BIDEN’S US TAX REFORMS LOOK SET TO INCREASE TAXES FOR HIGH INCOME US PERSONS LIVING IN THE UK
Following the passing of President Biden’s infrastructure plan attention in Congress will be turning towards a budget reconciliation that is expected to include the administrations proposed tax reforms. Our insights are drawn from the President’s policy announcements in particular, the “Made in America Tax Plan” and “American Families Plan”, the subsequent US Treasury explanation of the tax proposals, referred to as the “Green Book” and recent submissions to the Senate Finance Committee and the House Ways and Means Committee (HW&MC). We focus mostly on the President’s proposals and particularly on the HW&MC proposals (drawn from markup comments on draft legislation not yet introduced to the House), which seem most likely to form the outline of something that could make it through Congress with support of moderate Democrats.
Fine Margins: Whatever happens, President Biden is going to need almost all the House Democrats and will need support of all 50 Democrat Senators to get tax reforms through Congress in the budget reconciliation. In this context, any moderate Democrats may result in a scale back of some of the elements of the tax increases Biden initially proposed – whether that is the rates to be applied or the retrospective nature or other aspects. We can see this already in the proposals of the House Ways and Means Committee (HW&MC) which look much more moderate. From our position, the changes Biden proposed in Spring 2021 go too far and in places were really radical. Expect multiple proposals from different groups, horse trading, and then a final bill which will get through. This makes deciding what action to take in advance difficult however there are common threads (1) income tax rates are going up; (2) the increased rate on long terms gains for high income individuals will be a concern as it is higher than the UK rate; and (3) the unified credit for gift and estate taxes looks set to come down from $11.7m.
Below, we draw out 10 elements of the proposed tax reforms and start a discussion on the impact for clients and the interaction with UK taxes.
- Increase in the top ordinary income tax rate for 2022: This would appear nailed on. President Biden proposed a rate of 39.6% and the HW&MC have come out with the same. This would be back in line with the rate from the Obama administration and is no surprise. The HW&MC have this rate applying from $450k for joint filers and $400k for single filers. For those earning over $5m the HW&MC proposes an additional 3% surcharge tax – this would take the top rate to 42.6%. Of course we should remember the UK 45% income tax rate applies from £150k (c. $205k) so the UK remains the higher taxing jurisdiction on income.
- Increase in the long term capital gain rate in 2021: President Biden’s proposal was for the top income tax rate of 39.6% to apply to long term gains or qualified dividends for those earning over $1m – on any amounts arising after 28 April 2021 i.e. retrospectively. By comparison the house proposal is for a new 25% rate to apply for high income individuals with an additional 3% surcharge, for income/gain in excess of $5m (so total 28%). Don’t forget US persons will also be adding the 3.8% Net Investment Income Tax (NIIT) on top of this. At the moment the UK capital gains tax rate remains 20% so any increase over and above the current long term gain income tax rate of 20% means an increase in overall taxes for US persons living in the UK, who are either high earners or have property with large unrealised gains. The ability to plan is limited by the potential retrospective nature but equally requires urgent attention.
- Retrospective application of new capital gain rates: The Green Book proposes that the new capital gain rates will be back dated to the announcement of Biden’s American Families Plan on 28 April 2021. It would seem unusual to back date a tax increase to an outline policy announcement which included such limited detail compared to say, a date when a detailed bill was introduced. Will this date make it through? The HW&MC proposal is that an increase in capital gains tax should apply to 2021 but would apply only from the date of introduction of a bill. On this basis, disposals and binding contracts entered into before that date would still attract the previous 20% rate. Clearly, we have to work on the basis that there could be an April back dating with rates of 39.6% and as such, realising any gains in advance of the final bill is a gamble – however, looking at the political situation it may be a reasoned gamble. The UK capital gain rates are as good as they have been for a long time (speculation won’t stop that the rate may increase) and now could be a good time to take gains or alternatively consider gift planning.
- Deemed disposals on gifts and at death: The Green Book explained proposals that would see significant changes to the capital gain treatment of transfers by way of gift and at death. Gifts are generally non-recognition events for income tax with the donee inheriting the donor’s basis (or no gain / no loss in UK parlance). The Green Book proposes this would change so that gifts result in a deemed disposal of property with an exemption up to the first $1m of gain (this would bring the US more in line with the UK). This rule would not be retrospective and would apply from 2022 leaving a window for gift planning. At death there would also be a deemed disposal of appreciated property instead of the step up in basis currently enjoyed at the date of death (the UK also has a step up in basis so this would be a move away from the UK). Notably, we can’t identify either of these proposals in the HW&MC outline and it may be that they are too radical a change and we won’t see these implemented.
- Gift Tax: Unexpectedly President Biden’s proposals and the Green Book did not suggest a reduction in the life time gift and estate tax exemption which increased during the Trump Administration to $11.7m (perhaps because Biden preferred the deemed disposal at death rules above). The HW&MC proposes an immediate reduction of the exemption to $5m (plus inflation) from 2022. Other proposals have suggested $1m and an increased gift and estate tax rate (the current rate is 40%). The $11.7m exemption was already due to sunset in 2026 and it seems likely now that this will be reduced and so we are entering a use it or lose it window.
- The increasing corporate tax rate: President Biden’s proposal was for a 28% rate and the HW&MC proposal is a graduated increase up to 26.5%. For many this will have no impact at all however, for US persons who are owner managers of their own business (they have a controlled foreign corporation) – and are familiar with the Global Intangible Low Taxed Income (GILTI) provisions that have given them such grief since 2018 – it could spell more misery. The various proposals eliminate or reduce the 50% deduction previously enjoyed on GILTI income and retain the restriction on foreign tax credits for corporation tax but the greater immediate concern is that the increased corporate rate will mean the UK will cease to be a high tax jurisdiction (until our corporation tax rate reaches 25% in April 2023). The 2020 and 2021 years will continue to enjoy the high tax exemption on GILTI but 2022 will not and planning may be required before 31 December 2021.
- Foreign tax credits: The HW&MC proposals include limitations on foreign tax credits. These include limitations to be on a country by country basis i.e. taxes suffered on income from one country should not be used to offset income without a foreign tax credit from another country – this seems fair enough. More concerning are proposed adjustments to the carry back and carry forward of excess foreign tax credits. The 10 year carry forward would be reduced to five years and the one year carry back would be repealed. US persons living in the UK frequently need to make what we call accelerated payments of UK taxes to HMRC before each 31 December in order to be able to pick up the foreign tax credit in the calendar year the income or gain arose. However, where for various reasons an accelerated payment was not made, we could always rely on the one year carry back provision. The absence of the carry back from 2022 onwards will make the payment of foreign taxes on 2021 income by 31 December 2021 absolutely critical.
- Expansion of the Net Investment Income Tax (NIIT): The 3.8% NIIT, initially introduced to fund “Obamacare” has generally increased UK resident US persons taxes because it is a tax outside of the scope of the UK/US Tax Treaty and the UK/US Social Security Agreement – as such there is no foreign tax credit. This has meant a tax increase of 3.8% on investment income to all those to which it applies. Both the Green Book and the HW&MC proposals include expanding the scope of NIIT to include any income from business or trade that is not wages or subject to employment taxes – this could impact the self-employed and partners in pass through business entities (e.g. LLP or limited company with check-the-box election) as the NIIT could apply in addition to UK National Insurance Contributions in certain situations.
- Taxation of Carried Interest: President Biden proposed broadly that all carried interest be taxed at income tax rates which would be up to 39.6%, significantly more than the UK rate of 28% (for capital gain related carried interest). One suspects few democrats will be shedding tears for those who earn carried interest but with a strong venture capital and private equity industry in the UK and many US individuals involved this could have been a significant change for us. No doubt significant lobbying and application of pressure to moderate Democrats has taken place: a quick search of the HW&MC proposals (Ctrl + F: “carried interest”) yields no significant changes but an extension of the hold period for long term gain status to 5 years (currently 3) is possible – and of course it will be at the increased rates applicable to long term gain – so potentially 31.8% under the HW&MC proposals when you include the NIIT.
- Increased IRS Funding: The HW&MC proposals suggests $79b be appropriated for the IRS to increase enforcement activities and close the tax gap. This could mean more audits for clients but, hopefully, a better funded IRS also means agents to take our phone calls; tax returns and correspondence being processed instead of stockpiled; and, client refunds being issued in a timely manner. We can but hope.
This information is provided for general information purposes only and is not intended to be a comprehensive statement of law or current practice. No liability is accepted for the opinions it contains, or for any errors or omissions. No advice is contained herein and specific professional advice should be sought for all individual cases.