Understanding the Proposed Tax Changes
Last week, Sen. Warren reintroduced her “Ultra-Millionaires” wealth tax proposal to the Senate, sparking discussions on the timing of such a move. With the current Congress’s composition, the proposal’s chances of passing appear slim. However, the Senator’s initiative seems to be in line with the Administration’s Fiscal Year 2025 Budget, which also suggests a wealth tax, albeit with a similar fate for the time being.
The revival of these tax plans may be more than just political posturing in light of the upcoming White House race. The Administration has been vocal about addressing what it terms as tax avoidance by the wealthy, a focus that is likely to intensify as both chambers of Congress and the presidency are up for election.
Despite the political climate, business owners and their advisors should not dismiss these proposals as mere election year rhetoric. The Democratic Party’s recent control of the legislative process and near success in passing significant tax increases suggest that familiarizing oneself with the potential changes is prudent.
The Administration’s 2025 budget outlines several proposed income tax changes that could impact closely held businesses and their owners. For instance, the top marginal individual income tax rate could rise from 37 percent to 39.6 percent, with the new rate kicking in at lower taxable income levels. This increase would affect various forms of ordinary income, including compensation, interest, and rents.
For shareholders of S corporations and partners in tax partnerships, their share of ordinary business income would also be taxed at this higher rate. Additionally, gains from certain property sales between related persons could face steeper taxes.
The long-term capital gains tax structure could also see a shift, with high-earning married taxpayers potentially facing taxes at ordinary income rates for gains exceeding $1 million. This change could significantly affect those selling a business or receiving payments on installment notes.
Other notable proposals include an increase in the Net Investment Income Tax (NIIT) rate and an expansion of its base to cover all pass-through business income for high-income taxpayers. The additional Medicare tax on self-employment earnings and wages could also rise for individuals earning more than $430,000.
Corporate tax rates are not spared from potential hikes, with proposals suggesting an increase from 21 percent to 28 percent for C corporations. S corporations could face a flat income tax rate of 28 percent on net recognized built-in gains during the 5-year recognition period.
Furthermore, closely held C corporations might lose the ability to claim deductions for compensation exceeding $1 million paid to any employee. This change could have far-reaching implications for how businesses compensate their key employees.
Amidst these proposed changes, the national deficit looms large at approximately $35 trillion. With spending continuing to outpace revenue and interest payments on the debt growing rapidly, the economic and geopolitical consequences are becoming increasingly apparent. The question remains whether increased taxation can spur economic growth or if it will dampen the entrepreneurial spirit that drives business owners to take risks and invest in their ventures.
As we navigate this uncertain terrain, it is clear that businesses and their owners must stay informed and prepared for potential shifts in the tax landscape.