Tax Increases Are Coming - What Does It Mean for the Economy and Financial Markets?
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Private Wealth
Management
williamblair.com
Tax Increases Are Coming.
What Does It Mean for the Economy and
Financial Markets?
President Biden has outlined the three pillars of the Build Back Better initiative: the American
Rescue Plan (ARP), the American Jobs Plan (AJP), and the American Families Plan (AFP).
These plans touch just about every corner of the U.S. economy. The ARP aims to provide
immediate relief to individuals and businesses impacted by the COVID-19 pandemic.
The AJP is geared toward tackling the hard infrastructure of the American economy (roads,
bridges, tunnels, airports, broadband, etc.), as well as the soft infrastructure (healthcare,
childcare, education), in addition to a new green initiative to address the impact of climate
change. The AFP focus is on education, childcare, paid leave, and support for the unemployed.
The ARP is almost entirely funded by raising more government debt. The administration plans
to fund the AJP and the AFP by increasing taxes—in some areas, quite significantly.
In this special report, we focus on:
• Taxes on individuals and wealth planning strategies
• Taxes on the corporate sector
• Timeline, challenges, and implications for the economyTaxes on Individuals
The proposed changes to tax rates for higher-income 1. Individual Income Tax, Long-Term Capital Gains,
individuals and households are significant and are and Qualified Dividends
summarized below. While it is unlikely that these As the table shows, the proposals include meaningful
proposals will pass in their existing form, they changes for qualifying individuals. The plan raises
provide insight into President Biden’s plan to raise not only the top rate of marginal income tax, but also
taxes on the wealthy. the capital gains tax; effectively eliminates the carried
interest benefit for individuals; caps deferral of gains
on 1031 real estate exchanges; eliminates the step-up
basis; and subjects wages above $400,000 to social
security payroll taxes.
EXHIBIT 1
Proposed Individual Tax Changes
Provision Current Law Proposed Law Planning Considerations
Individual Income Tax1 37% top individual income tax rate Increase top tax rate to 39.6% • Accelerate income into 2021
• Roth IRA conversions
• Municipal bonds
Long Term Capital Gains and 20% top rate (plus 3.8% net Increase rate for taxpayers with • Donate highly appreciated
Qualified Dividends1 investment income tax) adjusted gross income > $1MM to securities to charity or Donor
39.6% (plus 3.8% net investment Advised Fund
income tax) • Revisit asset location
• Qualified Opportunity Zones
Itemized Deductions2 No cap on itemized deduction; Cap value of deductions at 28% • Qualified Charitable Distributions
Pease limitation eliminated until and reinstate Pease limitation for • Itemized deduction bunching
2026; $10K cap on state and local households with taxable income
tax deduction (SALT) >$400K/year
Gift and Estate Tax2 $11.7MM current estate exemption, $5.85MM in 2021 exemption, with • Use available exemption in 2021
reverting to $5MM (adjusted for possibility of being further reduced
inflation) in 2026 to $3.5MM
Basis Step-Up at Death1 Basis of assets is stepped-up to fair Eliminate step-up basis for gains • Use low basis assets for
market value at death > $1MM; immediate taxation of philanthropic and wealth transfer
appreciation at death and at the goals
time of gifting; exceptions for • Include ability to swap out assets
family-owned businesses and farms for newly created trusts
Carried Interest1 Taxed at long-term capital gain rates Taxed as ordinary income (top rate • Donate carried interest to Donor
(top rate of 20%) of 39.6%) Advised Fund
1031 Exchanges1 Ability to defer unlimited capital gain 1031 gain deferral capped at $500K • Qualified Opportunity Zones
tax on real estate exchanges • Installment sales
Payroll Tax2 12.4% social security payroll taxes 12.4% social security payroll tax on • Maximize pre-tax retirement plan
on earnings up to $142,800 earnings up to $142,800 and earnings and HSA contributions
above $400K
1 The American Families Plan – PROPOSED LEGISLATION
2 Biden’s Tax Proposals During Campaign
2 | TA X INCRE A SE S A RE COMINGTaxes on Individuals (continued)
EXHIBIT 2
Top Capital Gains Tax Rate for Individuals, % (1922-2022)
45
39.6% Capital Gains Tax = Highest Since at Least 1922
40
35
30
25
20 Average = 22.2%
15
10
1922 1932 1942 1952 1962 1972 1982 1992 2002 2012 2022
Source: Wolters Kluwer, William Blair Equity Research
Most prominent among these changes is the near- capital gains and qualified dividends rather than the
doubling of the longer-term capital gains tax rate from current 20% preferred tax rate, may consider diversifying
20% to 39.6%. This tax would be in addition to the concentrated positions to accelerate income, also
Medicare net investment income tax (NIIT) for higher- dependent on the effective date of the new rates. Ideally,
income investors of 3.8%, which would increase the this decision should be made in the context of a broader
tax rate to 43.4%. This increase would make this the planning conversation about goals and objectives, as
highest tax rate since at least 1922. According to President well as risk tolerance.
Biden, this rate would apply only to households with
adjusted gross income greater than $1 million. Brian Deese, High-net-worth individuals who prefer a different
director of Biden’s National Economic Council, has stated approach could consider donating highly appreciated
that this would affect only 0.3% of the U.S. population. securities to charity or investing gains in a qualified
opportunity fund. Transferring low-basis securities to
Wealth Planning Strategies charity or a Donor Advised Fund (DAF) generally
For higher-income individuals, accelerating income could provides a full fair market value deduction (limited to
effectively counteract a potential tax increase. Executing 30% of adjusted gross income), while shifting the
a Roth conversion may provide an opportunity to not only gain to these tax-exempt entities.
“pay” income tax at lower current rates, but also allow the
converted dollars to grow tax free. Qualified opportunity funds can provide triple tax
benefits: the deferral of taxes, an increase in basis, and
Taxpayers with adjusted gross income greater than a permanent avoidance of capital gains tax on the
$1 million, who may face tax rates of 39.6% on long-term reinvested capital.
W ILLI A M BL A IR PRI VATE W E A LTH M A N AGEMENT | 3Taxes on Individuals (continued)
This is an opportune time for individuals to review 3. Carried Interest, 1031 Exchanges, and Payroll Tax
their asset location strategies and make certain that Carried interest taxation has been a hot topic in recent
tax-inefficient assets producing interest income or high years. Per the Urban-Brookings Tax Policy Center, “carried
dividends are held in tax-deferred or Roth accounts. interest, income flowing to the general partner of a private
In addition, investors may want to explore portfolio investment fund, often is treated as capital gains for the
strategies to enhance overall tax-efficiency and assess purposes of taxation. Some view this tax preference as an
the tax-efficiency of specific investment vehicles being unfair, market-distorting loophole. Others argue that it is
used. For illustration, a taxable bond would have to yield consistent with the tax treatment of other entrepreneurial
5.3% to have the same after-tax yield as a tax-exempt income.” Biden’s proposal to tax it as ordinary income
municipal bond yielding 3%, presuming the proposed top would effectively close that loophole.
tax bracket of 43.40%.
Wealth Planning Strategies
2. Itemized Deductions For affected investors, transferring carried interest to
Itemized deductions, though not included in the formal a DAF can be an effective way to fulfill both philanthropic
proposals, are the topic of frequent debate. The Pease and tax planning goals in the process. Potential strategies
limitation would reduce the value of certain itemized for addressing such a development are best coordinated
deductions (mortgage interest, state and local taxes, with the support of professional advisors.
charitable contributions) by 3% for every dollar of a tax-
payer’s taxable income above $400,000, with a maximum 4. 1031 Exchanges
reduction equal to 80% of the total value of the taxpayer’s Like-kind exchanges, also known as 1031 exchanges,
itemized deductions. The Tax Cuts and Jobs Act of 2017 which allow for—under certain circumstances—exchange
eliminated the Pease limits but also capped the amount of properties and deferred capital gains recognition, have
of mortgage interest that could be deducted and capped been a popular technique used by individuals to defer
state and local tax (SALT) deductions at $10,000. Should income taxes on the sale of investment real estate. Biden’s
the Pease limit be reinstated, it is likely that high-income plan to cap the gain on a 1031 exchange to $500,000
taxpayers will be able to deduct more from their taxes. would severely limit the benefit of this provision for real
estate investors.
Wealth Planning Strategies
DAFs are accounts that hold donated assets (cash and Wealth Planning Strategies
securities) and allow the account owner to invest the Using installment sales to spread out income and stay
funds and then donate over time as desired. DAFs will under the threshold may be one way to address this issue.
provide the opportunity to donate more than a usual You may also consider qualified opportunity funds as
annual amount and take a larger deduction. You can another way to potentially capture some of the tax deferral
then parcel out the donations to your charities of choice benefits that would otherwise be lost.
over time. This can be an effective way to diversify stock
positions and reduce income tax liability. 5. Payroll Tax
Under current law, wages above $142,800 (for 2021) are
Taxpayers over 70½ with IRAs can consider qualified not subject to the 12.4% social security tax. The proposal
charitable distributions (QCDs). QCDs allow taxpayers would keep the existing threshold, so that wages between
to donate up to $100,000 directly to charity and, in the $142,800 and $400,000 would not be subject to the
process, avoid recognizing the distribution as income or payroll tax. However, because the existing cap of $142,800
the donation as a charitable deduction. QCDs generally is adjusted over time for wage growth and the $400,000
provide taxpayers with at least a marginal tax benefit and threshold is fixed, the gap would gradually close so that
often a much more significant one than when taking a all wages would eventually be subject to the 12.4% social
distribution and then contributing the proceeds to charity. security tax. For an employee, the payroll tax is split evenly
between the employer and the employee. Self-employed
4 | TA X INCRE A SE S A RE COMINGTaxes on Individuals (continued)
taxpayers with earnings above $400,000 would be Wealth Planning Strategies
required to pay the full 12.4% social security payroll tax. This would potentially represent a dramatic change
for inheritance planning purposes for beneficiaries in
Wealth Planning Strategies higher-income households.
With Biden’s campaign proposal to subject wages
above $400,000 to social security payroll taxes, taxpayers Funding irrevocable trusts that align with your wealth
approaching this threshold should maximize tax- transfer goals allows you to remove not only the gifted
deductible contributions to 401(k)s, IRAs, and HSAs. assets from your estate, but also all future appreciation.
6. Step-up Basis and Gift and Estate Exemptions With Biden’s proposal to severely curtail basis step-up
The proposal also includes the elimination of the step- benefits, taxpayers may consider using low-basis
up basis for certain assets. This provision allows for the assets to fund philanthropic endeavors or execute wealth
elimination of capital gains taxes on assets that are passed transfer goals.
to an heir, whereby the asset’s base price for capital gains
calculation purposes is reset to the fair market value at As mentioned, transferring low-basis securities to a charity
the time of the transfer to the heir, with the result that any or a DAF is a tax-efficient way to address charitable goals.
previously accrued capital gains that may have occurred Gifting low-basis assets to heirs may help minimize the
would be untaxed. In addition, under the current tax law, impact of the proposed basis step-up rules. Further, for
the higher estate and gift tax exemption levels will return gifts in trust, giving trustees the power to substitute assets
to $5 million adjusted for inflation per individual in 2026. enhances flexibility and allows them to better address the
Although not specifically included in the AFP, President restrictive basis step-up proposals. While details are
Biden has expressed an intention to reduce the estate and lacking, Biden indicated that protections will be provided
gift exemptions possibly sooner than the sunset. so family-owned businesses and farms will not have to pay
taxes when given to heirs. 10 Key Planning Strategies
EXHIBIT 3
Investment Strategy Considerations
Potential Changes on the Horizon Investment Strategy Considerations
Increased long-term capital gains and qualified dividends tax rate for Greater emphasis on opportunistic tax-loss harvesting throughout the
adjusted gross income >$1M year, implementing tax-efficient strategies as well as solutions specifically
focused on enhancing after-tax returns; revisit philanthropic objectives
and approach; potential acceleration of capital gains realizations, when/if
appropriate; explore risk and tax-management solutions for concentrated
and/or highly-appreciated positions; assess investment vehicle tax-
efficiency; review and organize asset location strategy
Higher top individual income tax rate Gauge after-tax yield levels within portfolios; potentially expand utiliztion
of municipal bonds in taxable accounts; contemplate converting assets to a
Roth account; review and organize asset location strategy
Corporate tax rate increase Lower potential profitability for certain U.S. businesses – take into account
related fundamental considerations
Increased tax pressures relating to foreign activities of U.S. multinationals May impact financial outlook and corporate strategy for select U.S.-based
multinational companies
Lower 1031 exchange deferral threshold and limited scope of basis step-up Reduced set of tax-efficient options for appreciated real estate assets;
upon death possibility of increased attention toward Qualified Opportunity Zone program
W ILLI A M BL A IR PRI VATE W E A LTH M A N AGEMENT | 5Corporate Tax
Taxes on the Corporate Sector and Key Proposed Biden also wants to repeal the deduction for foreign-
Corporate Tax Changes derived intangible income (FDII), and more importantly
The tax change that is perhaps getting the most introduce a global minimum tax of 21% for all OECD
coverage among institutional investors is the proposed countries, to help end the “race to the bottom” on corporate
increase in the corporate tax rate from 21% to 28% to tax rates and level the playing field.
help fund the AJP.
Furthermore, the OECD would also like to tie any global
• Increase maximum federal corporate tax rate to 28% minimum tax to the implementation of a digital tax on
• Raise the minimum tax on Global Intangible Low-Taxed U.S. tech firms, which will not go down well in Washington.
Income (GILTI)
• Introduce a global minimum tax for all OECD countries A decision by the OECD on this tax will be a key deciding
• Increased taxes for certain industries factor as to whether members of the U.S. Congress
decide to pass their U.S. corporate tax increase. As a first
The Trump administration cut the corporate tax rate step in this process, the G7 nations have recently agreed to
from 35% to 21%. The Biden administration views raising a 15% minimum rate on profits of multinational firms.
the corporate tax rate to 28% as reversing, in small
measure, some of that increase. And, it has made it clear The GILTI increase, as well as various other small
that it is flexible on the rate of increase. additions (including a possible digital tax), would mean
that while the headline U.S. domestic corporate tax
GILTI was created by the Trump administration as a rate increases a little (i.e., from 21% to an expected
way to prevent companies from harboring their foreign 25%), the real bite comes for those companies earning
profits offshore and/or shifting even more profits abroad, a significant share of their profits offshore. This is
while also encouraging them to be repatriated. Biden likely to be particularly relevant for industries such
proposes doubling this tax from 10.5% to 21%. as pharmaceuticals, information technology,
and biotechnology, which generate much of their
earnings abroad.
EXHIBIT 4
Statutory Federal Corporate Tax Rate vs Effective Corporate Tax Rate* (All US Corporate Business, %)
55
50
45
40
35%
35
30
25
21%
20
15
14%
10
Mar. ‘47 Mar. ‘54 Mar. ‘61 Mar. ‘68 Mar. ‘ 75 Mar. ‘82 Mar. ‘89 Mar. ‘96 Mar. ‘03 Mar. ‘10 Mar. ‘17 Mar. ‘24
Statutory Federal Corporate Income Tax Rate Effective Corporate Tax Rate
*Pre-tax Corporate Profits (without IVA & CCA) minus After-Tax Profits divided by Pre-tax Profits for all US corporate business. National Income & Product Accounts
Source: Bureau of Economic Analysis, William Blair Equity Research
6 | TA X INCRE A SE S A RE COMINGCorporate Tax (continued)
Alternative Taxes?
Could the Biden administration have raised alternative
taxes to fund this spending? Yes, potential alternatives to
income and corporate tax increases might have included
increasing the gas tax, introducing a value-added tax
(VAT), and establishing a carbon tax.
The gas tax, for example, has not been changed since
1993, and it is not indexed to inflation. As a result,
its purchasing power is 45% less than was the case back
then. Furthermore, the introduction of more fuel-
efficient vehicles and EVs has also eroded much of its
revenue-generating ability. Hence, there is a strong case to
be made for it being increased to help pay for the highway
infrastructure proposals.
Nevertheless, just like the introduction of a VAT (a goods
and services tax) or a carbon tax, the Biden administration
sees these as very regressive taxes, which fall harder
on lower-income households than higher-income ones,
moving away from his main message that it is time for
higher-income households to pay what they owe.
W ILLI A M BL A IR PRI VATE W E A LTH M A N AGEMENT | 7Impact on the Economy and the Markets Economic Impact If we look at a cross-section of estimates of the impact on There is significant uncertainty about these proposals GDP from the Tax Policy Center, the Tax Foundation, Penn and little doubt that the spending figures will be watered Wharton Budget Model, and Moody’s, most of these models down in the coming months. Nevertheless, the proposed estimate a modest drag on growth from the tax increases spending levels have not been seen since the Second (not including the offsetting spending initiatives), with World War. They represent a major attempt to shift the some indicating measured optimism in real GDP growth aggregate supply curve and expand the productive outlooks. capacity of the economy. If these policies work, they will likely usher in an era of increased government involvement in economic affairs for many years to come, i.e., higher taxes and higher spending. It will likely also be viewed as a template for greater government intervention around the globe. Europe in particular is watching this closely. Conversely, if the plan fails, where failure would be associated with a sustained increase in inflation, rising interest rates as investors balk at too much debt, and weaker GDP growth, it would similarly be seen as a major setback for the more government interventionist approach, pushing back this agenda likely also for decades to come. With regard to GDP growth, the multiplier impact of the ARP spending initiative will pack its biggest punch this year, when there is still plenty of slack in the system, and when just about all of the COVID relief is due to be released. The thing to note about these changes in tax and spending policies is that tax increases come with immediate effect (we assume they will be implemented January 1, 2022), whereas the benefits of the AJP and AFP spending largely take place over a period of the next 10 years. What’s different here, however, is that the tax increases will be borne entirely by higher-income households, who typically save a much higher proportion of their incomes. The net result is that this should be a slightly less fiscal drag on growth than would take place under a more broad-based tax increase. 8 | TA X INCRE A SE S A RE COMING
Impact on the Economy and the Markets (continued)
Inflationary Impact also helping increase the economy’s noninflationary
The reality is that the Biden administration is speed limit. Biden hopes that by increasing growth
attempting to pour about $6 trillion of spending (over in the labor force (through greater childcare, education,
the next decade) into a $22 trillion economy. It wants to healthcare, etc.) and increasing growth in the capital
run the economy hot, and the risks of higher inflation stock (provide better hard infrastructure, spending on
unquestionably increase as a result. R&D, and investment in technology), both will help
raise productivity growth, and therefore real potential
There are three points we can make here. The first is GDP growth, quelling inflationary pressures.
that team Biden does not view inflation to be in any way
its remit. According to Biden economic advisor Jared Last, Biden is arguing that most measures of the output
Bernstein, inflation is entirely the job of the Fed and it will gap have been wrong over the last few decades, the Phillips
have to respond to actions taken by the fiscal authorities curve has been much flatter than we previously thought,
if it deems necessary. and as a result we have been underestimating the available
space for noninflationary growth. Therefore, there is
Second, while these spending proposals will ultimately plenty of room to run the labor market hot before we start
be scaled back as the plan makes its way through Congress, to see a stronger pickup in wage demands that might then
it is very much Biden’s belief that these initiatives potentially boost inflation.
will expand the economy’s productive capacity, thereby
EXHIBIT 5
Percentage Change in Consensus Estimated EPS Growth Rates for 2018 Estimate at Year-end 2017 vs
Final Estimate for 2018, %
Consumer Dsicretionary 160.2%
Industrials 138.1%
Energy 137.5%
Healthcare 136.2%
Communication Services 116.0%
S&P 500 113.3%
Technology 106.0%
Financials 65.7%
Utilites 58.7%
Materials 44.1%
Consumer Staples 27.7%
Real Estate –21.7%
–50.0 0.0 50.0 100.0 150.0 200.0
Source: Refinitiv, William Blair Equity Research
W ILLI A M BL A IR PRI VATE W E A LTH M A N AGEMENT | 9Impact on the Economy and the Markets (continued)
Impact on Monetary Policy In theory, the sectors with the largest share of foreign
If these proposals pass in a format that is close to revenues, such as information technology (43.8%),
the one that is being proposed, it seems likely that a more healthcare (12.6%), and communication services (12.4%),
aggressive fiscal policy would require less aggressive could be the most adversely affected.
monetary support. This would then be another reason
to believe that rate increases will likely start slightly Obstacles and Timeline
sooner, i.e., in 2023, and not beyond, as the Fed has been While the ARP has already been pushed through
indicating. Furthermore, it could also suggest that Congress using the budget reconciliation process, the
the tapering program will come into effect at the end of big question remains, how will Biden attempt to pass
this year and/or the start of 2022. the other two proposals? With a majority of just one—
Vice President Harris in the Senate—and a very slim
Impact on Financial Markets majority in the House, there is no room for dissension in
The immediate impact on the stock market will be the ranks. Hence, this is far from a done deal.
from the tax rate increases as opposed to the spending
initiatives of the AJP and the AFP, where the benefits The budget resolution process allows for only a 10-year
are a little fuzzier, spread out over years, and broadly budget window and must be budget neutral, implying that
across industries and companies. these spending proposals require revisions particularly
considering that the proposed revenue generated from the
Over the longer term, investors should remember that corporate tax increases is over a 15-year time frame, not
it is not tax changes that drive the equity market, but the 10. Also, as mentioned above, Congress will want to wait
fundamentals of those specific businesses, industries, to see what the OECD decides with regard to a global
and the behavior of the aggregate economy itself. minimum tax. If nothing is passed, or it is deemed too low,
Congress will be reluctant to proceed with its own
Impact on Corporate Profitability tax increases, further defunding the spending proposals.
The Trump Tax Cuts and Jobs Act of 2017 cut the The Democrats would like to have an infrastructure
corporate tax rate from 35% to 21%. This can be estimated bill passed by the end of July, i.e., before the August (and
to have increased S&P 500 earnings by about 10%. most of September) recess. There has been less clarity
on when the passage of the AFP is proposed to take place,
With regard to economic sectors, the chart shows changes other than to say before the end of 2021. It will become
in analysts’ sector estimates from the end of 2017 to much harder to pass any new initiatives in 2022 just ahead
the final estimate for 2018. While there will of course be of the midterm elections.
other factors driving industry performance, it is notable
that consumer discretionary, industrials, and energy, The bottom line here is that while we believe that
which are all mainly domestic industries, recorded the large parts of this proposed legislation will be passed,
largest improvement in estimated EPS for the year. Real it is far from a done deal and there will be some trimming
estate, consumer staples, and materials recorded the along the way. We expect to see some final legislation
smallest relative improvement. passed in autumn.
With Biden planning to increase the corporate tax rate
from 21% to 28% (or a more likely 25%), a reasonable
estimate would be a 5% drag on aggregate EPS. However,
this would likely be an underestimate given the slew of
changes on the treatment of foreign profits, which will drag
effective rates much higher. Taking these changes into
consideration, the impact on corporate profitability could
be in the 8%-10% range.
10 | TA X INCRE A SE S A RE COMINGConclusion
We hope that this resource is a useful and practical guide
for assessing the tax outlook and its potential implications.
As always, it is important that decisions are weighed
in the context of each investor’s unique objectives and
circumstances. We are here to deliver you expert support
and guidance.
For more information, please contact your William
Blair Wealth Advisor.
W ILLI A M BL A IR PRI VATE W E A LTH M A N AGEMENT | 11June 2021 Past performance is not an indicator or guarantee of future results. An index is unmanaged and does not incur fees or expenses. An investment cannot be made directly into an index. This content is for informational and educational purposes only and not intended to provide or should not be relied upon for legal, tax, accounting, or investment advice or a recommendation to buy or sell any security. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions. Any investment or strategy mentioned herein may not be suitable for every investor. The factual statements herein have been taken from sources we believe to be reliable, but such statements are made without any representation as to accuracy or completeness. Opinions expressed are current opinions as of the date appearing in this material only. These materials are subject to change, completion, or amendment from time to time without notice, and William Blair is not under any obligation to keep you advised of such changes. This document and its contents are proprietary to William Blair & Company, L.L.C., and no part of this document or its subject matter should be reproduced, disseminated, or disclosed without the written consent of William Blair & Company, L.L.C. Any unauthorized use is prohibited. “William Blair” is a registered trademark of William Blair & Company, L.L.C
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