Tax increases could be looming. If you have stock options, restricted stock units or company shares, now is the time to analyze whether the tax changes proposed by President Biden could affect your financial planning, whether either directly or indirectly. Some of the potential tax increases, such as a large increase in the maximum rate of capital gains tax, may require you to take action before any new tax laws are passed.
The proposed tax provisions to follow are contained in the American Jobs Plan and the American Families Plan. The US Treasury General explanations of the Administration’s revenue proposals for the 2022 financial year, known informally as the âGreen Paperâ, provides a summary and rationale for the tax changes.
Don’t have time to read congressional legislation or a tome written by the US Treasury? No problem. I’ve read this stuff so you don’t have to, along with related reviews from law firms and other expert observers. Below, you’ll find what you need to know about the potential impact of Biden’s tax proposals on stock compensation and the shares of the company you own. For financial advisors, this provides an opportunity to contact clients about possible changes and the impact on decisions regarding stock options, restricted stocks, ESPPs and company shares.
1. Maximum tax rate
Currently, the flat rate supplemental payroll deduction, which applies to income such as stock compensation and cash bonuses, is 22% for annual amounts up to $ 1 million and 37% for annual amounts greater than $ 1 million. This higher withholding rate is linked to the higher tax bracket.
According to Biden’s plan, the top ordinary tax rate would drop from 37% to 39.6% as of January 1, 2022 (see page 60 of the Green Paper). This would therefore bring the higher rate of additional payroll deduction to 39.6%. This rate would also apply to short-term capital gains for anyone in the top tax bracket.
ACTION MEASURES: When you decide to exercise unqualified stock options (NQSOs), you are in control of when you will realize taxable income on exercise, including federal tax. If you are in the highest tax bracket or fall into your exercise of options, analyze whether, for tax reasons, it makes sense to exercise options in 2021 instead of 2022, when this rate of bracket may be higher.
While most financial advisers would not suggest that you make stock option exercise decisions just for a 2.6% tax saving, this potential tax increase is worth considering. evaluated as a factor for options near expiration. For options that are not near expiration, remember that NQSOs offer substantial leverage and upside, which ends as soon as you exercise the options. See my Forbes.com article Stock options gurus explain 5 financial planning topics to consider.
Private companies that have been the subject of a recent or future initial public offering (IPO) are particularly concerned. If your company has granted double-triggered restricted stock units (RSUs), in which the shares are not typically fully vested and delivered until six months after the IPO, the company may consider expediting the delivery. shares in 2021 if the change to the top tax bracket is enacted. Accelerating that income through 2021 by delivering the shares this year (when the maximum rate is 37%) will save taxes for employees who have already met the requirements of the vesting conditions based on time and time. liquidity event.
2. Capital gains tax rate
Long-term capital gains, such as company shares Sales, currently have a top tax rate of 20% (plus the 3.8% Medicare surtax). Biden’s tax plan would raise the maximum rate on long-term capital gains and on dividends eligible for the highest rate of ordinary income tax for households with adjusted gross income over $ 1 million ($ 500,000 for married filing separately).
The rate change would be retroactive to the date of its announcement, considered to be April 28, 2021, when President Biden released a fact sheet on the U.S. Family Plan. The change to taxes on capital gains realized on death and with donations, discussed below, would begin on January 1, 2022. (See pages 61-64 of the Green Paper for more details on these capital gains proposals .)
ACTION MEASURES: With the taxation of incentive stock options (ISO), when you own the shares more than two years after grant and one year after exercise, the full gain on the sale on the exercise price is a capital gain. While the tax treatment of NQSOs is set on a year-by-year basis, for ISOs, when you sell the shares outside of holding periods, the tax treatment changes to essentially follow ordinary income rates. Anyone with an annual income of over $ 1 million will want to consider whether to risk holding ISO stocks for the long-term capital gains rate when that rate would in fact match, under the plan. Biden, at his ordinary rate of income.
Similar thinking applies to the decision with restricted actions as to whether to make an election under section 83 (b) to be taxed at award instead of vest. A big advantage of the election is to start the period of holding long-term capital gains early. But under the proposed change, the long-term and short-term capital gains tax rates for people in the top tax bracket can become the same anyway.
Cloudy details about the proposed change and its potential impact
According to some experts, it remains unclear whether this higher rate of capital gains would apply to all capital gains income or to only part of it (see Tax reform in the American family plan of the law firm Morgan Lewis). Among the many other issues is the impact of this change on the 0% rate on Qualified Small Business Equities (QSBS). The potential impact of this proposed change for people with stocks, including the range of current issues and when to recognize capital gains income, is covered by articles from Tech Crunch (Startup Employees Should Pay Attention to Biden’s Capital Gains Tax Plans), McDermott Will & Emery (What an increase in the capital gains rate could mean) and Morningstar (Capital gains tax proposal, a wake-up call for valuing concentrated assets).
Law firm Proskauer Rose predicts that if the capital gains rate rises, affected taxpayers “will postpone sales of valued assets and use cashless tunnels and prepaid futures to reduce economic exposure and monetize liquid appreciated positions â(see Treasury Green Paper Provides Details on Biden Administration’s Tax Plan).
3. Capital gains realized on death or on donation of shares
Biden’s tax plan would radically change the treatment of capital gains through donation or on death for transfers of valued property, such as company stock. For example, the possibility of eliminating capital gains on death by increasing the base on shares, which allows heirs to pay tax only on capital gains after death, would no longer apply to earnings greater than $ 1 million per person ($ 2 million per couple).
Alert: This does not mean that the basis of the stock remaining on these amounts is simply carried over to the person (s) who inherit it or to the beneficiary, as has been misreported in some sources. The death itself triggers the recognition of capital gains tax on these amounts as if the share were sold.!
Likewise, any donation made in excess of these amounts would be taxable at that time for the donor. Currently, the beneficiary only postpones the base, and the donor would only be liable for gift tax if he had no amount left of his lifetime gift / inheritance exemption. Exceptions would apply, such as transfers to a spouse, to a charity, or to heirs of small businesses and farms that continue to operate those businesses. Donating highly valued stocks to charity would still avoid capital gains tax, making it an even more popular strategy.
The Biden administration’s proposals so far do not yet include lowering the estate tax exemption from the current $ 11.7 million per person ($ 23.4 million for couples married), which was discussed during the campaign and may be forthcoming. However, that amount automatically drops to $ 5.49 million per person (adjusted for inflation) at the start of 2026, when the provision expires at the end of 2025 under the Tax Cuts & Jobs Act (TCJA ).
4. Strengthening the application
The bill provides funding to “revitalize the app so that the rich pay what they owe” in an effort to narrow the tax gap, according to the fact sheet on the US Plan for Families. This definitely means an increase in audits of companies, executives and other wealthy people because of their stock compensation or the stocks of their founders. Audit rates on those earning more than $ 1 million per year, which fell 80% between 2011 and 2018, will increase dramatically. Financial institutions would be required to report information on account flows so that investment income, such as compensation in stocks and company shares, would be subject to broader reporting by the IRS.
Likelihood of changes in tax legislation
The adoption of either of these proposals in their current form and with the proposed effective dates remains uncertain. Doubts about what will happen are raised by experts quoted in articles by Investment news (Political reality seen holding back Biden’s tax plan) and Politics (Tax the rich? Executives predict Biden’s big plans will fail). The lobbyists and heads of business groups mentioned in the Politics The article appear confident they will pressure moderate Democrats in the House and Senate to “kill almost all of these tax hikes.”
A reminder of tax ideas that have not yet been proposed by Biden, such as the taxation of stock options on acquisition, appears in a commentary by Brownstein law firm Hyatt Farber Schreck (Will the US plan for Biden’s families target executive compensation?). This proposal was part of the initial draft of the TCJA, the tax reform law promulgated at the end of 2017.