Prospective tax legislation in the next Congress

Most major news organizations have projected that former Vice President Joe Biden will be the 46th president of the United States. While the outcome is not official until recounts are complete, legal challenges are resolved and states certify the results, discussion has begun about the potential direction of tax policy in the next administration.

Democrats are poised to retain their majority in the House of Representatives, but control of the Senate is uncertain. At the time of this writing, four races are still uncalled, including both Senate seats in Georgia. The Georgia races are headed to a Jan. 5 runoff election, which will determine final control of the Senate.

The purpose of this alert is to discuss what the expected tax proposals will be based on the election results to date as well as forecasted economic conditions between now and January.

Economic conditions and the state of pandemic-related stimulus will have a significant impact on how quickly any tax policy changes can or will be enacted. When President Obama came into office, his tax proposals were put on hold in order to first stimulate the economy during the 2008-2009 recession. The same could hold true after this election. A number of factors will come into play as to how and when tax policy can be addressed in the next Congress, such as:

• Stimulus IV in the lame-duck session
• Status of the Affordable Care Act (ACA)
• Composition of Congress
• Status of the economy
• Tax policy as a priority

Key takeaways

• The apparent election of Joe Biden would move control of the White House to the Democrats. It appears Congress may remain divided with Democrats controlling the House and Republicans the Senate, but final composition of the Senate will not be known until January. Even if the Democrats obtain control of the Senate, it will be by a razor-thin margin, which would likely limit the chances of drastic tax changes. A divided Congress would also leave the prospects for major tax legislation remote at best.
• Economic conditions and the state of pandemic-related stimulus will have a significant impact on how quickly any tax policy changes can or will be addressed.
• Typically, tax increases are not effective prior to the date a bill is first introduced in Congress. If tax legislation does manage to get traction next year, this might create an additional planning window to execute traditional “year-end” tax strategies from early January until a formal bill is introduced in the House Ways and Means Committee. As of yet, there have been no discussions regarding when the proposals will be effective.
• It remains unclear whether a fourth stimulus package (which could include another round of Paycheck Protection Program (PPP) funding and additional economic impact payments) will be passed in the post-election lame-duck legislative session.
• A U.S. Supreme Court decision overturning the ACA could prioritize new healthcare legislation over sweeping tax policy changes. A decision is expected in early 2021.
• Since Congress has not yet passed a fiscal year 2021 budget resolution, it is possible the new Congress could pass some priorities under a fiscal year 2021 budget in early January followed by a second round later in the year when a fiscal year 2022 budget is negotiated. This could be critical if the Democrats take control of the Senate since budget reconciliation bills are not subject to the filibuster, meaning a simple majority would be all that is needed for enactment.
• Bipartisan support appears to exist for infrastructure, manufacturing and retirement savings legislation; any or all of which could contain changes to tax law.

Stimulus legislation

COVID-19 stimulus negotiations between the White House and Congress reached an impasse in the weeks leading up to the election. The House passed its fourth stimulus package, called the Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act, in May and updated it in late September. On the other hand, the Senate introduced a series of smaller stand-alone bills (Health, Economic Assistance, Liability Protection and Schools (HEALS) Act) in July designed to stimulate the economy, but this package did not get far in the legislative process. While there are many different priorities, both packages would expand the employee retention credit (ERC), extend the supplemental unemployment benefits (albeit different amounts), issue another round of individual recovery rebates and replenish PPP funds. As previously mentioned, Senate races are still being decided, so it is not clear which party will control the Senate in the next Congress. Regardless, early indications suggest a smaller relief package is more likely before the end of the year. To whatever extent further stimulus legislation is not passed by year-end, further coronavirus response appears to be a top priority of the presumptive administration.

Status of the Affordable Care Act

It is possible that the ACA will be overturned. The Supreme Court will hear oral arguments in California v. Texas on Nov. 10. This consolidates two cases into one and addresses whether the ACA is unconstitutional in light of the individual mandate penalty being reduced to zero by the Tax Cuts and Jobs Act (TCJA). If the ACA is overturned, Congress may decide to address healthcare before considering changes to the tax code. The state of the economy may divert attention from healthcare, particularly if additional rounds of PPP and/or other funding is necessary to cushion the economy from any continued shutdowns due to COVID-19.

Composition of Congress

As noted above, a runoff election in January will decide not only the Senate seats, but also, most likely, control of the Senate. Unless the Democratic candidates win both races, Republicans will retain control of the Senate, meaning a divided Congress and more of what exists today: Slow-moving legislation with the likelihood of stalemate over large policy changes. Expect no further reduction of tax rates or extension of TCJA expiring provisions and some support for an infrastructure package. Major tax increases and/or repeal of the TCJA are also unlikely.

Additional economic stimulus, either during the lame-duck session or early 2021, could include:

• ERC expansion
• COVID-19 cleaning credits
• Another round of PPP funding
• Additional economic impact payments (whether it’s $1,200 or another amount remains to be seen)
• Enhanced unemployment benefits
• Infrastructure spending
• Temporary regulation freeze

Potential tax proposals

A potential increase in the corporate tax rate to fund infrastructure spending may be implemented as this seems to be another area where bipartisan support exists. Recall that an original goal of tax reform was to reduce the corporate rate to 25%, so it is possible that such an increase (from the current 21%) will be part of an infrastructure legislative package. Furthering the idea of a potential infrastructure deal, the Fixing America’s Surface Transportation (FAST) Act was already reintroduced in Congress. In addition, the House passed the Moving Forward Act, which contains infrastructure funding for schools, housing, broadband, green energy and child care.

In 2017, a freeze was put into effect on all regulations issued in the last few months of the Obama administration until those regulations were reviewed. This included tax regulations. If there is a change in administration, this could happen again potentially impacting tax regulations and guidance issued in the last few months.

Passage of the Endless Frontier Act, which had bipartisan support in the Senate back in May, could also occur in a divided Congress. This legislation would provide funds for regional tech hubs creating new American manufacturing and high-tech jobs.

Another Setting Every Community Up for Retirement Enhancement (SECURE) Act or similar legislation encouraging Americans to save for retirement as well as place safeguards around current retirement plans may also have backing from both sides of the aisle. The Retirement Security and Savings Act in the Senate and Securing a Strong Retirement Act of 2020 in the House Ways and Means Committee were introduced already.

The Organization for Economic Cooperation and Development (OECD) has offered global minimum tax proposals, but the U.S. may assess import taxes on countries imposing a digital services tax. Both sides agree on the need to protect American companies from unfairly imposed taxes by other countries until a global digital tax plan is agreed upon.

Bottom line: Expect small changes in tax policy instead of sweeping tax legislation as compromise on these issues has been, and will continue to be, elusive in the current political climate.

President-Elect Biden’s tax proposals

The Biden campaign platform indicated he would not raise taxes on incomes less than $400,000. However, the term “income” was not defined by the campaign. We are assuming the definition varies depending on the provision (i.e., income and capital gains tax rates and section 199A phaseouts are based on taxable income under current law; the limitation on itemized deductions was based on adjusted gross income (AGI) under earlier law). The limitation on the total dollar amount of itemized deductions a taxpayer can claim based on their AGI (commonly referred to as the Pease limitation) would be reinstated, but the fate of the $10,000 cap on the state tax deduction is unclear. The value of itemized deductions would be further capped at 28%.

Biden’s plan would assess the FICA portion (6.2%) of Social Security taxes on self-employment (SE) income and wages greater than $400,000 plus the section 199A deduction is targeted for phaseout on incomes over $400,000. Open questions include:

• Will S corporation income become subject to SE taxes?
• If so, would this be based on a shareholder’s allocable share of S corporation income over $400,000 or on actual cash distributions received?  

An increase to the capital gains rate to match ordinary income rates for taxpayers with income greater than $1 million is also being proposed. In addition, an increase of the corporate tax rate is likely to be included in his proposals. Consequently, any conversion from pass-through entity status to C corporation should be reevaluated considering the proposed rate structure. 

Carried interest taxation may become a revenue raiser in any tax legislation. Further, even if carried interests are not specifically targeted, the aforementioned increase in capital gains rates to match ordinary income effectively eliminates the preference afforded to long-term capital gains for taxpayers with over $1 million in income. Private equity firms may need restructuring to mitigate or minimize any impact.

The uniform federal estate and gift tax exemption would be cut in half or more under a Biden tax plan. Currently $11.58 million, the plan is to lower it to around $3.5 million. Furthermore, the tax rate would be at least 40%, meaning families would have more wealth taxed at higher rates. Plus, the step-up to fair market value at the date of death would be eliminated, so the estate would owe tax on any appreciation in asset value.

As noted above, unless the Democrats obtain control of the Senate, the chances for enactment of many of these proposals would appear remote.

We encourage you to reach out to your Baker Tilly tax advisor regarding how the above may affect your situation.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.