From Angela Bao
June 17, 2021
(Photo credit): Gettyimages.com/Warunya Pamee / EyeEm
A breakdown of President Biden’s proposed changes to the tax law to fund the Build Back Better plan.
As part of his three-part Build Back Better plan, President Joe Biden designed a series of tax proposals to pay for the planned infrastructure improvements and at least four additional years of free public education for children. The proposed changes would increase taxes for businesses and wealthy Americans, as well as extend certain tax breaks, which are expected to expire by the end of 2021.
Here are the top changes Biden has proposed that business owners and individuals should be aware of.
What is the Build Back Better Plan?
President Biden’s Build Back Better plan has three parts: the American Rescue Plan (which has already been passed), the American Jobs Plan, and the American Families Plan.
The American Rescue Plan provided people with direct relief by sending out stimulus checks for $ 1,400 per person who received unemployment benefits through Aug.
The American Jobs Plan is Biden’s proposal to invest nearly $ 2.3 trillion in infrastructure and jobs over an eight year period, funded primarily through increased taxes for companies over 15 years. The Jobs plan provides $ 1.3 trillion in transportation and community infrastructure spending, which spans areas like roads and highways, public transportation, electric vehicles, safe drinking water, housing, broadband internet, and more. An additional $ 580 billion will also be allocated to human resource development, research and development, and manufacturing, with an emphasis on investments in semiconductor manufacturing, medical manufacturing, small business, and clean energy.
The American Families Plan provides $ 1.8 trillion to help families and workers and is funded primarily through tax increases for high-income Americans. The family plan provides at least four additional years of free public education for children; Providing 12 weeks of guaranteed paid parental, family, personal sickness / safety leave for workers; and make some tax credits implemented in the American Rescue Plan permanent.
Breakdown of proposed corporate taxes
In 2019, the Institute on Taxation and Economic Policy found that 379 Fortune 500 companies that were profitable in 2018 paid an average effective federal tax rate of 11.3% on that year’s corporate income, which is roughly half the current statutory corporate tax rate of 21%. . Of those companies, 91 of them (including big names like Amazon, Chevron, and IBM) effectively paid no federal taxes on their U.S. earnings in 2018.
Peter Hong, senior vice president of wealth management at East West Bank, says the biggest proposed tax change in the American Jobs Plan is to raise the state corporate tax rate to 28%. This tax rate will still be lower than the corporate income tax rate of 35% in effect from 1994 to 2017 until the Trump administration enacts the Tax Cuts and Jobs Act. The American Jobs Plan will also remove the current exemption for the first 10% of foreign investment returns, abolish the preferential tax rate on remaining foreign investment profits, and impose a minimum tax of 21% on the income of multinational corporations (applied on a country basis).
Hong adds that Biden has also recently hinted that he will instead focus on a tax rate of at least 15% on corporate book revenue in order to get more GOP support for his plan.
Important findings from Biden’s tax plan
The biggest concern for companies, Hong says, is the impact the higher taxes could have on their cash flow. “Suppose a small business had a net profit of $ 10 million before tax,” Hong gives as an example. “Right now they only have to pay 21%, so they have to pay $ 2.1 million. But at the suggested rate of 28%, you need to prepare $ 2.8 million. Scale that to $ 100 million, and that’s a difference between $ 21 million and $ 28 million – that’s huge. ”
Even with high interest rates for certificates of deposit (CD), companies could still lose purchasing power after the tax hike. “So, given that working capital, we need to better manage that cash flow,” says Hong. Some solutions could include fixed annuities that yield higher interest rates that could help cover the difference.
“Fixed annuities typically pay much higher interest rates than CDs, with no interest rate risk or market risk,” explains Hong. “For private individuals, fixed pensions have additional advantages, such as a tax deferral. Company fixed pensions would enjoy higher interest rates but would not have the added benefit of a tax deferral. Therefore, the company’s own fixed pensions are taxed similar to a CD – interest income is taxable. ”
Breakdown of the proposed individual taxes
Hong says Biden’s proposal has many benefits for certain families, “such as families caring for children, elderly relatives, first-time home buyers and people buying electric vehicles, as well as low- to middle-income taxpayers.”
For example, the American Families Plan would extend the child tax credit, which has been increased to $ 3,600 per child under 6 and to $ 3,000 per child ages 6-17, to a total of $ 4,000 for one eligible child or $ 8,000 increased for two or more eligible children on the American Rescue Plan. Experts estimate that these measures could help reduce child poverty by 50%.
Some of the biggest changes Biden has proposed may affect the taxation of wealthy people. For the top 1% of taxpayers, the top tax rate would rise from 37% to 39.6%. Additionally, Hong notes that individuals who earn more than $ 400,000 a year will experience tax increases. “Currently, the maximum taxable income for Social Security is $ 142,800. So if you earn more than that amount, there will be no withholding social security tax afterwards, ”explains Hong. “But it looks like they are charging an additional 12.4% social security tax for people on high incomes.”
In the proposed plan, Biden would also remove the Section 199A deduction for these individuals and limit the itemized deduction to 28%, Hong says. For individuals making more than $ 1 million a year, the federal tax rate on capital gains could rise to 43.4% from its current 23.8%.
Another big change is Biden’s plans for state inheritance tax. “At the moment, a natural person is exempt from inheritance tax [for the first] $ 11.7 million; for a couple, that doubles to $ 23.4 million, ”says Hong. “The expectation is that there is a high probability that the individual tax exemption can be reset to $ 5 million or even lower to $ 3 million.” The proposal would also remove certain tax loopholes, such as the step-up-in base Rule that allows families to inherit property without paying taxes on any appreciation in value over time.
Here’s how to prepare for the upcoming tax changes
Biden’s tax plans are subject to change, but business owners and individuals should prepare as best they can. Hong recommends consulting an asset management advisor for “financial planning and individual advice” to plan the future.
“One thing I learned during the pandemic is that some business owners assume that their business will go on forever. They weren’t prepared for eventuality – they didn’t have enough cash on hand, ”said Hong. “They didn’t have a separate portfolio for their retirement, regardless of how their business went. This pandemic will change the world in many ways. Some industries are going to be completely turned inside out, and how we prepare, how we do our business, how we put our money aside, how we set up a separate retirement pool will change. ”
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