The Biden administration has rolled out its proposed changes to the tax code, which departs significantly from the tax policies enacted during the Trump administration.
Famers and small-business owners should be aware of the proposed changes, because the proposal has the potential to translate into higher annual taxes.
Importantly, before any proposed tax plan can become law, it must obviously be passed by Congress. The new tax proposals, if passed into law, will affect how attorneys and tax professionals recommend structuring farm liquidations and/or transitions of farms from one generation to the next.
It is therefore important for attorneys to be aware of the present proposal in order to meaningfully engage with clients and other professionals about farm planning matters.
President Biden’s tax plan includes significant changes to the income and capital gains tax, payroll tax, corporate tax, estate tax, and rules regarding stepped-up tax basis. Attorneys should brush up on some of the higher-profile tax policy proposals, so they can be prepared if or when any part of the plan passes through Congress.
Here are a few of the highlights.
Income and Capital Gains Tax
The tax rate for people with taxable income above $400,000 would go from 37% back to 39.6%.
For folks with taxable incomes above $1 million, the Biden plan also calls for treating capital gains as ordinary income, which would increase taxes on high-end earners from 20% to 39.6%.
President Biden’s plan imposes a 12.4% payroll tax on income earned above $400,000, evenly split between employers and employees. This would create a “donut hole” in the current Social Security payroll tax, where wages between $137,700, the current wage cap, and $400,000 are not taxed. A farm couple earning more than $400,000 a year from farm and off-farm employment would pay at least 2.6% higher income taxes.
The corporate tax rate would rise from 21% to 28%. This change will likely result in less farmers organizing C Corporations or electing for their LLCs to be taxed as C Corporations because of the higher tax burden.
Another key aspect of President Biden’s plan would be to reduce the estate tax exemption back to the 2009 level of $3.5 million, and increase the top tax rate to 45%. The current estate tax exemption is $11.7 million for individuals, which may double for married couples electing portability of any unused exemption available at the first spouse’s death.
The maximum tax estate tax rate is currently set at 40%. If the estate tax exemption is reduced, more family farms could face paying estate tax, due to the sheer volume of fixed assets needed to run farm businesses and the appreciating values of land sometimes due to land competition for other uses, such as residential development.
Ending the Step-Up in Basis at Death
President Biden’s tax proposal includes the ending of the step-up in basis at death on capital gains exceeding $100,000.
A stepped-up basis is the revaluing of the cost asset at the time of death to the current fair market value. Stepped-up basis allows estates (or other beneficiaries) to liquidate assets and avoid the tax that would have otherwise been incurred had the owner sold during life. Without stepped-up basis, estates will incur capital gains tax on the sale of assets or beneficiaries will inherit the deferred tax liability.
Under President Biden’s proposal, the capital gains tax would be assessed on the entire gain at a rate of 39.6%. If a farmer held highly appreciated land, depreciated machinery and equipment, or no-basis raised livestock, at death, the beneficiaries may be required to pay those taxes.1
Conclusion: Stay Tuned
Commentators have been predicting that certain of the Biden tax proposals will be difficult to pass and are not likely to be immediate priorities. Ron Aucutt, senior fiduciary counsel at Bessemer Trust Company writes, with regard to Biden’s tax plan, “not much and not soon:”
The legislative process in 2021 will be affected by the close margins in Congress. It will also be affected by some obvious priorities – COVID relief and prevention, social justice, environmental concerns, and infrastructure. But another priority is raising revenue, particularly after the 2020 surge of spending in response to the COVID pandemic on an emergency basis that postponed the issue of paying for it (appropriately so in an emergency). Even in 2021, raising revenue to make up for 2020’s spending will probably proceed with caution to avoid undoing some of the 2020 relief or jeopardizing the recipients of that relief. But sooner or later both Democrats and Republicans will have a keen interest in raising revenue again, although very likely with different reasons and different ideas how to do it and how to allocate the burden.2
Even with uncertainty of what will pass through Congress, it is important for attorneys to be aware of the potential impact of President Biden’s tax plan proposals in order to effectively engage with clients and other professionals.
This article was originally published on the State Bar of Wisconsin’s Agriculture Law and Rural Practice Blog of the Solo/Small Firm & General Practice Section. Visit the State Bar sections or the Solo/Small Firm & General Practice Section webpages to learn more about the benefits of section membership.
1 For a discussion of potential planning techniques resulting from the elimination of basis step-up, see Joan Crain and Justin T. Miller, “Stepping Away from the Step-Up in Basis at Death, A Global Perspective,” Leimberg Est. Pl. Newsletter #2825 (Sept. 17, 2020).
2 Ronald D. Aucutt, The Top Ten Estate Planning and Estate Tax Developments of 2020 (January 2021).