Post-Election Analysis 2020: Tax
Read Ahead: General Outlook for Business Taxes | General Outlook for Individual Taxes | International Taxes | Tax-Exempt Organizations | Pharmaceutical Tax Issues | Clean Energy Tax Issues | Real Estate Issues | Legislative Proposals of Interest
In contrast to President Trump, President-elect Biden campaigned on increased taxes for businesses and the wealthy to support his "Build Back Better" campaign platform. Rather than standing alone, the tax proposals generally are tied to issues like climate change, infrastructure, and healthcare. Some are tied to penalizing off-shoring US businesses. Thus, a legislative "tax reform" effort, similar to the Tax Cuts and Jobs Act of 2017 (TCJA), likely will not be offered. Instead, tax policy changes are expected to be associated with domestic policy initiatives to offset their fiscal cost or to incentivize related behaviors.
Although the Democratic House is highly supportive of many of these changes, the Republican-controlled Senate is expected to oppose them. Rather than engaging in an exhausting fight to push for tax increases, such as raising rates on the wealthy or increasing the corporate income tax rate, the president-elect likely will employ tax proposals as part of economic stimulus measures to strengthen the economy still hampered by the coronavirus pandemic.
As discussed further below, the TCJA was enacted in 2017 as part of a budget reconciliation measure. The procedural rules of the budget reconciliation process required the TCJA to have either no revenue effect or a positive revenue effect in its tenth year. While these tax cuts are estimated to reduce revenues by $1.9 trillion during their first decade, in the tenth year (i.e., 2027), the Joint Committee on Taxation estimated the cuts will increase revenues by $32.9 billion. To achieve this counterintuitive result, the legislative drafters phased out many of the cuts, so that in the target year, the TCJA raised revenue. Consequently, future policy makers face the choice of either finding the votes to extend the tax cuts further or allowing the steep tax increases called for in the TCJA to come into effect.
The president-elect may face substantial criticism from the Republican-controlled Senate because of sky-rocketing debts and deficits. Early this year, the CBO projected deficits would exceed their 50-year average of 3% in each year through 2030, driving the national debt sharply higher, past its previous peak in 1946. The CBO estimates the deficit will be 109% of gross domestic product by 2030. Although the response to the pandemic drove much of the current year's deficit, long-term policies that pre-date the coronavirus pandemic have contributed significantly to the sky-rocketing debt. To address the deficit, we expect the executive and legislative branches would have to work together.
General Outlook for Business Taxes
President-elect Biden's tax policy will stand in stark contrast to that of President Trump. President Trump's tax policy generally has been favorable to businesses and corporations, while President-elect Biden's campaign platform included several proposals increasing taxation of businesses and the wealthy. With Republicans in control of the Senate, we do not expect significant tax changes in the 117th Congress, however, the parties may find consensus on smaller, targeted changes.
Current Policy: The TCJA included a number of tax provisions that benefit businesses, some of which will expire after 2025. The expiration of these provisions was rooted in the budget reconciliation procedure that governed their enactment, discussed above. The primary TCJA provision benefitting corporations was the replacement of the graduated corporate tax rates, which included a maximum rate of 35%, with a flat rate of 21%. The TCJA also repealed the corporate alternative minimum tax (AMT). With respect to businesses operating in "pass-through" form (e.g., sole proprietorships, partnerships, and S corporations), the TCJA introduced a special deduction for non-corporate owners of pass-through entities, allowing them to deduct 20% of certain qualifying pass-through income, subject to certain limitations, through the end of 2025 ("pass-through deduction"). Subject to the boundaries of President-elect Biden's campaign pledges, such as no increased taxes on those earning less than $400,000 per year, Democrats will likely target these provisions to raise revenue for other policy objectives. Senate Republicans, however, have the votes to block any such proposal from advancing. As a result, resolution of these provisions will likely be delayed until the year they expire, unless incorporated into other "must-pass" legislation.
Corporate Tax Rate: During the 2020 campaign, President-elect Biden proposed increasing the corporate tax rate from 21% to 28% and reinstating a corporate AMT. The proposed corporate AMT would be a 15% minimum tax on book income for corporations with at least $100 million in annual income. When calculating this new AMT liability, corporations would be allowed to claim credits for foreign taxes paid and deductions for net operating losses (NOLs) from other years.
Pass-through Deduction: With respect to the TCJA's pass-through deduction, President-elect Biden proposed maintaining the deduction for those making under $400,000 per year, while phasing the deduction out completely for higher earners. While House Democrats will largely support these proposals, opposition from Senate Republicans will make passage unlikely.
Social Security Taxes: President-elect Biden proposed subjecting income above $400,000 to the 12.4% social security tax. Currently, for salaried workers, such taxes are split equally by the employee and employer. Self-employed workers pay the entire tax themselves. In 2020, such taxes are applied only to income up to $137,700. Thus, President-elect Biden's proposal would impose social security taxes on income below $137,700 and above $400,000, but not on income between those levels. Senate Republicans are likely to oppose enactment of this proposal, limiting its chances of enactment in the next Congress.
Business Deductions and Tax Credits: President-elect Biden made a number of other proposals with respect to business deductions and tax credits. President-elect Biden proposed, among other things, expanding and making permanent the new markets tax credit program, expanding the work opportunity tax credit, creating a new childcare construction tax credit to encourage businesses to build childcare facilities at places of work, and creating a new manufacturing communities tax credit that targets communities that experience mass layoffs. President-elect Biden proposed ending many of the tax incentives available for businesses investing in fossil fuels and expanding several renewable-energy-related tax credits and deductions. While many of these proposals have some level of support from congressional Democrats, they may not garner enough moderate Democratic and Republican support in the Senate. Narrow, targeted proposals, especially those tied to economic relief from the coronavirus, may obtain the needed Senate votes.
General Outlook for Individual Taxes
Current Policy: President Trump's tax policy generally resulted in lower individual income taxes. The TCJA lowered the maximum individual income tax rate from 39.6% to 37%. The TCJA, however, imposed limitations on various itemized deductions, including a $10,000 cap on state and local income and property tax deductions, while doubling the standard deduction. With respect to wealth transfer taxes, the TCJA doubled the tax exemption amounts applicable to the estate, gift, and generation-skipping transfer taxes through 2025 (increasing the exemption to $10 million adjusted for inflation). The amount of the exemption will revert to $5 million (adjusted for inflation) after 2025.
While many elements of President-elect Biden's tax proposals are detailed below, opposition from Senate Republicans will pose a substantial hurdle to any enactment. Positions in Congress are starkly aligned, with congressional Democrats strongly opposed to TCJA provisions and disposed to support President-elect Biden's proposals, and Senate Republicans protective of the TCJA, and likely to use that opposition to extract leverage in any policy debate where the tax provisions are at issue. For that reason, broad enactment of a stand-alone tax platform is unlikely. Instead, elements of these proposals may accompany other legislative vehicles, such as budget and spending deals.
Individual Income Tax Rate and Deductions: President-elect Biden has proposed increasing the top individual income tax rate from 37% to 39.6% for taxpayers making more than $400,000. For individuals earning over $1 million, he proposed taxing long-term capital gains and qualified dividends at the rate of 39.6%, instead of the current maximum rate of 20%. President-elect Biden also proposed capping itemized deductions at 28% (i.e., taxpayers in brackets with tax rates higher than 28% will receive limited benefit from itemized deductions) and putting additional limitations on deductions of individuals earning above $400,000. In addition, President-elect Biden proposed ending the $10,000 cap on state and local tax deductions, a proposal House Democrats included in the HEROES Act and are likely to push for as part of an economic recovery package in the next Congress. While Senate Republicans will likely oppose repealing the cap, targeted changes like indexing the cap for inflation or fixing the marriage penalty may be possible.
Inherited Property: Under current law, when heirs inherit appreciated property, they receive a "step up" in tax basis, meaning they inherit the asset with a tax basis equal to its current market value. This minimizes or even eliminates the capital gains tax if the heir sells the property shortly after receipt, or reduces future gains if the heir holds the property. President-elect Biden proposed eliminating the step-up in tax basis that a recipient receives with respect to inherited property, in order to eliminate the opportunity for taxpayers to pass appreciated property at death without such appreciation ever being subject to income tax.
Tax Credits: President-elect Biden proposed expanding a number of existing tax credits and establishing new tax credits, such as, among other things, reinstating a home buyers' tax credit, introducing a new low-income renters' credit, and expanding the earned income tax credit and the child and dependent care tax credit. President-elect Biden also proposed cancelling student loans, tax-free, after borrowers have been enrolled in an income-based repayment plan for a specified period. These proposals may be attractive to House Democrats as a way to provide economic relief to individuals and families hit hard by the coronavirus pandemic, but may be seen as over-reaching by Senate Republicans, especially if they are not tied directly to the duration of the pandemic.
Retirement Benefits: President-elect Biden made a number of proposals with respect to retirement benefits, including with respect to 401(k) plans. Under current law, workers contribute pre-tax dollars to 401(k) plans and thereby reduce their annual taxable income, but pay full tax on those funds when they are eventually withdrawn in retirement. The upfront tax break is perceived as more beneficial for higher earners since deductions are more valuable the higher one's income tax bracket is. President-elect Biden proposed replacing this deduction with tax credits for each dollar contributed to a 401(k) plan. President-elect Biden also proposed to permit automatic enrollment in individual retirement accounts for workers who do not have a pension or 401(k)-type plan. There is bipartisan support for expanded retirement benefits, illustrated by the bipartisan introduction by the Chairman and Ranking Member of the Ways and Means Committee of the Securing a Strong Retirement Act of 2020.
President-elect Biden's international tax policy generally would increase taxes on income of businesses related to international activities. Under a divided Congress, it is likely the Biden Administration would advocate for higher taxes on international activities of tech companies and tighten several rules regarding current international tax laws. Ultimately, a Republican Senate would generally preserve the TCJA structure for international tax.
GILTI: The TCJA created a new category of income, called "global intangible low-taxed income" (GILTI), that is includable pro rata in the income of certain US shareholders of "controlled foreign corporations" (CFCs) without regard to actual distributions. This provision expands on the previous CFC rules by subjecting a portion of the active income generated by a CFC (and not just passive and related-party income) to current US federal income tax. The current tax rate on such income allocated to a US corporate shareholder of a CFC is 10.5%. Facing a Republican Senate, we believe President-elect Biden would pursue other tax priorities rather than aggressively pursuing his proposal subjecting GILTI of a US corporate shareholder of a CFC to the full corporate tax rate, which currently is 21%.
BEAT: President-elect Biden has not published any plans to change the current minimum base erosion and anti-abuse tax (BEAT), a provision enacted as part of the TCJA. The BEAT is generally an AMT on the modified income of certain large US corporate taxpayers with significant deductible payments to non-US related parties. The tax rate under BEAT currently is 10% and will increase to 12.5% after 2025.
Domestic Workforce Incentives: President-elect Biden proposed a plan for both tax breaks and penalties to encourage US companies to move or keep manufacturing jobs in the United States, which paralleled similar proposals from President Trump. He proposed a surcharge increasing a company's tax liability on non-US income by 10% if that company uses non-US manufacturing facilities to sell products into the United States. The charge also would apply to companies that remotely supply services to the United States. He also campaigned for a 10% advanceable tax credit for a variety of domestic investments, including revitalizing or retooling US facilities, and reshoring non-US production into the United States. The credit would also apply to expansion of US facilities or an increase in a company's wages. Given Republican support in the Senate, these proposals could be enacted separately from President-elect Biden's other international tax proposals and could form part of a legislative stimulus package.
Digital Taxes: While President-elect Biden has sharply criticized technology companies for their tax practices, his administration likely will continue the Trump Administration's stance opposing foreign digital taxes (i.e., those taxes imposed on online services or other revenue generated online). The Trump Administration, together with a bipartisan group of lawmakers, opposed the proliferation of digital service taxes, reasoning US firms would bear the brunt of these taxes. This issue has implications for the negotiations undertaken by the Organization for Economic Cooperation and Development's (OECD) base erosion and profit shifting (BEPS) project. The Biden Administration is expected to continue to take a hard line against proposals that unduly burden US businesses, though President-elect Biden has not indicated whether he supports the Trump Administration's proposal to make digital taxes a safe harbor regime.
Tax policies under President Trump generally were unfavorable for tax-exempt organizations. The TCJA imposed several new restrictions and requirements on tax-exempt organizations. These included requiring tax-exempt organizations to compute unrelated business income tax separately with respect to each unrelated trade or business of an organization (preventing a tax-exempt organization from using losses from one unrelated business to offset income from a different unrelated business), placing a 1.4% excise tax on the net investments of certain private colleges and universities with large endowments, and enacting a 21% excise tax on the excess renumeration of the five highest paid employees of applicable tax-exempt organizations. More generally, the TCJA increased the standard deduction for individual taxpayers while also capping the state and local tax deduction and eliminating some other itemized deductions, which raised concerns that charitable giving would decrease because individuals who previously itemized would have less incentive to donate. The TCJA also doubled the estate tax exclusion, which could potentially decrease charitable giving as a function of estate planning. Despite these concerns, there does not appear to have been a material decrease in charitable giving since the enactment of the TCJA.
President-elect Biden has not provided detailed policies with respect to nonprofit organizations. He has proposed scaling back the estate tax exclusion to $5 million from its current threshold of $11.58 million. Reducing this exclusion could increase charitable giving as part of estate planning. President-elect Biden also proposed the elimination of the step-up in basis for inherited assets. This could encourage individuals to donate more to charitable organizations during their lifetimes in order to minimize tax consequences at death. With a divided Congress, the Republican Senate is likely to block such policy proposals.
While President Trump had proposed the elimination of the so-called "Johnson Amendment," which prohibits 501(c)(3) tax-exempt charitable organizations, including churches, from supporting or opposing political candidates or participating in, or intervening in, any political campaign, this change was not widely supported by congressional Democrats. President-elect Biden is unlikely to propose this change.
In the near-term, nonprofit organizations have been affected by the COVID-19 pandemic. The CARES Act (Pub. L. 116-136) and the Protecting Nonprofits from Catastrophic Cash Flow Strain Act of 2020 (Pub. L. 116-151) provided relief to nonprofit organizations operating as "reimbursing employers" by offsetting 50% of the cost of unemployment benefits. Both the HEALS Act and the HEROES Act (H.R. 6800) provide some relief to nonprofit organizations through the Paycheck Protection Program and the expansion of the employee retention tax credit, although the HEROES Act generally provides more relief to nonprofit organizations, including creating a lending program for certain mid-size nonprofits serving low-income communities. Congress, however, is very unlikely to pass either bill in its current form. In addition, while the Biden and Sanders Unity Task Force Recommendations propose increases in emergency funding for school districts and public and nonprofit colleges and universities, such policies are unlikely to pass the Republican Senate.
Pharmaceutical Tax Issues
While President Trump's tax policy has been generally favorable to pharmaceutical companies (as opposed to his contentious relationship with the industry on trade matters), President-elect Biden frequently made statements during the 2020 election regarding "standing up to" pharmaceutical companies. However, with a divided Congress, President-elect Biden may not be able to achieve many, if not all, of the tax reform proposals discussed below. Instead, President-elect Biden likely will pivot to incentivizing the on-shoring of drug manufacturing and research and development, where there is some policy agreement with the Republican Senate.
While we expect the Biden Administration will seek policies that support research and development, he is also likely to propose tax policies that reduce tax benefits for pharmaceutical companies. For example, given the focus on drug pricing issues during the 2020 election, President-elect Biden proposed imposing a tax penalty on drug manufacturers that increase the costs of brand-name, biotech, and "abusively priced" generic drugs by more than the general rate of inflation. In addition, the president-elect promised to end a tax deduction for advertising spending for pharmaceutical companies as part of his proposal to address the opioid epidemic, which is similar to a 2018 proposal from Sen. Claire McCaskill (D-MO) (S. 2478 – 115th) and a 2019 proposal from Sen. Jeanne Sheehan (D-NH) (S. 73). The proposal would disallow a deduction for expenses related to direct-to-consumer advertising of prescription drugs. This bill had no Republican co-sponsors, and, in a divided Congress, this proposal likely will not law.
The TCJA contained several new tax provisions, including the BEAT and the GILTI provisions, which were intended to prevent companies from avoiding taxes by offshoring intangible assets. As a result of the reduced corporate effective tax rate for GILTI, the implementation of these provisions appears to have led to a lower effective tax rate for some pharmaceutical companies who moved intangible income, such as intellectual property, outside of the US, which has led to increased importations of pharmaceuticals. Due to supply chain difficulties raised by the COVID-19 pandemic, President-elect Biden proposed increasing the effective tax rate on GILTI earned by corporations, including pharmaceutical companies.
The TCJA also included a provision ending the election to expense or amortize research costs for tax years after 2022. Even under a divided Congress, we expect the repeal of this provision, allowing taxpayers to continue to elect to expense these costs.
Clean Energy Tax Issues
President-elect Biden campaigned on an extensive climate and clean energy platform, including promises to achieve net-zero emissions, economy-wide, by no later than 2050, as well as a carbon pollution-free power sector by 2035. Such achievements rest on, among other things, heavy subsidies for electrical generation, electric vehicle and charging deployment, and energy efficiency across residential and commercial buildings. We anticipate however, the president-elect will not make a concerted effort to enact a price on carbon due to the economic challenges posed by the coronavirus pandemic.
The Democratic controlled House of Representatives will strongly support these efforts, having vocally supported aggressive climate policies during the 116th Congress. Tensions, however, remain between more moderate and progressive factions of the Democratic Party, demonstrated by disagreements regarding the Green New Deal resolution and a proposed ban on fracking. Losses among House Democrats in the election will heighten these tensions. Senate Republicans will strenuously oppose expansive environmental and energy policies and will block the president's more ambitious proposals.
Given opposition from Senate Republicans to more expansive changes, elements such as an extension and expansion of existing measures, such as the Production or Investment tax credits for clean energy, as well as tax measures supporting deployment of electric vehicles and related charging deployment, and energy efficiency across residential and commercial buildings may be areas of modest bipartisan agreement, conceivably agreed to in an economic stimulus package.
Real Estate Issues
President Trump's tax policy generally favored the real estate industry. For example, the TCJA preserved the ability to do tax-deferred exchanges of like-kind real property (but eliminated such exchanges for personal property) and included favorable rules for the real estate industry in connection with the pass-through deduction. The TCJA also allowed for the deduction of 100% of the cost of certain qualifying property in the year such property is placed in service (so-called "bonus" depreciation).
During the 2020 campaign, President-elect Biden proposed to eliminate like-kind exchanges of real property (potentially only for filers with taxable income over $400,000) to fund some of his domestic policy priorities. While President-elect Biden's campaign promise was, at least in part, politically motivated to target President Trump's tax avoidance practices, the Biden Administration will face pressure to find ways to fill budget holes created by the coronavirus pandemic. According to the Joint Committee on Taxation, like-kind exchanges for real property are projected to save real estate investors $51 billion of taxes between 2019 and 2023. Therefore, elimination of this provision may be very attractive to the Biden Administration.
Aside from eliminating like-kind exchanges for real property, the Biden Administration is likely to propose tax policies, including repealing certain TCJA provisions, that will significantly impact real estate investors, such as increasing ordinary income tax rates and long-term capital gain rates. Similarly, President-elect Biden proposed phasing out the pass-through deduction for filers with taxable income more than $400,000, which would impact non-corporate taxpayers investing in real estate through pass-through entities. In addition, during previous campaigns, President-elect Biden criticized "bonus" depreciation, though his campaign has not provided details on what changes the Biden Administration would propose. President-elect Biden also proposed eliminating the $25,000 exemption from the passive loss rules for rental losses and accelerated depreciation of rental housing.
Based on previous campaigns, President-elect Biden may consider eliminating the "carried interest" provision. A manager of an investment fund, including real estate funds, typically receives as a component of its compensation, a so-called "carried interest," which is a percentage of the profits (including capital gain) recognized by the fund. Such manager may be taxed on income related to the carried interest at preferential long-term capital gain rates, instead of ordinary income rates, to the extent such income is treated as long-term capital gain in the hands of the fund. Although President-elect Biden has campaigned on eliminating the carried interest provision in the past, saying in 2016 there was "no justification for it," his campaign has not provided details on what changes the Biden Administration would propose in 2021.
With a divided Congress, President-elect Biden is unlikely to enact these tax proposals. For example, although various factions of House Democrats support elimination of the like-kind exchange provision for real property and taxing income with respect to carried interests as ordinary income, House Democrats as a whole chose not to repeal those measures in past Congresses. Even if House Democrats were able to advance these proposals in the House, the Republican-controlled Senate is likely to block those efforts.
Legislative Proposals of Interest
President-elect Biden is expected to introduce an economic recovery package that contains tax provisions within the first hundred days of his administration. Perceived economic weakness may limit Democratic appetite to raise taxes, at least initially. Despite this reticence, the 117th Congress likely is to consider some of the following tax proposals:
- Raising the corporate income tax rate from 21% to 28%;
- Imposing a 15% tax on the book profits of corporations with $100 million or more in income, allowing for deductions of net operating losses and credits for foreign taxes (companies would pay the greater of their regular corporate income tax liability or the 15% minimum tax);
- Doubling the tax rate on GILTI earned by foreign subsidiaries of US corporations from 10.5% to 21%;
- Restoring the top marginal income tax rate to 39.6%, from 37%, for individuals with taxable income of more than $400,000;
- Taxing capital gains and qualified dividends at ordinary income tax rates for individuals with taxable income of more than $1 million; and
- Imposing the Social Security payroll tax of $12.4% on wages earned above $400,000.
In addition, the 2020 Democratic Party Platform includes several tax reform proposals for which House Democrats may advocate. These proposals include: (1) increasing the Child and Dependent Care Tax Credit, (2) creating a first-time homebuyer tax credit, (3) expanding the Low-Income Housing Tax Credit to incentivize affordable housing construction, (4) expanding and making permanent the New Markets Tax Credit, (5) eliminating tax breaks for prescription drug advertisements; and (6) raising the estate tax to pre-TCJA levels. We would expect many of these proposals to be considered by the 117th Congress but most will face fierce opposition from Senate Republicans, especially those that repeal or limit provisions from the TCJA.
With a split Congress, President-elect Biden's economic recovery package is unlikely to receive consideration in the Republican-controlled Senate. One area that may garner bipartisan support are incentives for American manufacturing. Especially during the pandemic, when vulnerabilities in our global supply chains became pronounced and impacted many American's ability to access goods, such as personal protective equipment, bipartisan support for reshoring manufacturing built quickly. It was one of the few issues that President Trump and President-elect Biden agreed on during the campaign. Both candidates focused on expanding tax credits that support domestic manufacturing.
Given the bipartisan support for domestic manufacturing tax credits, we expect these provisions to be included in the Biden Administration's economic recovery package during its first one hundred days. Aside from domestic manufacturing tax credits, President-elect Biden will have difficulty advancing tax reform proposals, especially ones that propose repealing TCJA provisions.
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© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.