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4 Ways Biden's Tax Proposals Could Affect Stock Comp Financial Planning

Millions of employees in the United States have stock compensation and/or holdings of their companies' shares. Many of them may be depending on these for major financial goals, such as a buying a house, saving for retirement, or funding children's college tuition. Could President Biden’s proposed tax changes impact their gains and their financial planning?

The short answer: yes, they very well could, depending on your income. While the future of the proposals remains highly uncertain, some of the proposed tax increases, such as a major hike in the top rate of capital gains tax, may require you to take action well before any new tax legislation is adopted.

The proposed tax provisions to follow are in the American Jobs Plan and the American Families Plan. The US Treasury’s General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, known informally as the “Green Book,” provides a summary and rationale of the tax changes.

Don’t have time to read Congressional legislation or a tome written by the US Treasury? No problem. At myStockOptions, we read that stuff so you don’t have to, along with related commentaries from law firms and other expert observers. Below is what to know about the potential impact of Biden’s tax proposals on stock compensation and company shares that you hold. For financial advisors, this provides an opportunity to reach out to clients about the possible changes and the impact on decisions involving stock options, restricted stock, ESPPs, and company stock holdings.

1. Top Tax Rate

Currently, the flat supplemental wage withholding rate, which applies to income such as stock compensation and cash bonuses, is 22% for yearly amounts up to $1 million and 37% for yearly amounts in excess of $1 million. That higher withholding rate is tied to the top tax bracket.

Under Biden’s plan, the highest ordinary tax bracket rate would go from 37% to 39.6% starting January 1, 2022 (see page 60 of the Green Book). That would therefore increase the higher rate of supplemental wage withholding to 39.6%. This rate would also apply to short-term capital gains for anyone in the top tax bracket.

ACTION STEPS: When you decide to exercise nonqualified stock options (NQSOs), you control when you will realize the taxable income at exercise, including federal tax. If you’re in the top tax bracket or will be from your option exercise, analyze whether for tax reasons it makes sense to exercise the options in 2021 instead of in 2022, when that bracket rate may be higher.

While most financial advisors would not suggest you make stock option exercise decisions solely for a 2.6% tax savings, this potential tax hike is worth evaluating as a factor for options close to expiration. For options not close to expiration, remember that NQSOs offer substantial leverage and upside, all of which ends as soon as you exercise the options (see the prior article in this blog).

Private companies with a recent or upcoming initial public offering (IPO) have a special concern. If your company has granted double-trigger-vesting restricted stock units (RSUs), in which typically the shares are not fully vested and delivered until six months after the IPO, the company may want to consider accelerating the share delivery into 2021 should the change to the top income-tax bracket be enacted. Accelerating that income into 2021 by delivering the shares this year (when the top rate is 37%) will save taxes for employees who have already met the requirements of both the time-based and the liquidity-event vesting conditions.

2. Capital Gains Tax Rate

Long-term capital gains, such as from company stock sales, currently have a top tax rate of 20% (plus the 3.8% Medicare surtax). Biden’s tax plan would raise the top rate on long-term capital gains and on qualified dividends to the highest rate of ordinary income tax for households with over $1 million in adjusted gross income ($500,000 for married filing separately).

The rate change would be retroactive to the date it was announced, considered to be April 28, 2021, when President Biden issued a Fact Sheet on the American Families Plan. The change for taxes for capital gains realized at death and with gifts, discussed below, would start January 1, 2022. (See pages 61–64 of the Green Book for more details on these capital gains proposals.)

Action Steps: With incentive stock options (ISOs) taxation, when you hold the shares more than two years from grant and one year from exercise, the full gain at sale over the exercise price is capital gain. While the tax treatment for NQSOs is fixed at exercise, for ISOs when you sell the stock without meeting the holding periods the tax treatment changes to essentially follow the ordinary income rates. Anyone with annual income of more than  $1 million will want to evaluate whether to risk holding ISO shares for the long-term capital gains rate when that rate would actually, under Biden’s plan, match their ordinary income rate.

Similar thinking applies to the decision with restricted stock about whether to make a Section 83(b) election to be taxed at grant instead of vesting. One big advantage of the election is to get an early start on the holding period for long-term capital gains. But under the proposed change, the tax rates on long-term and short-term capital gains for people in the top tax bracket may become the same anyway.

Details Murky On Proposed Change And Its Potential Impact

According to some experts, it remains unclear whether this higher capital gains rate would apply to all capital gains income or to only some portion of it (see Tax Reform In The American Families Plan from the law firm Morgan Lewis). Among the many other issues are how this change would impact the 0% rate on qualified small business stock (QSBS). The potential impact for individuals with stock by this proposed change, including the range of open issues and when to recognize capital gains income, is addressed by articles from Tech Crunch (Startup Employees Should Pay Attention To Biden’s Capital Gains Tax Plans), McDermott Will & Emery (What a Capital Gains Rate Hike Could Mean), and Morningstar (Capital Gains Tax Proposal a Wake-Up Call to Assess Concentrated Holdings).

The law firm Proskauer Rose predicts that if the capital gains rate increases, affected taxpayers will “defer sales of appreciated property and to use cashless collars and prepaid forward contracts to reduce economic exposure, and to monetize, liquid appreciated positions” (see Treasury’s Green Book Provides Details on the Biden Administration’s Tax Plan).

3. Capital Gains Realized Upon Death Or At Gifting Of Stock

Biden’s tax plan would dramatically change the capital gains treatment via gifting or upon death for transfers of appreciated property, such as company stock. For example, the ability to eliminate capital gains at death by a step-up in the basis on the shares, which allows heirs to then pay tax only on the appreciation after death, would no longer apply to gains over $1 million per person ($2 million per couple).

Alert: This does not mean that the basis for the remaining stock over these amounts is just carried forward to the person(s) inheriting it or the beneficiary, as has been misreported in some sources. Death itself triggers the recognition of capital gains tax on these amounts as if the stock was sold!

Similarly, any gifts made over these amounts would be taxable at that time to the gifter. Currently the receiver just carries forward the basis, and the giver would owe gift tax only if they did not have any of their lifetime gift/estate exemption amount remaining. Exceptions would apply, such as with transfers to a spouse, a charity, or heirs of small businesses and farms that continue to run those businesses. Donations of highly appreciated stock to charities would still avoid the 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 married couples), which was discussed during the campaign and may be forthcoming. However, that amount does automatically go down to $5.49 million per person (adjusted for inflation) at the start of 2026, when the provision sunsets at the end of 2025 under the Tax Cuts & Jobs Act (TCJA).

4. Beefed-Up Enforcement

The proposed legislation provides funding to “revitalize enforcement to make the wealthy pay what they owe” in an effort to shrink the tax gap, according to the Fact Sheet on the American Families Plan. This means with certainty an increase in audits of companies, executives, and others who are wealthy because of their stock compensation or founders’ stock. The audit rates on those making over $1 million per year, which fell by 80% between 2011 and 2018, will increase substantially. Financial institutions would be required to report information on account flows so that earnings from investments, such as from stock compensation and company stock holdings, are subject to broader IRS reporting.

Likelihood Of Tax-Law Changes

Whether any of these proposals will get adopted in their current form, and with the proposed effective dates, remains uncertain. Doubts about what will happen are raised by experts quoted in articles from Investment News (Political Reality Seen Curbing Biden’s Tax Plan) and Politico (Tax The Rich? Executives Predict Biden’s Big Plans Will Flop). The lobbyist and business group leaders quoted in the Politico article seem confident that they will pressure moderate Democrats in the House and Senate to “kill almost all of these tax hikes.”

A reminder of what tax ideas have not yet been proposed by Biden, such as taxing stock options at vesting, appears in a commentary from the law firm Brownstein Hyatt Farber Schreck (Will Biden’s American Families Plan Take Aim At Executive Compensation?). That proposal had been part of the initial draft of the TCJA, the tax-reform law enacted at the end of 2017.

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Wealth Tax Debate: The Movie

As the 2020 presidential election year approaches, Democratic candidates, most notably Senator Elizabeth Warren, have proposed a 2%–3% wealth tax on the assets of the super-rich to help ensure that they pay their fair share along with other taxpayers.

Upon first hearing about a wealth tax, we at myStockOptions.com thought it could apply to any company founder that built a successful company, executives with substantial grants of stock options or restricted stock units, or employees who joined an early-stage startup and now have significant wealth after an IPO or acquisition. However, the proposed tax is really for the super-wealthy: billionaires and mega-millionaires. Under Senator Warren’s proposal, for example, the wealth tax would be triggered only if your household net worth, including stock holdings, is over $50 million. It would apply to individuals such as Jeff Bezos, Michael Bloomberg, Bill Gates, Larry Ellison, Larry Page, Mark Zuckerberg, and others whose enormous wealth comes from stock in the companies they founded.

To find out more, we watched the live internet-streamed seminar The Wealth Tax Debate, recently held by the Penn Wharton Budget Model (PWBM). It’s a nonpartisan research-based initiative at the Wharton School, the business school at the University of Pennsylvania. Three scholars discussed the feasibility and tradeoffs of the wealth tax proposed by Senator Warren and other Democratic presidential candidates. Below I present a few highlights from each speaker’s talk.

While this streaming video is perhaps not as exciting as Amazon Prime or Netflix, for anyone interested in tax and public policy issues it’s an absorbing drama and short enough to watch in one sitting. It runs about 90 minutes (presentations 50 minutes and Q&A for remainder), shot with a single camera and no editing, with the speakers’ slide decks on screen during their talks.

After watching the full 90-minute running time of the seminar, you’ll come away with a better understanding of the complex issues involved with the wealth tax. Those who oppose the wealth tax will give this movie a thumbs up, while supporters of the wealth tax may find parts of it tough viewing.

Wealth Tax In Brief

Many of the wealthiest US citizens have vast assets but little income, so traditional income taxes struggle to reach them. In the view of some of the Democratic presidential candidates, a wealth tax would ensure that these very richest Americans pay their fair share.

Another underlying purpose for the wealth tax concerns democracy. By reducing income inequality, the wealth-tax proposals seek to protect democracy itself by limiting political oligarchy: the amount of wealth and related political influence that the rich can accumulate. The aim is to control the potential for one tiny plutocracy to dominate election campaigns.

The Wealth Tax Debate

In the Penn Wharton seminar, Senator Warren’s proposed wealth tax is the primary focus of the three speakers. Her proposal’s research, rationale, and estimates of revenue potential were developed by Emmanuel Saez and Gabriel Zucman, two economists at the University of California, Berkeley.

Part One: Economic Growth

Richard Prisinzano, Director of Policy Analysis at Penn Wharton Budget Model (PWBM), presented his research team’s initial projection of the impact Senator Warren’s proposed wealth tax would have on revenue and the US economy. The researchers found that if the tax raises as much new revenue as intended and the revenue is used to cut the federal debt, annual economic growth in the United States would slow from the current average of 1.5% to an average of just over 1.3% over a decade.

Broadly, the PWBM finds that wealthy Americans would simply consume more, save less, and invest less to reduce taxable wealth. The resulting drop in investment would, in its modeling, reduce economic growth. “The wealth tax shrinks the economy because saving is more expensive,” Mr. Prisinzano summarized. “The results also suggest that the negative effect of the tax increases as the tax rate increases.”

For commentaries that critically review at least parts of this PWBN analysis for not fully considering the potential economic growth generated from government programs that spend the new tax revenue, see articles in Business Insider, The Week, and New York Magazine’s Intelligencer.

Part Two: Questions Of Revenue, Constitutionality, And Alternatives

Natasha Sarin, Assistant Professor of Law at the University of Pennsylvania Carey Law School, dissected the revenue estimates of Senator Warren’s wealth tax that were calculated by Emmanuel Saez and Gabriel Zucman at UC Berkeley. In short, she finds their assessment flawed and unrealistic. When she dynamically corrects what she considers “sloppy math” and unfounded assumptions about actual wealth holdings and tax compliance among the rich, she projects that the proposed wealth tax would generate $1.1 trillion, far lower than the Warren team’s estimate of $2.75 trillion.

Additionally, the task of annually assessing the net worth of the wealthy for a wealth raises difficult practical issues. Given that over 50% of wealthy assets are illiquid, how would they be valued?

Furthermore, shifting from economics to law, Professor Sarin noted that a wealth tax would almost certainly be challenged as unconstitutional and probably nixed from the start. Under the US Constitution, direct taxes must be evenly apportioned across the states. However, the roughly 75,000 super-wealthy households impacted by a wealth tax are not evenly distributed across states. Given two centuries of legal precedent against a wealth tax, she believes that the current US Supreme Court, for better or worse, would inevitably rule that a wealth tax is unconstitutional.

Professor Sarin shows in her slide deck that, instead of attempting a wealth tax that may be problematic, there are more efficient ways to raise federal revenue:

• crack down on IRS tax compliance among the wealthy (she recently wrote a paper on this with economist Lawrence Summers)
• close corporate and individual tax shelters
• eliminate the stepped-up basis of assets at death
• cap taxable deductions for the wealthy
• end pass-through deductions
• broaden the estate-tax base
• increase the corporate tax rate

She estimates that these measures would increase revenue by $2.83 trillion, slightly beating the revenue estimate of $2.75 trillion put forward by Senator Warren’s team—and hugely exceeding Professor Sarin’s $1.1 trillion estimate of the wealth tax’s actual revenue potential.

Part Three: Tax Tradeoffs

Greg Leiserson, Director of Tax Policy and Chief Economist at the Washington Center for Equitable Growth, discussed the approaches and tradeoffs of taxing wealth. He explained the issues in the different approaches of taxing wealth itself compared to taxing the income generated from wealth, and the difference between taxation based on valuation compared to when the gains are realized.

He summarized the advantage of the income approach:

• More seamless integration with existing income tax
• Greater risk sharing between taxpayer and government
• Reduced constitutional risk

He summarized the advantages of the wealth approach:

• Taxes assets that generate consumption flows
• Less volatile revenues
• Easier to explain

He concludes that any approach needs to look at who the tax is burdening, which we assume impacts compliance, and how much revenue is going to be realistically raised. (For the challenges involved in raising more tax revenue from the super-wealthy, see what financial advisors have to say in an article from The New York Times.)

Wealth Planning: Not Just For The Super-Rich

Whatever the size of your wealth from stock compensation and company stock holdings, you and your advisors will find useful planning ideas and insights in the section Financial Planning at myStockOptions.com.

Capital Gains Tax: What Democratic Presidential Candidates Are Saying And What Tax Changes Might Look Like

At myStockOptions, we are listening for policy hints from the Democratic presidential candidates that may affect equity compensation if Democrats regain control of the White House and Congress in 2020. This includes the potential for changes in the long-term capital gains tax, a stated goal for several of the Democratic candidates.

Capital Gains Tax: A Review

Capital gains on asset sales are often still associated with the wealthy and not the middle class. However, anyone who sells a house is subject to the tax rules of capital gains and losses. Anyone who sells stock, ETF holdings, or mutual funds in non-retirement brokerage accounts incurs a capital gain or loss. Nowadays, that's not just the wealthy. For example, an employee incurs a capital gain or loss when selling company shares acquired from stock option exercises, restricted stock/RSU vesting, or ESPP purchases, even if the number of shares is small. Capital gains tax has therefore become a commonplace feature of individual taxation for many US citizens, not just the wealthy minority.

While the Tax Cuts and Jobs Act made significant changes in the rates and brackets of income tax in 2018, it did not modify the long-term capital gains tax rates (15% and 20%) that apply to gains from shares acquired from stock compensation and held for at least one year. Those rates have been in place for many years.

However, if Democrats win the presidency and a workable majority in Congress, we should expect changes in the long-term capital gains tax as part of Democrat efforts to increase federal revenue and reduce income inequality. This is clear from statements made by Democratic candidates, the tax-policy positions they have issued, and research from other sources (see commentaries from Politico, The Hill, and Kiplinger). If your decisions at year-end on whether to hold or sell investments tend to be tax-driven, you could be very busy in December 2020.

Democratic Presidential Candidates: What They Are Saying

Below is a sample of specific policies for capital gains tax that Democratic presidential candidates have proposed:

• taxing capital gains income the same as compensation income (Cory Booker, Amy Klobuchar, and others)
• increasing the capital tax rates for incomes over $1 million (Joe Biden)
• eliminating the lower capital gains rates for those with household income above $250,000 (Bernie Sanders)
• a wealth tax for the richest top 0.1% that in essence taxes the gains on assets before any sale proceeds are realized (Elizabeth Warren)
• ending the step-up at death in the basis of inherited assets

Meanwhile, as we discussed in a recent blog commentary, the Trump White House is pulling in the opposite direction on capital gains. It is seriously considering a presidential executive order which would index the capital gains cost basis for inflation. That would effectively result in a tax cut—controversially, without the approval of Congress. It seems that the future of capital gains taxation could take a very different path if the Democrats do not regain the White House in 2020.

Varying Approaches To Capital Gains Taxation

While most of the Democratic candidates appear to support eliminating the different tax rates that apply to long-term capital gains compared to compensation income, those policies might not mean all the gain would be taxable. There could be an income-exemption amount for a certain percentage of gains. No candidate has mentioned this approach, which was actually part of the US tax code before the Tax Reform Act of 1986. Tax exemptions on a certain percentage of capital gains are applied by several other countries now. For example, in Canada, only 50% of capital gain is included in income, and it's then taxed at the individual's income tax rate.

Interestingly, tax policies in countries around the world embrace the rationale that capital gains should be taxed differently than employment income. For example, that is the case in Denmark, Sweden, and Germany, countries that have more progressive social-welfare programs and less income inequality than the United States. (You can sample other tax treatments of capital gains and equity compensation around the world in the Global Tax Guide at myStockOptions.com.)