Editor's Note: As of September 24, 2021, the capital gains tax proposals have changed. We will keep you updated as more information comes out. For now, this blog Ways & means Committee Issues List of Tax Provisions for Budget Bill has the latest information.

The release of the Biden administration’s “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals,” commonly known as the “Green Book,” makes clear that capital gains are among the administration’s top tax targets. The book, which summarizes the tax proposals in Biden’s proposed budget, includes two broad proposals that, if approved, would significantly change how gains are taxed, including one that would apply retroactively.

Long-Term Capitals Gains

Currently, long-term capital gains and qualified dividends are taxed at a federal rate of 20%, or 23.8% when combined with the 3.8% net investment income tax. Under the Green Book’s proposal — and the previously released American Families Plan — for individuals with an adjusted gross income of more than $1 million in a tax year, these amounts would be taxed as ordinary income, at a rate of 39.6%, or an effective rate of 43.4% (a separate proposal would raise the top ordinary income rate from its current 37%).

The income threshold would be indexed for inflation after 2022. And the tax would apply only to the extent that the income exceeds $1 million.

According to the Green Book, the proposal would be effective for gains required to be recognized “after the date of announcement.” Some confusion exists as whether this refers to the date it was first announced in the American Families Plan (April 28, 2021) or the date the Green Book was released (May 28, 2021).

Transfers by Gift or Death

The Green Book also notes that capital gains are taxable only when realized, generally at the sale or other disposition of an appreciated asset. But transfers by gift or death aren’t “realization events.”

When an appreciated asset is gifted, the recipient’s income tax basis in the asset essentially carries over from the donor, with no realization of capital gain (or loss) until the recipient disposes of the asset. And the tax basis of an inherited asset is the asset’s fair market value (FMV) at the time of the decedent’s death, not the decedent’s original cost for it. As a result of this “stepped-up basis,” the gain on the appreciation during the decedent’s lifetime is never taxed.

The Green Book proposes to treat transfers by gift or death as realization events. For the donor of a gift, the gain would equal the amount by which the asset’s FMV on the date of the gift exceeds the donor’s basis.

For a decedent, the gain would be the excess of the FMV on the date of death over the decedent’s basis. It would be taxable to the decedent on the gift or estate tax return or a separate capital gains return. The tax would be deductible on the estate tax return.

The proposal includes several exclusions. For example, an inflation-indexed $1 million per-person (or $2.5 million per couple when combined with existing real estate exemptions) exclusion would apply.

Appreciated property donated to charity wouldn’t generate a taxable capital gain, and gains on transfers by a decedent to a U.S. spouse wouldn’t be recognized until the spouse disposes of the asset or dies. The basis in both circumstances would carry over from the decedent.

Also, capital gains tax on the appreciation of certain family-owned-and-operated businesses wouldn’t be due until the interest in the business is sold or the business is no longer family-owned-and-operated. The proposal generally would allow a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, too.

To Be Determined

It remains to be seen whether these proposals will make it through Congress and, if so, how they’re altered in the process. Contact us for the latest developments on this topic, as well as the strategies you should take in response to any tax law changes.