On Friday, May 28, 2021, the Biden administration released its Green Paper outlining the President’s revenue and policy proposals. Of particular interest to investors is the administration’s proposal to increase the tax on long-term capital gains from its current maximum rate of 23.8 percent (including the 3.8 percent capital gains tax) to a new rate of 40.8 percent for certain higher-income taxpayers to raise: Individuals with an adjusted gross income greater than $1 million when filing jointly and greater than $500,000 when filing separately as spouses or individuals. While no effective date is given, the Green Paper provides that the proposal would apply to profits recognized “after the date of announcement”, which could refer to the date the proposal was first published in April 2021 .
- The Green Book also suggests that the transfer of valued property, whether gifted during lifetime or inherited upon death, would be a taxable event for the transferor.
- Accompanying this proposed transfer tax would be a lifetime exclusion of $1 million per married couple, indexed to inflation. If approved, this proposal is expected to come into force on December 31, 2021.
- Taxpayers should consult with their income tax and estate planning advisors to determine the appropriate response to these potential changes.
Details of the tax rate changes
The increase in long-term capital gains proposed in the Green Book would be the first retrospective increase in capital gains in US federal tax history and would have potentially far-reaching implications. For example, such a tax rate increase would create a significant tax burden for owners of conduit companies who receive “phantom income” as a result of the conduit company’s undistributed profits should the conduit company dispose of their estimated capital assets. Additionally, in the context of selling a business, the parties would need to determine who should bear the brunt of the increased costs (ie, should the seller expect a higher purchase price from the buyer to account for the additional income tax expense).
The tax on the transfer of valued property proposed in the Green Book would effectively amplify the effects of the long-term increase in the capital gains rate by imposing an additional income tax burden on top of estate tax for many wealthy taxpayers. For example, under current law, a gift of a long-term capital asset valued at US$10 million on a basis of US$5 million would not give rise to income or transfer taxes provided the transferor had sufficient lifetime exemption. As of 2021, the tax exemption for lifetime gifts is $11.7 million per person and $23.4 million per married couple.
While under the Green Book proposal, the same $10 million gift would trigger a capital gains tax of $1,632,000 provided none of the $1 million exclusion had previously been used ($5 million profit minus $1 million exclusion , multiplied by the proposed rate of 40.8 percent). This does not include government tax.
Figure 1. Comparison of gift giving, current vs. future (if proposal accepted)
What that means for you
Taxpayers should consult with their income tax and estate planning advisors to determine the appropriate response to these potential changes. Although the Green Book is only a proposal and not law, it encourages investors to prepare for changes in how capital gains are taxed.