The House Ways and Means Committee Releases Proposed Tax Changes
On September 13, 2021, The House Ways and Means Committee released proposed tax changes to pay for and be incorporated in the Build Back Better act (the $3 trillion budget reconciliation bill currently being discussed by Congress). The House proposals modified many of the tax changes on President Biden’s agenda, ignored some of his proposals, and included a few surprises. Here are the highlights of the proposed changes with most being effective in 2022. The themes of the proposed legislation are tax increases for corporations and wealthy taxpayers and the “marriage penalty” is back. We will continue to keep you updated as there will be many changes and modifications to the proposed bill before being approved by the House and Senate.
Tax Provisions for Corporations & Businesses
- Tax Rate: the proposed bill changes the corporate income tax rate from a flat 21% to 18% on the first $400,000 of income, 21% on income up to $5 million, and 26.5% on income above $5 million. The graduated rate would phase out for corporations making more than $10 million. Personal Service Corporations would be taxed at a flat 26.5% rate.
- 1202 Stock (Qualified Small Business Stock): for individual taxpayers with Adjusted Gross Income equal to or exceeding $400,000 (and all estates and trusts), the special 75% and 100% exclusion rates for gains realized from certain qualified small business stock would not apply. Instead, a 50% exclusion would be allowed. This provision applies to sales on or after September 13, 2021 unless the sale was subject to a binding contract in effect prior to that date.
- Cryptocurrencies: the proposed bill would extend the wash sale rules to digital assets, such as cryptocurrencies. These rules prevent taxpayers from deducting a loss from an asset sale if the asset is repurchased within a set time limit.
- Research Expenses: the proposed bill delays the requirement to capitalize research and development expenses from years beginning January 1, 2022 to years beginning January 1, 2026.
- GILTI & FDII: the proposed bill changes the maximum effective rate on GILTI to 16.5625% and FIDI to 20.70%. The GILTI inclusion must be calculated on a country-by-country basis.
- Interest Deduction Limitation: the proposed bill would limit the interest deduction of certain domestic corporations that are members of an international financial reporting group to an allowable percentage of 110% of the net interest expense.
Tax Provisions for Individuals
- Tax Rates: the proposal would increase the top marginal individual income tax rate, effective in 2022, to 39.6% (from 37%). The new rate would apply to:
- married individuals filing jointly with taxable income over $450,000;
- heads of household with taxable income over $425,000;
- unmarried individuals with taxable income over $400,000;
- married individuals filing separate returns with taxable income over $225,000; and
- estates and trusts with taxable income over $12,500.
- Capital Gains: the proposed bill would increase the maximum tax rate on capital gains to 25% (from 20%) effective for gains realized on or after September 13, 2021. Sales subject to a binding contract in effect prior to September 13th would be taxed at the 20% maximum rate.
- Net Investment Income Tax (NIIT): for taxpayers with greater than $400,000 in taxable income (single filers) or $500,000 (joint filers), the proposed bill would expand the 3.80% net investment income tax to cover income derived in the ordinary course of a trade or business. This also applies to trusts and estates.
- Under current law, pass-through income from an S-Corp is not subject to the NIIT for active shareholders. The proposal would make the income subject to NIIT for both passive and active shareholders.
- Capital gains from the sale of a pass-through business would also now be subject to NIIT.
- Rental income of taxpayers qualifying as “real estate professionals” would now be subject to the NIIT
- Qualified Business Income Deduction: many owners of pass-through entities and sole proprietorships claim this deduction equal to 20% of their income. The proposed bill would cap the maximum allowable deduction at:
- Joint return – $500,000
- Individual return – $400,000
- Married individual filing a separate return – $250,000
- Trust or estate – $10,000
- Limitation on Excess Business Losses: the proposed bill would permanently disallow excess business losses for non-corporate taxpayers (net business deductions in excess of business income). Unused losses would be carried forward.
- High-Income Surcharge: the proposed bill would impose a tax equal to 3% of a taxpayer’s modified adjusted gross income in excess of $5 million ($2.5 million for a married individual filing separately).
- Limits on Deductions for Qualified Conservation Contributions Made by a Partnership: In an effort to prevent perceived abuses from “syndicated conservation easements” the bill would deny a charitable contribution deduction if the deduction exceeds 2.5 times the partner’s basis in the partnership and allow the IRS to assess a 40% penalty. Effective for contributions made after December 23, 2016.
- Carried Interest: the proposed bill increases the holding period for favored long-term capital gain treatment from three to five years.
Estate and Gift Tax Provisions
- Unified Credit: the proposed bill would revert to the 2010 unified credit amount against estate and gift taxes of $5 million per taxpayer (approximately $6 million after indexing for inflation) down from the current $11.7 million. Under existing law, this reduction was scheduled to occur January 1, 2026.
- High-Income Surcharge: the proposed bill would impose a tax equal to 3% of an estate or trust’s modified adjusted gross income in excess of $100,000.
- Grantor Trust Changes: tax treatment of grantor trusts will be changed so generally, the assets held by the trust will be included in the estate of the grantor, and a sale of assets between a grantor and the grantor trust will be a taxable transaction. Changes are generally effective for trusts created after the date of enactment of the final bill.
- Asset Valuations: generally, for estate and gift tax purposes, no valuation discounts will be allowed for nonbusiness assets (passive assets not used in the active conduct of a trade or business).
Provisions for Retirement Plans
- Contributions to IRAs: the proposed bill would prohibit further contributions to a Roth or traditional IRA for a tax year if the total value of an individual’s IRA and defined contribution retirement accounts generally exceeds $10 million as of the end of the prior tax year.
- The proposed limit would apply to “high-income taxpayers”: single taxpayers/taxpayers married filing separately with taxable income over $400,000; married taxpayers filing jointly with taxable income over $450,000; and heads of household with taxable income over $425,000.
- RMDs: if a “high income taxpayer’s” combined traditional IRA, Roth IRA, and defined contribution retirement account balances exceed $10 million at the end of a tax year, a minimum distribution would be required the following year (generally 50% of the amount by which the individual’s account balance exceeds the $10 million limit). This provision would apply to all taxpayers regardless of age.
- Roth Conversions: the proposed bill would eliminate Roth conversions for “high-income taxpayers” effective after Dec 31, 2031 (this is not a typo). Currently, there is no income limitation for taxpayers to be eligible for a Roth conversion.
- After Tax Plan Contributions: the proposal would eliminate employee after-tax contributions to qualified plans and prohibit the conversion of after tax contributions to a Roth IRA for all taxpayers.
- IRA Investments: the account can lose its tax-exempt status if it holds investments in entities owned by the account holder or investments in certain private placement securities.
Provisions Still Being Discussed
- SALT Cap: modification to or temporary repeal of the $10,000 cap imposed on individuals for their itemized deduction of state and local taxes. The cap has been effective for tax years beginning on or after January 1, 2018 and limits the federal tax benefit for state income taxes paid by taxpayers. In response to the cap, many states have enacted “work around” legislation to benefit the owners of pass-through entities such as partnerships and S-Corporations. Our recent blog (California Enacts a Pass-Through Entity Tax) discusses the California “work around” to bypass the cap. Several legislators have promised to include “relief” from the SALT cap before the House and Senate legislation is voted on.
- Closing the Tax Gap: provide additional funding to the IRS to implement programs to close the “tax gap” of uncollected payroll and income taxes. Provisions will allow the IRS to require financial service providers, such as banks, to annually report account inflows and outflows. This has been proposed as a way to pay for the loss in tax revenue due to a modification or repeal of the SALT cap discussed above.
- Modification of Section 1031 Tax Deferred Exchanges: President Biden proposed limiting the annual gain that can be deferred with an exchange. This provision is not included in the House Bill and may not be included in the Senate version either.
- Elimination of Step Up in Basis for inherited Assets: proposed by President Biden but not included in the House bill.
Please contact us if you have any questions about how these proposed tax changes may affect you or your business, or if you have any additional tax-related questions.