President Biden’s 2022 Budget and Congress Increasing Taxes Retroactively
Recently, President Biden unveiled his 2022 budget request. As was widely anticipated, President Biden’s budget calls for some significant changes to the capital gains rules, including a proposal to increase the top capital gains rate from 20% to 39.6% plus an additional 3.8% net investment income tax, making it a maximum capital gains tax of 43.4% for income in excess of $1 million. The President’s budget calls for the increase in the top capital gains rate to be implemented retroactively. This means it would apply to some point in 2021. Not only would this be one of the highest capital gains rates in history, this would be one of the handful of times tax law has been changed retroactively which could be devastating tax wise considering the dynamic we are in currently. We have exorbitant appreciation in housing prices and businesses selling for gains. Here’s one of the biggest questions; can Congress make changes to the Tax Code today that affects the taxes of yesterday? In one word, “yes.” The president and congress did it in March 2021 and had retroactive treatment back to January 2020. When it comes to tax policy, Congress has the ability to enact policy as it sees fit, within constitutional limitations. Accordingly, there is nothing stopping Congress from passing the Biden tax plan and making the proposed 39.6% top capital gains rate retroactive to some point earlier this year. Here’s the next question; will Congress increase the top Capital Gains tax retroactively? We don’t know. If history repeats itself, the answer is probably yes. It happened under the Clinton and Obama administrations. However, it is looking like the earliest the Biden tax plan will be passed is Q3 2021. By then, what is legally permissible, retroactively changing the capital gains rules, becomes far less politically feasible, as retroactive tax hikes tend to be viewed in an especially harsh light. Dramatically changing tax policy, to increase taxes, more than halfway through the year when many individuals have already acted would likely be unpopular especially with mid-term elections being a year away. Plus, a change to the capital gains rules with a midyear effective date (e.g., a 20% top capital gains rate for pre-April, May or July 2021 sales, and a 39.6% top capital gains rate for sales made after April, May or July 2021 or later) would be a logistical nightmare for taxpayers, CPAs, tax preparers, and even the IRS. As a profession, we hope for an effective date of January 1, 2022. Time will tell what happens.
Our motto is plan for the worst and hope for the best. So tax planning is crucial. With just a few months left in which taxpayers can take action to mitigate the potential of a dramatically higher capital gains rate. Business owners, for instance, may wish to accelerate the sale of their companies in order to capture gains at the current top rate. The same goes for owners of highly appreciated real estate and other taxable investments. Conversely, those individuals with already-anticipated 2021 sales for which payments will be made over multiple years may want to plan to opt out of the installment method of accounting to ensure gains are reported in 2021. Ultimately, the list of potential planning strategies is long, but the time in which individuals have to implement them is not. Simply put, if you’re the owner of highly appreciated assets, the best time to begin planning for the potential changes to the capital gains rate was yesterday. The next best time is today.