The American Families Plan

• April 28, 2021
• Paul Neiffer

President Biden today released The American Families Plan.  He had previously released his infrastructure plan which would primarily be paid for by an increase in corporate taxes.  This plan provides direct and indirect benefits to families and the taxes will be paid by individuals including farmers.  Lets go over the details.

Benefits

• Free pre-school for all three- and four-year old children.  This would be in conjunction with the states and would likely operate similar to Medicaid which means additional state tax revenues might be required.
• Free community college education for the first two years.  Again, this is in conjunction with the states.
• Direct assistance to Historically Black Colleges and Universities, Tribal Colleges and Universities, and institutions serving Hispanics, Asian-Americans and Native American Pacific Islanders.
• Provide direct support for families who need child care.  For most families under a certain income level, child care services would be capped at 7% of gross income.
• Create a nationally comprehensive paid family and medical leave program.
• Extend the child tax credit and earned income tax credit changes recently enacted until 2025.
• Provide incentives and payments to teachers.
• Expand summer EBT to all eligible children nationwide.
• Expand healthy school meals.
• Allow persons with drug-related felony convictions to qualify for SNAP.
• Reform unemployment insurance.
• Expand the ACA premium tax credits in the American Rescue Plan on a permanent basis.
• Make the increased child care credits permanent.  This could allow up to a $8,000 credit for two or more children under age 13.  This, in conjunction with the direct support, may make child care “free” for most Americans.
• Allow the IRS to regulate paid tax preparers (this may be a good time for my retirement).

How to Pay For It

• Increase the top tax rate to 39.6% on income roughly over $500,000 (depending on married or single filing status).
• Tax capital gains at 39.6% for gains/income over $1 million.
• Eliminate the “carried interest” tax break.  However, if the gain is over $1 million, it would be eliminated by the previous requirement.
• Require banks to report “all deposits” similar to the current 1099 reporting.  Does this mean all deposits are income unless you can prove otherwise?
• Eliminate Section 199A for income over $400,000 (we are assuming this since it was not specifically mentioned in the Fact Sheet but President Biden has already proposed this).
• Incorporate the STEP Act into law.  The plan only gives a brief overview of these changes but it appears to mimic the STEP Act.  The wording indicates that farmers and closely held businesses would not be subject to the tax as long as the business remains in the family.  Similar to the STEP Act, this likely means if the kids stop farming the land, then an immediate tax is due with interest.  They continue to state that this eliminates the step-up in basis, but this is not totally true.  The first million at death will get step-up with no tax.  Any amount over that level the deceased taxpayer owes the tax but the heirs get the step-up.  Personal residences would be exempt up to $500,000 of gain for married couples.
• There is no mention of reducing the lifetime exemption amount.  However, this may come into play later.
• The State and Local Income Taxes (SALT) limit of $10,000 remains in place.  However, this is scheduled to expire after 2025 (but it will be easy for them to make it permanent due to revenue raised).
• Permanently extend the Excess Business Loss limitations.  This means if you have a $2 million farm loss and have wage income of $2 million you can only offset $500,000 (indexed) against wage income.
• Require deferred gains in excess of $500,000 on Section 1031 transactions to be taxed.
• The Net Investment Income Tax (NIIT) will now be required on almost all sources of income over $400,000.  If you farm as an S corporation and your income is let’s say $1 million, $600,000 of the income will now be subject to an extra 3.8% Medicare (or Net Investment Income Tax).  The NIIT was imposed as part of ACA starting in 2013 and it was supposed to be on investment income only.  President Biden indicates there are “holes in the law” that allow many taxpayers to not pay this tax.  There are no holes in the law.  It was how the law was written, but this allows them to raise billions of taxes.

Examples

Let’s review some examples on how this may affect your families income taxes.

Example # 1

Jane owns 2,000 acres of Iowa farm ground which is self-rented to her husband’s farm operation.  This generates $500,000 of rental income each year.  Under current law, none of this income is subject to the NIIT tax.  If President Biden’s law goes into place, then Jane will owe an extra $19,000 of tax.

Example # 2

Same facts as number 1.  Currently, Jane qualifies for the the 20% Qualified Business Income (QBI) deduction which saves her family $37,000 of income taxes ($500,000 X 20% X 37%).  Under the new plan, she would owe an extra $39,600 of taxes.

Example # 3

Same facts.  Jane desires to trade a half-section of land that she paid $500,000 for many years ago.  It is now worth $4 million.  Under current law, she could “1031” her $3.5 million gain into new land and not owe tax and if it went through her estate, the heirs would get a step-up to $4 million.  Under this plan, she can defer $500,000, but pay tax on $3 million of gain.  Let’s assume she is already over $1 million in other income.  This means she will owe 43.4% capital gains tax on the $3 million gain or $1,302,000 with no cash from the sale.  This means she may need to borrow $1.3 million to pay the capital gains tax.

Example # 4

Jane’s land is worth $20 million and her tax cost basis if $5 million.  Upon her death, she will be required to report a $15 million gain.  Perhaps up to $1 million of this gain may be exempt from tax.  If the land continues to be farmed by her heirs, then the tax is not owed to the IRS.  However, if the heirs do not farm the ground or stop farming the ground, then it is likely that the tax will be due with interest.  Let’s assume that the heirs stop farming after 10 years.  They would owe tax of $6,510,000 (assuming a 43.4% capital gains rate on all $15 million gain) plus interest plus any related state income taxes.  Also, a lien will be placed on the property at the time of Jane’s death (this assumes that President Biden’s proposals mimic the STEP Act).

Bottom Line

This plan will likely benefit young farmers with children under the age of 17.  These families will see increased tax savings due to the child tax credit increases, reduction in net child care expenses, and other items.

However, for almost all other farmers, a net tax increase will be owed.  It will be in the form of extra income taxes during lifetime such as the NIIT, reduced 1031 gains options, no Section 199A deduction, increased top rate, etc..  There will also be additional taxes owed on transfers of property to the next generation (either during life or at death).

Will this pass?  In a normal year, we would probably so no.  But this is not a normal year.  We will keep you posted.

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