a more sweeping tax change would be the elimination of the “step-up in basis.” Under current law, assets received as part of an inheritance receive a “step-up” in valuation to current market value. The new proposal would keep assets valued at the price of the descendant’s original purchase, meaning that inheritors would have to pay capital gains taxes on the difference between the market value and the original purchase price if they chose to sell the asset – which may be costly for assets that have greatly appreciated in value.
Real Estate Investors- 1031 options become limited
Another proposal under the plan would adjust like-kind exchange rules for real estate properties, limiting the capital gains exemption to only $500,000 and taxing the difference.
As a reminder these proposals are subject to change as they go through the legislative process in both houses of Congress. Furthermore,just because one version of the bill passes in either the House or the Senate,there is no guarantee it will become law. Any changes that do get enacted would be unlikely to take effect until the 2022 tax year. We will be following these proposals as they evolve and will inform you should any come to fruition. As always, if you have experienced any changes in your financial situation or have questions about your portfolio, please let us know.
Thanks again from all of us for your continued vote of confidence!
Your Team at Main Street Research
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