Proposed Federal and New York Tax Changes

Proposed Increases to Individual Income Tax

The President Biden and Governor Cuomo teams propose raising incomes taxes to a combined top tax rate of ~75%. A combined ~73% tax rate applies to income exceeding $400,000, and a combined ~75% tax rate applies to income exceeding $1,000,000. The top federal tax rate would rise from the current 40.8% rate to ~56.3%, for taxable income exceeding $400,000. The rise includes a 43.4% tax rate, plus a new perpetual 12.4% social security tax, plus a . 5% effect to a 28% limit on the deductibility of itemized deductions

These tax changes would raise taxes far higher than they were under Clinton, Bush, Obama, or any other prior president. Small business owners say that the new approach to taxes would discourage innovation by punishing people who risk everything to start a business that then thrives.

In addition to the top tax rate of ~75% on ordinary income, the top combined tax rate on capital gains would rise to ~82%, as the federal tax rate would rise from the 23.8% current tax rate to 43.4%.

The Corporate income tax rate would rise 33%. The potential effect being “technically” a 33% increase in stock PE ratios resulting in a 33% reduction in stock share values.

One way to predict the possible effects of the tax changes is to look at a country that tried something similar: France. The proposed combined 75% tax rate would equal the 75% supertax rate implemented by France’s Socialist President François Hollande in September 2012, and subsequently forced to be dropped two years later in year 2014. When France implemented the 75%tax rate it sparked accusations of an anti-business agenda. After the “supertax” was announced in September 2012 the government was accused of shooting itself in the foot by risking an exodus of high-profile personalities.[1] Business leaders expressed fears that investors would pull out of France.

The fact is that France’s 75% supertax led to a mass exodus of wealthy individuals, most notably actor Gerard Depardieu and Bernard Arnault, chairman of LVMH Moet Hennessy Louis Vuitton. Star soccer players threatened to go on strike, and there was fear that France would become a wasteland for entrepreneurs.[2]

The final nail in the coffin of France’s 75% tax came from President Hollande’s economy minister described the supertax as “Cuba without the sun”. “The reform clearly damaged France’s reputation and competitiveness,” said Jorg Stegemann, the head of the executive search firm Kennedy Executive. “It clearly has become harder to attract international senior managers to come to France than it was.” Tax lawyer Jean-Philippe Delsol, author on a book on tax exiles called Why I Am Going To Leave France, said last month many high earners had agreed with their companies that salaries would be limited during the two years the tax rate applied. [3]

Proposed Increase to New York Income Tax

Gov. Andrew Cuomo proposed during his January 2021 State of the Union Address raising taxes for the wealthiest New Yorkers to a top rate of 10.86%, up from 8.82%.  New York City residents would pay a top potential tax rate of 18.7% in state and local taxes, the highest income tax rate in the nation. The 18.7% total maximum tax rate would consist of 10.86% NYS tax, 3.88% NYC tax, and 4% NYC Unincorporated Business Tax.

Proposed Increases to Federal Estate Tax

Federal proposed tax changes also include a significant increase in estate tax. The increase would consist of three components:

      • elimination of basis step-ups for inherited assets
      • a 67% reduction of the exemption amount; and
      • a 12% increase in the estate tax rate

What Is the Effect of the Loss of Step-Up In Basis?

When people inherit assets a step-up in basis offers a potentially huge tax benefit. Assets passed down, like a home or stocks, generally have gained in value since the deceased purchased them.

Here’s where a step-up in basis comes in handy for inheritance. Typically, the basis is the amount paid to purchase the asset. But, assets that are inherited have their basis reset, “stepped up”, to the present fair market value of the asset on the date of passing.

A hypothetical example is this:

Deborah spent $10,000 on a portfolio of stocks a long, long time ago, and the shares are worth $1,000,000 when Deborah passes away. Deborah didn’t sell the stock; she willed it to her daughter, Stephanie. If Stephanie sells the stock when she receives it, the step-up in basis means the IRS would treat her investment as if Stephanie had just bought the stock for $1,000,000, resulting in zero capital gains and income tax.[4]

But what is the effect of the proposed tax change, where assets no longer are allowed to be “stepped up” in basis? The practical effect is that inheritances will be substantially reduced as income tax will be due by the estate after passing.

Let’s see two examples to compare the effect of the proposed tax change in numbers, Situation #1 and Situation #2:

What May Happen

Any proposed tax amendments must be passed by the House and Senate before heading to the President’s desk for approval. Joe Biden has expressed the need for tax reform for months while on the campaign trail and looks poised to do exactly that. If President Biden’s tax plan passes, many top earners may cut their losses and seek prospects in states with low or no state income tax. High-tax states, New York and California, have already expressed anxiety over the resulting effects.

 

[1] https://www.theguardian.com
[2] https://www.bloomberg.com
[3] https://www.theguardian.com
[4] https://www.forbes.com