Plans for the reform of tax legislation in the USA

Introduction

Ever since the elections in the US federal state of Georgia, at the beginning of January 2021, Biden’s party has had a majority in both chambers of the US Congress and, therefore, the possibility of pushing through tax reform. In the following section we have aimed to give an overview of the reform plans that have already been released. However, you should bear in mind that changes to these plans are still possible and/or even probable as no bills have yet been introduced in Congress.  

Income Tax

The intention is to push up the top tax rate for incomes above USD 400,000 from currently 37% back to 39.6%. 

Furthermore, this rate would also apply to long-term capital gains (holding periods of more than one year) if the overall income adds up to more than USD 1m. Up to now, a special tax regime has been applicable to long-term capital gains that provides for a top tax rate of just 20%.

Recipients of income above USD 400,000 would, in future, contribute more to social security (social security tax). Up to now, the income cap for social security tax was USD 142,800 (status date: 2021) with a 12.4% contribution rate that is evenly split between employers and employees. In future, incomes above USD 400,000 would once again be liable to social security tax with no upper limit. Therefore, only recipients of incomes between USD 142,800 and USD 400,000 would be exempt from additional social security contributions. 

Please note: This would also mean a noticeable increase in personnel costs for employers given that the proportional social security tax contributions (6.2%) for salary payments above USD 400,000 would have to be taken into account.

Estate and gift taxes

The intention is to raise the top rate of estate tax applicable at the federal level from 40% to 45%. Moreover, the applicable lifetime exemption for 2021 would be reduced from USD 11.58m to USD 3.5m per person. The generous lifetime exemption for estate and gift taxes would therefore be reduced by almost 70% and would, thus, be rolled back to the level that applied when President Obama assumed office in 2009. 

Furthermore, there are plans to put a stop to frequently used structuring possibilities where individual assets are contributed to business assets and then stakes in the respective company are transferred. To date, up to 40% in estate and/or gift taxes could be saved as it has been possible to apply so-called valuation discounts on business assets.

Corporate income tax

The intention is to increase corporate tax rates, too. The Federal tax for enterprises that are treated as corporations under US tax law would be increased from the current rate of 21% to 28%. If the other tax charges at the level of the Federal States, - which may vary from Federal State to Federal State -, are taken into consideration then this could potentially result in an overall tax burden for corporations of approximately 36%.

In future, corporations in the USA would have to pay tax on profits that have been generated abroad at a rate of 21% instead of 10.5% currently. This rule would apply to corporations with foreign shareholdings where the corporation holds at least 50% of the shares (so-called controlled foreign corporations, or CFCs for short). Profits from these CFC shareholdings are then already taxed if they arise in the foreign country and not just subsequently when the profits are transferred to the USA as a profit distribution to the parent company.However, this does not include CFC shareholdings in those countries where the effective tax rate is the equivalent of at least 90% of the US Federal tax rate for corporations. In the event of an increase in the US Federal tax rate to 28%, the only CFC shareholdings that would then be excluded would be the ones based in those countries with an effective tax rate of, at least, 25.2%. 

Please note: Therefore, shareholdings in German corporations whose effective tax rate is normally approximately 32% should thus generally be unaffected by this rule. 

Biden, just like his predecessor, would like to create more jobs in the USA and to stop production operations being shifted overseas. To this end, the intention is to create new incentives for companies, such as, e.g., in the form of a 10% “Made in America” tax credit for investing in the revitalisation of production facilities in the USA or providing substantial salary increases for employees who work in production.

By contrast, companies that shift their production operations overseas would be penalised. It is envisaged that this would entail applying a surtax on the profits generated as a result of shifting production facilities overseas (a so-called offshore penalty tax) as well as a prohibition on the tax deduction of the outlay spent on shifting the production operations overseas.

Conclusion: German corporations with subsidiaries in the USA will essentially be affected by the increase in the tax rates resulting from the planned tax reforms. Nevertheless, further investments in locations and production capacities could be a sensible course of action as the “Made in America” tax credit could, potentially, compensate for the effects of the increase in the tax rate.