Overview of Tax Proposals in the Latest Version of HR 5376
The revised Build Back Better Act (BBB) made significant changes to individual, corporate, and estate tax proposals contained in the original September draft. The following is a summary of the tax changes in the latest version of BBB according to a summary released by the Joint Committee on Taxation and the House Rules Committee on November 3, 2021.
Proposed Tax Changes for Individuals
BBB would impose a surtax of 5% on modified adjusted gross income (MAGI) in excess of $10 million and an additional surtax of 3% on MAGI in excess of $25 million. The surtax would be imposed on MAGI and not on taxable income, meaning the effective federal tax rate on such taxpayers could reach up to 42% and 45% respectively.
3.8% Net Investment Income Tax
Under current law, the pass-through business income of S corporations and partnerships is not subject to the 3.8 % Net Investment Income (NII) tax when the partner or shareholder materially participates in the business. The same is true for proceeds/income from the sale of the S corporation or partnership. Under BBB all trade or business income from pass-through entities would be subject to the 3.8% NII tax, including income from the sale of the S corporation or partnership. Additionally, net operating losses would no longer be allowed in computing the NII tax. These new rules would apply to taxpayers earning more than $500,000 annually (Married Filing Jointly) and $400,000 (single taxpayers).
As is noted below, the new version of BBB did not raise tax rates on qualified dividends or long-term capital gains. However, the combination of these two provisions will make the effective tax rate on long term capital gains from the sale of a business as much as 28.8% and 31.8% respectively. This, coupled with the fact that there were no changes to C corporation tax rates, may cause more pass-through businesses to switch to C corporation status.
Proposed Tax Changes for Trusts
Surtax on Non-Grantor Trust
Similar to the surtax provisions discussed above, a 5% surtax would apply to the adjusted gross income of non-grantor trusts in excess of $200,000. The additional 3% surtax would apply to trust adjusted gross income in excess of $500,000. Should this bill pass, trustees might consider distributing more of the annual income of the trust to the beneficiaries.
Trade or Business Income of Trusts
Again, similar to the provisions discussed above, all trade or business income earned by a trust would also be subject to the 3.8% NII tax regardless of whether the trustee materially participates in the trade or business.
Proposed Tax Changes for Corporations
Corporate Alternative Minimum Tax (AMT)
For corporations with financial statement income in excess of $1 billion, a 15% AMT on adjusted financial statement income would apply.
Stock Redemption Excise Tax
A 1% excise tax would be imposed on the value of stock repurchases by publicly traded US corporations.
Foreign Income Tax Provisions
BBB would make a number of modifications to the tax regime contained in the 2017 Tax Cuts and Jobs Act applicable to US corporations that have foreign income of foreign subsidiaries.
Other Business Tax Provisions
Section 1202 Stock
The revised act maintains the language in the September version which provides that for taxpayers with AGI over $400,000, a 50% exclusion rate on the gains from the sale of qualified small business stock applies, rather than the special 75% and 100% rates currently allowed. The rate reduction would apply for sales after September 13, 2021.
Section 163(j) Business Interest Expense Limitation
For flow through entities, the limitation of Section 163(j) would apply at the shareholder or partner level and not at the entity level.
Other Tax Provisions
The current version of BBB also includes a number of new tax incentives for Child Care, Higher Education, Health Care, Workplace Training, and Clean Energy. which are beyond the scope of this article.
Finally, over the weekend the Democrats in the House reached agreement on a provision that would increase the deduction limit for state and local taxes to $72,500 from the current $10,000 limitation. This provision would be effective for tax years after 2020.
Tax Provisions NOT Included in the Build Back Better Bill
A number of individual, business, and estate tax provisions were included in earlier versions of the legislation, which no longer appear in the latest draft. Provisions that have been left out, include:
- Increase in individual income tax rates
- Increase in individual income tax rates applicable to qualified dividends and long-term capital gains
- Increases in C corporation income tax rates
- Changes to the taxation of grantor trusts
- Accelerated reduction in Gift, Estate, and GST exemptions
- Anti-Discounting Rule modifications
- Increase in the required holding period for Carried Interest from 3 to 5 years
- Tax free conversions of S corporations to partnerships
- Increased limitation on the Section 199A Qualified Business Income deduction for high income taxpayers and trusts
- Limitations on the ability to use the tax deferred exchange rules of Section 1031 to defer tax on gain for qualified real estate exchanges.
- Changes to basis step-up or deemed realization rules at death
- Annual tax on unrealized appreciation
This new legislation is still a long way from being passed by Congress and becoming law. There is a good chance that there will be further modification as the Bill is discussed in the Senate and House over the coming weeks.
Stay tuned for what promises to be an interesting Fall for changes in federal tax legislation.
Your Keiter Opportunity Advisors are closely monitoring proposed and new legislation. We will keep you informed on tax changes that may impact you and your business. Please contact us if you have any tax questions or need tax advice specific to your situation.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.