The tax increases proposed by President Biden may affect your public company piggy bank
There may be a threat of tax increases. If you have stock options, restricted stock units, or company shares, now is the time to analyze whether President Biden’s proposed tax changes could directly or indirectly affect your financial planning. Some of the potential tax increases, such as a significant increase in the maximum capital gains tax rate, may require you to take action before new tax laws are enacted.
The proposed tax regulations are included in the American Jobs Plan and the American Families Plan. The US Treasury Department’s General Explanation of the US Government Revenue Proposal for Fiscal Year 2022, informally known as the “Green Paper,” provides a summary and rationale for the tax changes.
Don’t have time to read Congressional Legislation or a Treasury Department tome? No problem. I read this stuff so you don’t have to, along with related comments from law firms and other knowledgeable observers. Below is information about the potential impact of Biden’s tax proposals on share compensation and the company shares you hold. For financial advisors, this provides an opportunity to notify clients of possible changes and the impact on decisions related to stock options, restricted stocks, ESPPs, and company stock holdings.
1. Highest tax rate
Currently, the flat supplementary wage withholding rate that applies to income such as stock compensation and cash bonuses is 22% for annual amounts up to $ 1 million, and 37% for annual amounts above $ 1 million. This higher withholding tax rate is linked to the top tax bracket.
According to Biden’s plan, the highest ordinary tax rate would increase from 37% to 39.6% from January 1, 2022 (see page 60 of the Green Paper). This would increase the higher wage supplement rate to 39.6%. This rate would also apply to short-term capital gains for those in the top tax bracket.
ACTION STEPS: If you choose to exercise non-qualifying stock options (NQSOs), you have control over when you will earn taxable income upon exercise, including federal tax. If you are in the top tax bracket or expect to exercise your options, analyze whether it makes sense for tax reasons to exercise the options in 2021 instead of 2022, when this tax bracket may be higher.
While most financial advisors would not suggest making decisions about exercising stock options solely for a 2.6% tax saving, that potential tax increase should be assessed as a factor in options near the expiration date. For options that are not near the expiration date, keep in mind that NQSOs offer significant leverage and high potential, all of which end once you exercise the options. See my Forbes.com article Stock Option Gurus Explaining 5 Financial Planning Topics To Consider.
Private companies with a recent or upcoming initial public offering (IPO) have a particular concern. If your company has granted Double Trigger Vesting Restricted Stock Units (RSUs), in which shares are typically not fully transferred and delivered until six months after the IPO, if the change occurs, the company should potentially accelerate stock delivery up to 2021 consider to be waived for the highest income tax bracket. Accelerating that income into 2021 by delivering the stocks that year (when the peak rate is 37%) will save taxes for employees who have already met the requirements of both the time-based and liquidity event exercise conditions.
2. Capital Gains Tax Rate
Long-term capital gains, e.g. B. from company shares sales, currently have a top tax rate of 20% (plus 3.8% Medicare surcharge). Biden’s tax plan would raise the top long-term capital gains and qualified dividend rate to the highest ordinary income tax rate for households with adjusted gross income above $ 1 million ($ 500,000 for separate marriages).
The tariff change would be retroactive to the date of the announcement, is April 28, 2021when President Biden issued a fact sheet on the American Families Plan. The following change in taxes on capital gains in the event of death and gifts would come into effect on January 1, 2022. (See pages 61–64 of the Green Paper for more information on these investment income proposals.)
ACTION STEPS: In the taxation of incentive stock options (ISOs), the full capital gain above the exercise price is a capital gain if you hold the shares for more than two years from allocation and one year from exercise. While the tax treatment for NQSOs is fixed on exercise, for ISOs if you sell the stock without meeting the holding periods, the tax treatment changes to essentially follow normal income rates. Anyone with an annual income greater than $ 1 million should consider taking the risk of holding ISO stock for the long-term capital gains rate when that rate would actually match their normal income rate, according to Biden’s plan.
Similar considerations apply to the constrained shareholding decision as to whether a Section 83 (b) election should be made for taxation on grant rather than on vesting. A big advantage of the choice is the early start of the holding period for long-term capital gains. But under the proposed change, tax rates for long-term and short-term capital gains may become the same for people in the top tax bracket anyway.
Murky details on proposed changes and their potential impact
It remains unclear, according to some experts, whether this higher rate of return would apply to all or part of the return (see Morgan Lewis Law Firm’s Tax Reform In The American Families Plan). Among the many other problems is how this change would affect the 0% rate on Qualifying Small Business Stocks (QSBS). The potential ramifications of this proposed change for people with stocks, including the series of open questions and capturing capital gains, are discussed in articles by Tech Crunch (startup employees should be aware of Biden’s capital gains tax plans), McDermott Will & Emery (which mean a rate hike on capital gains Could) and Morningstar (capital gains tax proposal a wake-up call to the valuation of concentrated holdings).
Proskauer Rose law firm predicts that if the capital gains ratio rises, taxpayers will “postpone the sale of valued properties and use cashless collars and prepaid futures contracts to reduce economic risk and monetize liquid valued positions” (see Treasury Department’s Green Book ). Provides details of the Biden Administration tax plan).
3. Capital gains on death or gift of shares
Biden’s tax plan would dramatically change the treatment of capital gains by gift or death for the transfer of valued property such as company shares. For example, the ability to eliminate capital gains in the event of death by increasing the share base, which would then allow heirs to only tax the increase in value after death, would be for profits over $ 1 million per person (2 million per couple). .
Alarm: This does not mean that the basis for the balance above these amounts is simply carried over to the person (s) or the beneficiary, as incorrectly stated in some sources. Death itself triggers offsetting of capital gains tax on these amounts as if the stock had been sold!
Likewise, all gifts in excess of this amount would be taxable at this point in time to the giver. Currently, the recipient is only transferring the base, and the giver owes gift tax only if they have no remaining balance of their lifetime gift / estate allowance. Exceptions would apply such as transfers to a spouse, charity, or heirs to small businesses and farms that continue to run those businesses. Donating highly valued stocks to charities would still avoid capital gains tax, making it an even more popular strategy.
The Biden government’s proposals do not yet include lowering the inheritance tax exemption from the current $ 11.7 million per person ($ 23.4 million for married couples) that was discussed during the campaign and may be in preparation. However, that amount will automatically decrease to $ 5.49 million per person (adjusted for inflation) in early 2026 when the provision expires in late 2025 under the Tax Cuts & Jobs Act (TCJA).
4. Enhanced enforcement
The proposed bill will provide means to “revitalize enforcement so the rich pay what they owe” to reduce the tax gap, according to the American Families Plan fact sheet. This certainly means an increase in audits of companies, executives, and others who are wealthy based on their share-based compensation or founder’s share. Audit rates for those who earn more than $ 1 million a year, which fell 80% between 2011 and 2018, will increase significantly. Financial institutions would be required to report information about account flows so that income from investments, such as equity awards and corporate interests, would be subject to more comprehensive IRS reporting.
Probability of changes in tax law
It remains uncertain whether one of these proposals will be adopted in its current form and with the proposed deadlines. Doubts about what will happen are voiced by experts cited in articles from Investment News (Political Reality Seen Curbing Biden’s Tax Plan). and Politico (Tax The Rich? Executives Predict Biden’s Big Plans Will Fail). The lobbyists and corporate group leaders quoted in the Politico article seem confident that they will pressure moderate Democrats in the House and Senate to “abolish almost all of these tax increases.”
A comment from the law firm Brownstein Hyatt Farber Schreck (Will Biden’s American Families Plan Take Aim At Executive Compensation?) This proposal was part of the first draft of the TCJA, the tax reform law passed in late 2017.