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💸 How does Biden's $5T proposed tax increases impact you?

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Hi there,

Vieje back here again. Spring is in the air and a third of the year is officially over. You know what that means...

It's Gonna Be May Meme

(sorry… I had to)

I’m not sure about you all, but I’ve got the travel bug right now. My colleague John who you heard from a couple weeks ago is kicking back on the Big Island in Hawaii and I’m truly jealous. My travel season kicks off shortly with a Secfi team off-site to Chicago in May followed by my in-law’s family reunion in Maine in June, and then a trip to Barcelona and San Sebastian with my wife in July. I’ll take any and all recs for food so hit me up if you have any suggestions!

I know April is over and most of you don’t want to hear the word taxes until next year, but Biden’s proposed tax increases for FY2025 caused such a stir that I thought it was worth discussing in today’s newsletter. These tax changes could have a major impact on both startups and employee equity.

I’ll start out by discussing the high level proposed changes, then discuss how it may impact you as a startup employee, and then end with my analysis on the situation. This is meant to be a high level analysis so please be sure to consult a tax professional for your own particular circumstance. Let’s jump in.

💲So am I going to have to pay more taxes?

Possibly. On March 11, President Joe Biden sent Congress his proposed 2025 budget which includes tax increases on both businesses and individuals. This does not mean that Biden is imminently trying to increase taxes this year, but outlines a plan for 2025 if he is reelected. 

One important key note is that former President Trump’s 2017 Tax Cuts and Jobs Act (TCJA) provisions are set to expire at the end of 2025 so the next President and lawmakers are likely to leverage this opportunity to pass new tax laws and provisions.

On the individual front, President Biden is proposing to increase the top ordinary income tax rate back to 39.6% which was the highest tax bracket prior to the 2017 TCJA. The current highest ordinary income rate is 37% so this represents a 2.6% increase in taxes for those in the highest brackets. This is the rate you pay on your wages and any exercise of NSOs.

Probably the most debated topic in the budget is Biden’s proposal to increase the capital gains tax. If you sell your investments like stock, crypto or real estate, you will pay capital gains tax if your investments appreciated. At the current moment, you pay up to 20% on long-term capital gains tax which is much lower than the 37% ordinary income tax rate. Biden is proposing to effectively get rid of the lower rates and tax capital gains at the highest proposed tax bracket of 39.6%.

In addition to getting rid of the capital gains tax break, Biden is also proposing to increase the current 3.8% net investment income tax to 5%. The net investment income tax applies to investments for high earners effectively adding to the capital gains tax. This means that if enacted, the highest capital gains tax rate could be 44.6% (39.6% capital gains and 5% net investment income).

There is also a proposal to tax the unrealized gains for the ultra-wealthy meaning those with over $100M. I'll save the "wealth tax" conversation for a different day as it probably deserves its own newsletter and won't apply to the vast majority of people reading this.

Also worth mentioning for you VC, hedge fund, and PE fund folks out there: Biden is also proposing to tax carried interests as ordinary income, not capital gains. Please don’t shoot the messenger - I don’t need an army of Patagonia vests chasing me.

Patagonia vest finance bros

⁉️ So what could this mean for me and my equity?

An increase in ordinary income may mean higher taxes upon exercising your stock options. The much bigger potential impact is the increase in long-term capital gains tax which could severely eat into your profits after your company’s IPO or exit. If the law is put in place, you could be on the hook for a 44.6% tax on your gains versus the current 23.8%, and that is not including state taxes like California’s 13.3%.

Before you freak out, it’s worth reiterating that nothing is put in law yet. A proposed budget does not necessarily mean that it will be exactly what Biden takes to Congress if he’s reelected. In fact, prior to the last election in 2020, Biden’s campaign put forward his campaign tax proposals which looks very similar to his 2025 budget proposal. And yet, none of it was put into law after he was elected. 

Presidents and President hopefuls from both parties love to talk about taxes and their plans during their campaigns, but what actually happens after the election is a different story. Even President Trump promised to kill carried interest during his campaign but eventually backed off putting the provision in the 2017 TCJA. 

The bad news? We had a common saying at my previous job at PwC… “taxes are only going up”. The general consensus view of my tax professional colleagues is that taxes are going to increase, not decrease in our lifetimes. We’ll have to see when and how that looks in the future.

My personal take is that this seems like a classic negotiation tactic. Both parties seem to believe that there will be a major tax bill considering the sunsetting of the 2017 TCJA and Biden decided to kick off the future negotiation with setting (a very) high bar. It could also very well be part of his campaign’s tactics as he seeks reelection in November.

We’ll see if it works come next year. But for now, we expect to hear a lot about taxes during the election.

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