By Derek Gray, CPA
With a change of administration taking place in January, many Americans are wondering what this might mean for future tax bills. While keeping in mind the complexities of making campaign promises into law, it is imperative to begin preparing for any implications a new administration may have on your tax outlook.
What Distilleries Should Pay Attention to in the New Year:
As the transition of administrations begins, our eyes now turn to Georgia.
On January 5, a rare two-seat runoff election will take place that ultimately determines control of the Senate. So why are these elections so important for the Biden administration’s ability to pass tax reform? It all has to do with tie-breaking in the Senate.
As of the date of this publication, Republicans hold a 50-48 majority in the Senate. Let’s discuss a few possible scenarios:
Let’s assume that the Democrats take both seats in the runoff elections, and let’s further assume that a future Senate vote on tax reform goes solely along partisan lines and each side receives 50 “yays” and 50 “nays”. In that case, the deciding vote on tax reform would be cast by Vice President-elect Kamala Harris, seemingly tipping the scales in the Democrat’s favor.
In this scenario, with the tie-breaking vote in the Senate and a slim majority in Congress, the Biden administration’s path to tax reform becomes much easier. After all, in this scenario, Democrats then effectively control the Senate, control Congress and hold the Oval Office. Were that to be the case, President-elect Biden would likely be able to push through comprehensive tax reform and undo many of the tax changes passed under the Trump administration.
If Republicans gain one of the Georgia runoffs, the Biden administration’s chances of substantial tax reform decrease dramatically.
Without diving too deep into the complexities of Senate procedures, in general, it takes 60 senators to end debate on a bill and bring it up for a vote. Without 60 senators in agreement, the debate can continue, and eventually, the bill will likely become “filibustered” and die on the floor. In other words, without a 60-vote majority in the Senate, chances of a bill passing are slim.
One exception to the 60-vote rule is a legislative process known as “budget reconciliation.”
Reconciliation bills are unique in that they are not subject to the general 60-vote rule, a process that has been historically used by Democrats and Republicans alike. You may recall the most recent example when the bill better known as the Tax Cuts and Jobs Act (“TCJA”) was passed at the end of 2017. Because Republicans held control of the Oval Office, Congress, and the Senate, they were able to pass that bill with nary a Democratic vote. Without a 50-50 split of Senate seats, however, budget reconciliation isn’t going to be an option available to Democrats by the time President-elect Biden takes office.
In summation, while our crystal ball is still a little murky, many pundits are predicting Republicans will pick up at least one seat in Georgia, which again, renders it extremely unlikely that significant tax reform will happen in the next two years before mid-term elections will again reshuffle control of Congress.
That’s not to say that there may not be some tax measures introduced in the Biden administration’s first term. Additionally, Democrats could sweep the Georgia runoffs, lawmakers may choose to come across the aisle and compromise on certain tax measures, and lawmakers may look to tax reform as a way to help pay for stimulus money given during the COVID-19 pandemic.
Even with so much unknown surrounding the tax implications under a new administration, it is important to begin preparing for and considering all scenarios. If tax reform does come not in a sweeping manner, but in smaller doses, what should Americans expect? To answer that question, let’s revisit some of President-elect Biden’s tax plans from his campaign.
Perhaps the simplest change to Biden’s plan is the proposed increase in tax rate for the wealthiest Americans. The Biden administration has proposed raising the top marginal tax rate on ordinary income from 37% to the former top marginal rate of 39.6%. While discussed less frequently, it’s also likely the Biden administration would be in favor of lowering the adjusted gross income (“AGI”) levels at which the higher rates take effect. For example, under current tax rates, a married couple filing a joint return wouldn’t hit the 37% rate until they made $622,000 in AGI; under this proposed tax plan, that same couple might hit the 39.6% rate at an AGI amount far lower than $622,000, perhaps $400,000 or $450,000, similar to levels in effect under the Obama administration.
Another highly publicized change proposed under. Biden’s plan is to raise the top long-term capital gains and qualified dividends rate. Currently, the highest rate for these transactions is 20% (excluding the 3.8% net investment income tax), but Biden proposes to increase that rate to 39.6% (same as the ordinary rate) for taxpayers earning more than $1 million.
While Biden’s plan keeps the vast majority of the TCJA intact, it does involve phasing out the popular Qualified Business Income (“QBI”) deduction. Under Biden’s plan, the 20% deduction for QBI would be phased out entirely for those earning over $400,000. This could potentially be a sizeable tax increase for small business owners who have seen a major reduction in their tax liability under the Trump administration.
The Biden tax plan also proposes increasing the Social Security payroll tax for higher-income taxpayers. Currently, employers and employees split a 12.4% Social Security tax on wages up to $137,700, and a 2.9% Medicare tax on all wages. Biden’s tax plan would raise the Social Security tax on individuals making over $400,000 by enacting a 6.2% Social Security tax on wages over the $400,000 floor.
For the 97% of Americans earning less than $400,000 annually, the Biden administration has proposed several measures that would decrease their income taxes. Among these measures are enhancements to the Earned Income Credit, the Child Tax Credit, and the Child and Dependent Care Credit, as well as restoring a tax credit for first-time homebuyers.
What the individual provisions mean for distillery owners who hold their ownership in pass-through entities:
As the owner of a pass-through entity which is taxed as either a partnership or an S-corporation, the distillery’s income flows through the company and is included in the income of its owners. Your favorability of the Biden administration’s proposals may have more to do with your distillery’s size than your political leanings. As the COVID-19 pandemic continues, Americans seem to be reaching more for bigger brands and less for the product of craft distillers. If you’re the owner of a larger, well-established distillery, Biden’s plan could potentially raise your taxes in a significant manner. Owners of struggling craft distilleries, however, may welcome some of these proposed tax changes to provide a reduction of taxes in their time of need.
Many distillery owners may share a dislike for the potential increase in capital gains rates up to 39.6%. With the recent bourbon boom, many owners have been able to sell their distilleries and pay tax at a relatively low rate of 20%. Under Biden’s plan, the rates on a liquidation event would nearly double, taking a substantial amount out of the proceeds of a selling distillery owner. Similarly, many distillery owners may dislike a proposal to phase out the 20% deduction for QBI. The QBI deduction has been extremely beneficial for non-corporate manufacturers of all sizes, including distilleries. Since the deduction is largely based on a distillery’s ordinary income, many distilleries large and small enjoy the benefits of this tax provision.
The Biden administration campaigned in favor of an increase for corporate income taxes. The current proposal would increase the corporate tax rate from a flat 21% to presumably a flat 28%. While some may see this as a sizeable increase above the current 21%, others are quick to point out this change as a compromise, seeing as the pre-TCJA corporate tax rates were based on a graduated scale and maxed out at 35%.
Also noteworthy for corporate taxpayers, the Biden plan introduces a 15% minimum tax on “book income” for corporate taxpayers making over $100 million. This 15% tax would be a new form of corporate alternative minimum tax, which was repealed under the TCJA.
What the corporate provisions mean for distillery owners:
While many remain skeptical about the potential increases to individual tax rates, capital gains rates, or a phase-out of the QBI deduction, there may be more of an appetite to increase corporate tax rates. Such an increase was mentioned as a compromise to enact post-TCJA middle-class tax cuts or to make technical corrections to that bill. Such an increase is also frequently mentioned as a revenue raiser that could assist with helping to cover the cost of COVID-19 stimulus packages. An increase in corporate tax rates does not appear to be imminent, but of all the changes mentioned in this article, it would probably be the least surprising to occur.
Updates to the Federal Excise Tax Credits for Distillers:
For small distillers, perhaps more important than any of the aforementioned changes is the extension of the Federal Excise Tax (“FET”) break under the Craft Beverage Modernization and Tax Reform Act. The passage of this bill in 2017 was a significant windfall for small craft distillers, significantly lowering their FET expense. Initially this reduction was only for two years; however, there was a 12-month extension at the end of 2019.
With the end of 2020 approaching, many small distilleries are grappling with a potentially devastating combination of the COVID-19 pandemic and a substantial increase to their FET. Without action from Congress, many craft distillers won’t recover from this and will be forced to shut their doors.
Although the initiative seemingly has support from Democrats and Republicans alike, we’re left to hope again for another extender bill in a lame-duck session of Congress.
As with any change in administration, it’s understandable to be concerned about possible policy change. Although we don’t anticipate any sweeping tax reform, it’s always helpful to understand the key issues and plan accordingly. If you have any questions or concerns about what the Biden administration may mean for your tax bill, please don’t hesitate to reach out to Derek Gray or any member of the Blue Beverage Service Group.