To fund infrastructure upgrades and new social programs, the White House has proposed a series of tax reforms. Here are answers to five key questions.
Tax-rate increases might be coming as part of the Biden administration’s plan to pay for trillions of dollars of additional federal spending on infrastructure and social programs. Among the initiatives outlined in the American Families Plan: raising the top marginal individual income-tax rate by 2.6 percentage points, increasing the capital-gains rate for high-income investors and ending an inheritance tax exemption.
Much uncertainty remains. The current proposals may be considered a starting point for some of the expected changes by Congress, which could also reject some or all of the administration’s proposals. If passed, the timing for many of the potential changes to the tax code likely wouldn’t take effect until next year, although some may take effect for 2021.
In their current form, what could the proposed changes in tax law mean for you and your family? Our Wealth Management strategists answer five of the top questions they’re hearing from clients:
The proposed tax plan would restore the top marginal income-tax rate to 39.6%, the same rate before the Tax Cuts and Jobs Act of 2017 cut it to 37%. For the year 2022, this proposed top marginal federal tax rate would only apply to taxable income above $452,700 for unmarried individuals, $481,000 for head-of-household filers, $509,300 for married individuals filing a joint return, and $254,650 for married individuals filing a separate return.1
Biden’s plan would also significantly alter the federal capital-gains tax treatment for high-income taxpayers. Under current law, these taxpayers pay 20% on long-term capital gains. The new proposal would tax long-term capital gains and qualified dividends as ordinary income for those with taxable income above $1 million. The Biden administration has proposed that this increase in the capital-gains tax rate be made retroactive to the date the American Families Plan was announced on April 28, 2021. As a result, new capital gains rates of 37% for high-income taxpayers would apply in 2021, matching the current-law marginal tax rate, and 39.6% in 2022 and beyond when the proposed increase in the marginal income-tax rate to 39.6% would take effect.
The Biden proposal would treat death as a recognition event that would trigger income tax on any appreciated assets owned by the decedent at death.
Under current law, the “cost basis” of assets, such as stocks, bonds or real estate, owned by a decedent at death is adjusted to the fair market value of the assets on the decedent’s date of death. That means that when the assets are sold, those who inherited them will only owe income taxes on any appreciation in the assets’ value that has occurred after the decedent’s death. Although the basis may be adjusted upward or downward, this adjustment is commonly referred to as a “step-up in basis at death.”
Critics of the step-up provision view it as a loophole that allows many wealthy Americans to escape income taxes on their appreciated assets by holding them until death and then passing them onto beneficiaries, who are never subject to income tax on that appreciation. The Biden proposal would treat death as a recognition event that would trigger income tax on any appreciated assets owned by the decedent at death. The Biden proposal includes a capital gain exemption of $1 million per person, or $2 million per couple. That exemption would be in addition to the existing exemptions of $250,000 per person or $500,000 per couple on the sale of a principal residence.1
The tax on the appreciation of certain family-owned and -operated businesses wouldn’t be owed until the business is sold or ceases to be family-owned and -operated.
3. Would the proposed reforms limit how much wealth I can give away free of federal estate and gift taxes?
The short answer is no. Under current law, an individual is exempt from federal gift and estate taxation on a combined $11.7 million in estate bequests and lifetime gifts. During the 2020 presidential race, the Biden campaign indicated that it wanted to lower the amount a person could pass on to beneficiaries free of federal estate tax to $3.5 million. The campaign also floated the idea of limiting the federal lifetime gift tax exemption to $1 million.2
However, in 2021 the Biden administration decided not to include that change in the American Families Plan,3 suggesting it is not currently under consideration by the administration. Unless Congress makes changes to existing law, after 2025, the exemption will revert back to a $5 million exemption per person (adjusted for inflation).
Morgan Stanley has found that changes to individual income taxes have little correlation with the economy's performance.
Morgan Stanley has found that changes to individual income taxes have little correlation with the economy's performance. In an analysis by our Global Investment Office, our strategists found a weak relationship between gross-domestic-product growth and changes in individual federal income tax rates since 1954. In fact, the correlation was measured at just 0.3, where 0.0 shows no correlation and 1.0 shows perfect correlation. A correlation of 0.5 or more is considered statistically significant.
The correlation between capital-gains tax changes and the performance of the S&P 500 stock index has been even lower—only 0.1—over the past 67 years. While the stock market's correlation with federal capital-gains taxes might be positive, the number is statistically insignificant. In short, higher federal capital-gains taxes have not directly translated into negative or positive equity returns.
President Biden has said he would like to raise the federal corporate tax rate from its current rate of 21% to 28%.1 According to the Morgan Stanley and Co. Research team, raising the corporate income tax to 28% could lead to a 6% decline in earnings for the S&P 500 in 2022. If the rate were raised to just 25%, the projected earnings decline would be 4%. Still, our strategists believe that while the federal corporate tax debate could drive volatility in equity markets, any direct impact to earnings would likely be manageable.
Find out more in Morgan Stanley’s report “U.S. Policy Pulse: Tax Policy FAQs.” Ask your Financial Advisor for a copy or find an advisor.