By: Rosalind Sutch, CPA, MT
While many tax advisors were busy working to wrap up September 15th deadlines on Monday, House Ways & Means Committee Chairman Richard Neal released 881 pages of proposed legislative text intended to become part of the Build Back Better Act, a budget reconciliation bill forthcoming from Congress. That same day, Ways & Means Committee staff prepared and released an 18-page, section-by-section outline of the potential tax legislation required to cover the Biden administration’s $3.5 trillion spending plan. It’s still early in the legislative process and what will become law is still somewhat of a guessing game. But we are at the stage when we start following the proposals more closely, and today we highlight the more significant provisions in the House bill...in significantly fewer pages.
Tax Rate Increases and Deduction Limitations
Individual Income Tax Rates & Deduction Limitations
- The top individual tax rate for 2022 is currently 37% for single taxpayers with income over $523,600 and married filing joint taxpayers with income over $628,300. The proposed legislation increases the top rate to 39.6% beginning in 2022 for single taxpayers with income over $400,00 and married filing joint taxpayers with income over $450,000.
- The proposed legislation adds a new 3% tax surcharge on income over $5 million beginning in 2022. This additional 3% surcharge is in addition to the 3.8% Net Investment Income Tax that would remain in place under the proposed law, but would apply to all income over $5 million, not just investment income.
- The top preferential capital gains rate of 20% would increase to 25%, effective as of September 13, 2021. The old rate would apply to certain transactions initiated before the effective date but consummated after.
- Each of these rate increases, thresholds, and effective dates will be heavily negotiated.
- The Net Investment Income Tax (NIIT) surtax of 3.8% currently applies to investment income not derived from a trade or business for single taxpayers with income over $200,000 and married filing joint taxpayers with income over $250,000. The proposed legislation expands the application of this tax to include investment income derived from a trade or business and increases the income threshold for single taxpayers with to $400,000 and married filing joint taxpayers to $500,000 beginning in 2022.
- Applying the NIIT to investment income related to a trade or business will have a significant impact on taxpayers with investment income from a trade and business and capital gains from the sale of a trade or business.
- There is currently no cap on the Section 199A Qualified Business Income Deduction. The proposed legislation sets a maximum allowable deduction of $400,000 for single taxpayers and $500,000 for married filing joint taxpayers beginning in 2022.
- The Excess Business Loss provision introduced with the Tax Cut and Jobs Act (TCJA) was scheduled to sunset in 2026. The proposed legislation removes the sunset and make the Excess Business Loss provision permanent.
- By “permanent” we mean until a future tax law change, since this provision has been altered by every tax law passed since it was enacted.
Trusts & Estate Income Tax Rates
- The top trust and estate income tax rate for 2021 is 37% for trusts or estates with income over $13,050. The proposed legislation increases the top rate to 39.6%, beginning in 2022, for trusts or estates with income over $12,500.
- The 3% tax surcharge for high-income taxpayers discussed above and the NIIT change relating to income derived from trade or business will apply to trust and estates, too.
Corporation Income Tax Rates
- The current corporate tax rate is a flat 21%. The proposed legislation provides a graduated rate structure of 18% on the first $400,000 of income; 21% for income up to $5 million, and a top rate of 26.5% thereafter. However, the graduated rate phases out for corporations with income over $10 million and is not applicable to personal service corporations.
Retirement Plan Rule Modifications
Contribution and Rollover Limitations
- Beginning in 2022, the proposed legislation prohibits a taxpayer from contributing to IRA accounts for any taxable year where (1) the total value of their IRA and defined contribution retirement accounts exceeds $10 million at the end of the prior taxable year, and (2) their taxable income is over $400,000 for single taxpayers and $450,000 for married filing joint taxpayers.
- Beginning in 2022, the proposed legislation prohibits after-tax (non-deductible) contributions to qualified plans and 401(k) plans from being converted to ROTH accounts, regardless of income level.
- Beginning in 2032, the proposed legislation eliminates ROTH IRA conversions for those with taxable income over $400,000 for single taxpayers and $450,000 for married filing joint taxpayers.
- Together, these proposed changes appear to eliminate the annual “back-door” ROTH contributions some high-income taxpayers use when their income exceeds the amount allowable for direct ROTH IRA contributions. However, it seems taxpayers will still be able to convert tax-deferred IRA and qualified plans to ROTH accounts for the next 10 years. The proposed legislative text and section-by-section summary has this provision effective beginning in 2032. We are unsure if this was a typo that will be corrected to 2022 in future versions or if this was meant to be a revenue raiser during the 10-year budget window.
New RMDs for Large Retirement Account Balances
- Taxpayers who otherwise would be subject to required minimum distribution (RMD) rules, with income over $400,000 for single taxpayers and $450,000 for married filing joint taxpayers, will be subject to new RMD rules if their retirement plan assets exceed $20M and $10M thresholds.
- Beginning in 2022, the proposed legislation requires taxpayers with over $20 million in IRA and defined contribution retirement accounts at the end of the prior taxable year, to take an increased RMD. This RMD would be made proportionately from all their ROTH IRA and defined contribution retirement accounts until either (1) their ROTH IRA accounts have been fully distributed, or (2) the balance of all their IRA and defined contribution accounts is $20 million in the aggregate.
- Once this $20 million RMD rule is satisfied there would be a new $10 million RMD rule. Those with retirement accounts with an aggregate balance more than $10 million would be required to withdraw half of the excess over $10 million annually. The taxpayer can determine from which accounts to make this distribution.
- There are significant additional retirement account balance reporting requirements added by the proposed legislation to ensure compliance with the new RMD rules being proposed.
Prohibition on Certain Self-Directed IRA Account Asset Holdings
- The proposed legislation has several provisions impacting taxpayers who hold “non-traditional” assets in their IRAs (usually held in “self-directed” IRAs). These include assets that would generally be available only to accredited investors or could be considered self-dealing (e.g., ownership in a corporation, partnership, trust, or estate in which the IRA owner is greater than 50% owner). There is a two-year transition period for IRAs already holding any prohibited assets before they would lose their IRA status.
- Effective 2022, the gift and estate tax exclusions would be $5 million per individual, indexed for inflation down from the current $11.7 million
- Grantor trusts rules would change substantially. These rules would apply to any trusts created on or after the date of enactment and to any portion of the trust attributable to contributions made on or after the date of enactment.
- All assets in a grantor trust would be includable in the grantor’s estate.
- Distributions from grantor trusts to beneficiaries would be treated as gifts made by the grantor.
- Sales between a grantor and their grantor trust would no longer be disregarded for income tax purposes.
- Estate and gift tax valuation discounts would not be permitted when valuing nonbusiness assets transferred to a trust or family-owned entity. The effective date of this provision is the date of enactment.
- This proposed legislation omits any reference to removing the step-up in basis of assets inherited from any estate. However, since this is still proposed legislation, changes are not off the table yet.
Miscellaneous Other Provisions
S Corps to Reorganize as Partnerships Without Tax
- Under the proposal, eligible S corporations could reorganize as partnerships without triggering tax. Eligible S corporation means any corporation that was an S corporation on May 13, 1996 (prior to the publication of current law “check the box” regulations with respect to entity classification). The eligible S corporation must completely liquidate and transfer all its assets and liabilities to a domestic partnership during the two-year period beginning on December 31, 2021.
Qualified Conservation Contributions
- The proposed legislation aims to curb syndicated conservation easement tax shelters by denying charitable deduction for contribution of conservation easements by partnership and other pass-through entities if the contribution (and therefore the deduction) exceeds 2.5 times the sum of each partner’s adjusted basis in the partnership that relates to the donated property. This proposal applies to contributions made after December 23, 2016.
- If you are affected by this, consult with a tax advisor. There are many more details in the proposed legislation and section-by-section summary.
- The proposed legislation omits any reference to the $10,000 limit on state and local income tax deductions, however earlier this week House Ways and Means Chairman Richard E. Neal (D-MA), Oversight Subcommittee Chairman Bill Pascrell, Jr. (D-NJ), and Congressman Tom Suozzi (D-NY) released a statement that read:
“President Biden’s historic Build Back Better plan is one of the most significant bills Congress has ever considered. Its makeup is complex and will be shaped and crafted continuously to get it right. So, what we consider now is an important step in the process, but not the final step. With Speaker Pelosi, we continue to work among our colleagues and the Senate to undo the short-sighted capping of SALT by Republicans. We are committed to enacting a law that will include meaningful SALT relief that is so essential to our middle-class communities, and we are working daily toward that goal.”
Any first draft of proposed legislation is just the beginning. Stay tuned and buckle up as this highly anticipated legislation moves through the chambers of Congress in the coming weeks. As always, The Tax Warriors® at Drucker & Scaccetti will keep a watchful eye on the many moving parts of this legislation that may impact your ability to grow and sustain your wealth.