On September 13th, the House Ways & Means Committee released a listing of proposed tax changes to be included as part of the Build Back Better Act, the budget reconciliation bill Democrats are hoping to pass in the coming weeks. The tax provisions target large corporations and high-income individuals to cover tax relief programs for the middle class, aid in funding new spending as part of infrastructure projects/initiatives, and help address climate change.
Although it is expected there will be changes to current proposals as the bill navigates through House approval and reconciliation with the Senate bill’s tax provisions, we anticipate that many of the House provisions will be included in the final legislation.
We’ve compiled the following summary of the most significant tax provisions that taxpayers should be aware of:
Tax Rate Changes
- Corporate – The current flat 21% corporate tax rate would be replaced with a graduated rate of 18% on taxable income up to $400,000, 21% up to $5 million, and 26.5% above $5 million. The graduated rate would phase out for corporations exceeding $10 million.
- Individuals – The top marginal tax rate would increase to 39.6% (from 37%) and apply to married individuals filing jointly with taxable income over $450,000 (married filing separate at $225,000), heads of households over $425,000, single taxpayers over $400,000, and trusts over $12,500.
- Capital Gains – The top capital gains tax rate would increase to 25% (from 20%) and includes a transition rule that would make this effective beginning September 13, 2021. The current 20% rate would apply to gains recognized prior to this date and may be applicable to gains recognized after, if the transaction was entered into prior to September 13 and pursuant to a written binding contract.
- NEW High-income Tax Surcharge – A new tax ‘surcharge’ of 3% would be imposed on taxpayers with modified adjusted gross income in excess of $5 million ($2.5M if married filing separate).
- EXPANDS Net Investment Income Tax – The Net Investment Income Tax (NIIT) would also be applicable to ‘income derived in the ordinary course of a trade or business’ for married filing joint taxpayers exceeding $500,000 in taxable income and single exceeding $400,000. This means the NIIT would apply to income derived from ‘active’ parts of a (passthrough) business for individuals in excess of these thresholds.
Estate Planning & Retirement Changes
- Estate Tax Exemption – The estate tax exemption would revert to $5 million per taxpayer, adjusted for inflation, beginning in 2022, which amounts to approximately $6 million. Changes would also be made to the unified tax credit. There is no elimination of the current step-up rules for inherited assets.
- Contributions to IRAs – Contributions to an Individual Retirement Account would be prohibited for a tax year when an individual’s IRA and defined contribution retirement accounts exceed $10 million as of the end of the preceding year. The limitation does not apply to married filing joint taxpayers with taxable income under $450,000, heads of household under $425,000, and single taxpayers under $400,000.
- Required Minimum Distributions (RMDs) – For ‘high-income taxpayers,’ (meaning with taxable income in excess of figures in the preceding item,) with combined retirement accounts in excess of $10 million at the end of a tax year, must take a minimum distribution of 50% of the amount by which the aggregate balance exceeds the $10 million limit. If combined retirement account balances exceed $20 million, the excess must be withdrawn from Roth IRAs and Roth designated accounts in defined contribution plans up to the lesser of 1) the amount needed to reduce aggregate funds to the $20 million limit or 2) the aggregate balance in Roth IRAs & Roth designated accounts in defined contribution plans.
- Roth Conversions – Roth conversions would no longer be available for ‘high income taxpayers’ – those with taxable income in excess of $450,000 for married filing joint, $425,000 for heads of households and $400,000 for single taxpayers.
- Qualified Business Income Deduction – The maximum allowable deduction under Sec. 199A would be capped at $500,000 for married filing joint taxpayers ($250,000 for married filing separate), $400,000 for single, and $10,000 for trusts & estates.
- Limitation on Excess Business Losses – The excess business loss limitations enacted as part of the Tax Cuts and Jobs Act would be made permanent with one change – the losses would be carried forward indefinitely as a deduction subject to the excess business loss rules (rather than carried forward as a net operating loss under current law). This would be retroactively applied to tax years beginning after December 31, 2020 (these rules were suspended for tax years 2018 – 2020 under the CARES Act).
- Carried Interest – The holding period for carried interests would increase from three years to five years for long-term capital gain treatment. The three-year holding period would remain for real property trades and taxpayers with adjusted gross income below $400,000.
- Section 1202 Stock – The special 75% and 100% exclusion rates for gains realized from qualified small business stock are not available for taxpayers with adjusted gross income exceeding $400,000. The 50% exclusion remains available.
- Tax Credits – The expansion of the Child Tax Credit (CTC) under the American Rescue Plan Act (ARPA), enacted March 11, 2021, is being extended through 2025 and the entire CTC will be made fully refundable permanently. The ARPA’s expansion of the Earned Income Tax Credit and Child and Dependent Care Tax Credit will also be made permanent. A number of employment-focused and renewable/green energy tax credits are included and/or expanded as part of the proposed legislation.
- Increase in Funding to the Internal Revenue Service – Additional funding of approximately $80 Billion would be provided to the IRS over the next 10 years for increased enforcement of Federal tax laws applicable to Corporations and high income individuals.
There are no provisions regarding the current State & Local Tax (SALT) cap of $10,000, but there is a possibility they may be added later.
Given the significant proposed changes and the limited time available for planning if/when the bill passes, now is a great time to consider year-end tax planning or gifting & estate planning strategies. It may make sense to accelerate income into 2021 and/or defer deductions to 2022 to minimize tax liabilities. The current effective date of the 25% capital gains rate may also change in the final legislation, meaning capital gains planning should still be considered for 2021. Particularly given the implementation of the Washington State capital gains tax of 7% beginning in 2022 (pending legal challenges).
We will continue to monitor future developments and provide updates, as things will be very fluid over the next few weeks and additional details will become available.
Please contact our office with any questions or if we can assist with developing a tax plan as it relates to these proposed provisions.