The American Families Plan and the Potential Impact on Your Taxes

President Joe Biden introduced the American Families Plan in late April. It includes three main parts: a focus on education, easing the financial burdens of working families and several tax proposals. However, much uncertainty remains about the details and probability of each piece of the proposed legislation becoming law.

Below, we outline several key proposals in the plan that could have broad-ranging impacts on investors. They include an increase in the top marginal tax rate—back to 39.6% for taxpayers earning $1 million or more per year in taxable income—an increase in long-term capital gains tax rates and the forced realization of capital gains taxes at death without elimination of the estate tax. More specifically, a $6 million estate comprised of gains that today are all transferable to heirs would be able to transfer only about $3.8 million to heirs under the new tax regime (not considering any state-level taxation).

On May 28, 2021, the Treasury issued a report, General Explanation of the Administration’s Fiscal 2022 Revenue Proposals, which further defines some of the proposed tax law changes outlined in the American Families Plan. However, it’s still unclear exactly which individuals and types of assets will be impacted. Some exceptions have already been outlined for family-owned businesses and farms with heirs who continue to run the businesses.

The American Families Plan Contains These Tax-Related Proposals

  • Discontinue step-up in basis for capital gains of more than $1 million.
  • Increase top marginal income tax rate from 37% to 39.6%.
  • Increase top capital gains rate to 39.6% for households making over $1 million.
  • Discontinue like-kind exchanges for real estate.
  • Eliminate preferential treatment for carried interests.
  • Eliminate wage-based cap for Medicare tax for those making over $400,000.

Additional Details Continue To Emerge 

Additional guidance indicated taxpayers should assume that any increase in capital gains tax would be retroactively applied when the Biden administration first outlined the plan in April. So investors hoping to avoid higher capital gains by selling assets now in advance of legislation passing would have no such luck.*

So, what are investors, savers and retirees left to do as this debate unfolds in Washington D.C.? That likely depends on several variables, and there is no substitute for speaking with a wealth management and tax professional. But certain aspects of the plan are more likely to come to fruition than others, namely some increase in the capital gains rate.

Figure 1 outlines the maximum federal long-term capital gains tax rate in the U.S. back to the 1950s. The current proposal increases it to 43.4% after the inclusion of the 3.8% in net investment income tax for taxpayers with an adjusted gross income of more than $1 million. In this article, we review some tools available to investors that help maximize the potential benefit of tax deferrals in portfolios and leverage underlying investment strategies that tend to be more tax efficient.

Figure 1 | Maximum Tax Rate on Capital Gains Since 1954


Federal Capital Gains Tax Collections, Historical Data | 1954-2018 ( 

Data from 1/1/1954 – 12/31/2014. Source: U.S. Department of the Treasury, Office of Tax Analysis.

Tax Sheltering and Compounding

The benefits of compounding are well known, and this certainly applies inside a tax shelter. The ability to reinvest gains and let them grow produces an accelerated increase in final wealth. For example, the growth of $1 million invested at a 10% annual return that is taxed at a 40% rate after 15 years produced 20% higher final wealth—$500,000 more than the same $1 million taxed on an annual basis at the same 40% rate—$2.9 million versus $2.4 million.

The fact is both income and capital gains taxes can detract from a portfolios' ability to benefit from compounding. Sheltering the portfolio from taxes is a huge benefit, and therefore, saving inside retirement accounts is beneficial for investors.

The limited annual contribution of 401(k) and individual retirement accounts forces most affluent investors to complement their tax-deferred retirement accounts with savings for retirement inside taxable accounts and face potential annual taxation on income and capital gains realizations.

Advisors can employ a variety of tools to increase the benefit of compounded growth in a taxable account. These range from clever asset location (e.g., locating more tax-efficient assets in the taxable accounts) to tax-loss harvesting activity in an effort to achieve longer deferrals despite realized gains to using tax-efficient investment vehicles.

Mutual funds and Exchange Traded Funds (ETFs) are the primary commingled vehicles leveraged in taxable accounts. For a full comparison of the two structures, please see our May 2021 paper “ETFs: Begin with the Basics.”

Since capital gains and tax deferrals are the focus of this article, we will point out the most important differences between mutual funds and ETFs concerning capital gains. Figure 2 illustrates the similarities and differences at a high level.

Figure 2 | Comparing and Contrasting ETFs and Mutual Funds

However, in ETFs, the exchange of shares by investors often involves market makers, who can create or redeem shares with the investment advisor by exchanging the underlying securities directly or in kind. This creation/redemption mechanism means portfolio managers do not necessarily have to sell underlying securities if an investor wants to sell shares.

The ETF structure has continued to gain recognition by investors, as evidenced in Figure 3. Since 2013, equity ETFs have seen more than $1.9 trillion in net inflows, while equity mutual funds have faced close to $1.7 trillion in net outflows.

Figure 3 | Investors Continue To Adopt ETFs Over Mutual Funds

A Plan for Many Paths

Changes to the tax code are not new. We can look back in history at the prevailing top federal marginal tax rates and federal capital gains rates as clear examples of this fact. We have seen tax rates increase and subsequently decrease more than once. The old saying about the only two certainties in life being death and taxes carries a fair bit of truth. And when it comes to paying capital gains taxes, it generally means there was a positive return on investment.

NOTE: There is one exception where, if you buy into a legacy mutual fund with significant unrealized capital gains, you are taking on potential future tax liability for gains embedded in the fund you did not enjoy.

Regardless of the prevailing capital gains rate, investors and advisors can leverage various vehicles and tools to maximize deferral benefits, benefit from compounded returns and increase the chances of achieving their financial goals.

* Richard Rubin, “Biden Budget Said to Assume Capital-Gains Tax Rate Increase Started in Late April,” Wall Street Journal, May 27, 2021.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.