Noted Washington observer and tax expert Andy Friedman recently told American Century Investments clients that high-income Americans and corporations will likely take the brunt of proposed federal tax hikes. Friedman said the changes likely would take effect at the beginning of 2022, with the exception of some provisions that could take effect this year. He made his remarks during a Sept. 14, 2021, webinar.
Friedman said many elements of the plan are similar to President Joe Biden’s tax proposals with new twists. Revenue from tax hikes would fund spending for an expansion of social programs such as health care, education and efforts to fight climate change.
The House Democratic lawmakers’ plan includes raising the top rate for the highest earners from 37% to 39.6%. It also would impose a 3% surtax on people making more than $5 million. The plan doesn’t raise the $10,000 cap on deductions for state and local taxes (SALT), but Friedman believes lawmakers could add this adjustment as negotiations continue. Raising the cap on SALT is a high priority for legislators representing high tax states such as New York, New Jersey and California.
The House proposal calls for raising the top tax rate on dividends and long-term capital gains from 20% to 25% for individuals earning more than $400,000 ($450,000 for married couples). This rate is significantly lower than Biden’s proposed 39.6% rate for households earning more than $1 million.
Notably, the House plan calls for an effective date for the higher capital gains rate retroactive to Sept. 13, 2021, the day the House Ways & Means Committee introduced the legislation. Friedman said making the hike retroactive would help avoid a market sell-off triggered by those seeking to realize gains at the current rate. He believes the retroactive date might change as the tax bill advances.
Under current law, those who inherit stock receive a stepped-up tax basis equal to the security’s value on the date of the benefactor’s death. This resets the capital gains calculation on the inherited shares, typically reducing a beneficiary’s tax liability when the asset is later sold.
Biden’s proposal would have eliminated this provision, but the House Democrats’ version doesn’t. Instead, the House proposal reduces the estate tax exemption from the current (approximately) $11.5 million to $5 million.
House Democrats are targeting a 26.5% top corporate tax rate compared with Biden’s proposed 28%, both higher than the current 21% rate. Meanwhile, corporate taxes on foreign income would rise from 10.5% to 16.6%, which also is lower than Biden’s proposal. Friedman thinks Senate negotiations could reduce the corporate rate to 25%.
There’s a long way to go before House and Senate lawmakers iron out details of the legislation. Friedman believes the final tax law will present investors with a mixed bag. Higher taxes are generally a headwind, and the higher corporate rate will take a bite out of profits.
On the other hand, the expansion of social programs will inject more stimulus into the economy, which should be a positive for the markets. Friedman also thinks that finalizing the tax plan will remove some of the uncertainty that’s been hanging over the market.
American Century prepared this summary based its understanding of Friedman’s presentation. There is no guarantee as to its accuracy or completeness.
The views expressed in this presentation are the speaker’s own and not necessarily those of American Century Investments. This presentation is for general information only and is not intended to provide investment, tax or legal advice or recommendations for any particular situation or type of retirement plan. Please consult with a financial, tax or legal advisor on your own particular circumstances.
Andy Friedman is not affiliated with American Century Investments.