Cross-Border Transactions and International Investment: Potential Impact of President Biden’s Capital Gains Tax Proposal
President Biden’s “American Families Plan” includes a proposal to impose ordinary personal income tax rates (which the plan proposes to increase to 39.6%) on long-term capital gains of individuals with taxable income of more than $1 million. Coupled with 3.8% net investment income tax, the plan, if enacted, could increase capital gains taxes on both inbound and outbound U.S. investment.
Overview of Capital Gains Tax Proposal
The tax proposal and plan, in general, seeks to reduce the disparity among taxes imposed on high-, low-, and middle-income taxpayers. Currently, long-term capital gains (derived from assets held one year or more) are subject to tax at 15% or 20% (on taxable income exceeding $40,400 for the 2021 tax year), which is lower than the current highest personal income tax rate of 37%. Under the tax proposal, investors with U.S. taxable income exceeding $1 million would be subject to tax at ordinary income rates on long-term capital gains (but only to the extent taxable income exceeds $1 million). For example, an investor with $1.1 million in taxable income ($200,000 of which is capital gain) would only be subject to tax at ordinary income rates on the first $100,000 of capital gain, and the remaining $100,000 would still qualify for a lower preferential capital gains tax rate.
Qualified Dividend Income
Since 2003, U.S. investors in certain foreign corporations (including those eligible for the benefits of a U.S. tax treaty or has their stock is traded on a U.S. stock exchange) are generally eligible to have dividends received from such corporations taxed at a preferential capital gains rate. The tax proposal could increase U.S. investors’ tax liability on these dividends by imposing ordinary income tax on at least a portion of such dividends that otherwise would be taxed at a preferential rate.
Inbound U.S. Investment
Biden’s tax proposal may also impact the taxes of foreign investors in a U.S. partnership with an active U.S. trade or business. Foreign investors, absent eligibility for the benefits of a U.S. tax treaty, are subject to U.S. taxes on the U.S. partnership’s income and on the sale of a U.S. partnership interest. Under the proposal, recognition of gain on the sale of a U.S. partnership interest that would otherwise be fully taxable at a preferential capital gains rate (depending on the structure of the transaction), may at least be partially subject to tax at a higher ordinary-income rate.
The American Families Plan and the tax proposal discussed above have yet to be formally considered by Congress.