Ben Franklin once stated that “nothing is certain except death and taxes.” Clearly, he had never experienced a political environment like what we faced in 2021 and 2022—the revolving door of tax proposals meant there was very little certainty about taxes.
After many twists and turns, Congressional Democrats ultimately overcame intraparty discord and passed a scaled down version of President Biden’s climate and tax agenda in the form of the Inflation Reduction Act (IRA).
IRA tax provisions and their impact on wealthy investors
Over the past several years, countless articles, conferences, webinars, and conversations have been devoted to the topics of tax policy and tax reform. Significant time and energy have been spent covering the dozens of different tax proposals as well as every major legislative development along the way.
When viewed through that lens, the overall list of major tax-related provisions included in the IRA1 may appear remarkably short and perhaps a bit anticlimactic in light of the more aggressive tax proposals Democrats considered.
- 1% excise tax on corporate stock buybacks
- 15% minimum tax on corporations with “book income” in excess of $1 billion
- Various green energy and electric vehicle tax credits
- $80 billion in additional Internal Revenue Service (IRS) funding over 10 years
The IRA also funds various climate and energy initiatives, reduces the federal deficit, and allows Medicare to negotiate prices and cap out-of-pocket costs of certain drugs.
Eighteen months ago, few people would have guessed that a Democrat-controlled Congress passing major tax reform would leave the Tax Cuts and Jobs Act of 2017 (TCJA) virtually untouched (including the controversial $10,000 state and local tax cap) or that the highest-earning Americans wouldn’t face a major tax hike.
Yet, as evidenced by the limited tax provisions included in the bill, the IRA doesn’t unravel the TCJA and won’t have a large, direct impact on the taxes of many wealthy investors. The IRA also doesn’t directly impact the benefits of tax-loss harvesting.
However, IRS audits of wealthy taxpayers will likely increase with the additional IRS funding. From 2010 to 2019, the IRS scaled back audit rates of individual income tax returns, including those of high earners, due to decreased funding. This trend is likely to reverse with increased IRS funding.
IRS audit rates of individuals with income > $5 million
|> 16%||< 3%|
What isn’t included?
One can’t fully appreciate the tax provisions included in the IRA, or lack thereof, without revisiting earlier proposals that are NOT included. Perhaps most glaring is the myriad of capital gains proposals that are not part of the final bill, some of which are listed below.
If passed, many of these changes would have constituted significant tax regime changes and would have had a drastic effect on planning for those impacted.2 Such proposals understandably caused anxiety for many advisors and wealthy investors over the past couple of years, yet none of them are included in the IRA.
The current makeup of Congress complicated the process and contributed to the watered-down tax provisions included in the IRA. As President Biden has pointed out, when the Democrats hold 50 seats in the Senate, every single one of them is essentially president, and several senators played an outsized role in the process due to their ability to veto the entire bill. A slim Democratic majority in the House made the prospect of passing major tax reform all the more challenging.
Planning during periods of political uncertainty
Few could have accurately predicted all the twists and turns that tax reform took in 2021 and 2022. During such times, altering planning every time a new tax proposal is released may resemble a futile and potentially detrimental game of “whack-a-mole” and lead to adverse long-term outcomes.3
Aperio has repeatedly cautioned over the past several years that making drastic changes to a client’s investment strategy based on political predictions can be risky. A better course of action for many investors during such times may be to maintain flexibility and a long-term perspective while waiting until the legislative environment/outcome is clearer.4
Future tax changes
Yogi Berra has been credited with saying, “It’s tough to make predictions, particularly about the future.” Accurately forecasting legislative changes to the tax landscape in future years may be just as difficult as it was in 2021 and 2022.
As we’ve seen in the past, tax proposals tend to have long shelf lives and may be floated again in future administrations. In Washington, some say there’s no concept of a bad idea, just ideas whose time hasn’t come yet.
It used to be that major tax reform happened every few decades. In today’s polarized political environment, it seems to be happening much more frequently.
Some of the tax proposals that weren’t passed are scheduled to occur anyway in the future. For example, in the absence of additional tax legislation, the top ordinary income and short-term capital gains rate will increase and the gift and estate tax exemption will be reduced after 2025 when the individual provisions of the TCJA sunset.
History has not been kind to whichever party holds the White House heading into midterm elections, and many prognosticators expect Democrats to lose their majority in at least one of the chambers of Congress come November, most likely the House. If that happens, major tax reform changes would be unlikely for the next few years. The one exception may be the retirement security focused Secure Act 2.0 (Securing a Strong Retirement Act), which appears to have broad bipartisan support and seems fitting given that the IRA just passed.
However, if Democrats end up retaining control of both the House and the Senate and build on their slim majorities, that may give their party a second wind in their efforts to pass more aggressive tax proposals in 2023.
Ultimately, nobody knows how the tax landscape may evolve. What we do know is that ongoing changes and increased tax complexity mean there will continue to be substantial value in proactive tax planning and hopefully solid job security for Aperio Tax Economists.
In judging the merits of the IRA, some investors may be less focused on sound tax policy and instead may echo sentiments that have been attributed to Senator Russell Long:
A tax loophole is “something that benefits the other guy. If it benefits you, it is tax reform.”
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