On September 13, 2021 the House Ways and Means Committee released its proposed tax changes that would be used to pay for the proposed $3.5 billion “BUILD BACK BETTER” reconciliation spending program.
The proposals contain a number of International tax reforms that are beyond the scope of this article.
The initial provisions of the proposed individual tax changes that are of most interest to our clients are discussed below.
What Executives Need to Know About the Income Tax Proposals
Increase in Top Marginal Income Tax Rate
The top individual income tax rate would be increased from 37% to 39.6% effective for tax years beginning after 2021. The new rates would apply to taxable income over $450,000 for married filing joint taxpayers, $400,000 for unmarried taxpayers and $12,500 for estates and trusts. The current thresholds for the top 37% tax rates are $628,301, $523,601, and $13,050 respectively.
Top Capital Gains Rate Moves to 25%
The proposals retroactively increases the current top tax rate for long term capital gains and qualified dividends to 25% from the current 20%. The proposal would retroactively apply for tax years ending after September 13, 2021 which makes the rate change effective for tax year 2021.
However, under the proposal, current 20% rate will apply for qualified dividends and long-term capital gain realized prior to September 31, 2021. In addition, long term capital gains recognized pursuant to a written contract in place on or before September 13, 2021 would be treated as executed prior to September 13, 2021.
PLANNING NOTE: The binding contract exception would apply to the sale of a business or a sale of real estate that was under contract prior to September 13, 2021. Conceivably this rule should apply to payments received under an installment sale that was executed prior to September 13, 2021. The tax treatment of installment sale payments executed in a transaction prior to September 13, 2021, but received in tax years after 2021 is unclear at this time.
Expansion of Net Investment Income Tax (NIIT)
Under current law, trade or business income passed through to an individual where the individual materially participates in the business is not subject to the NIIT. The same is true for the gain on the sale of that business. Effective for tax years beginning after December 31, 2021, ALL taxpayers with greater than $500,000 in taxable income (married filing joint) and $400,000 (single filer) would be subject to the NIIT on their business income regardless of material participation.
Limitation on Qualified Business Income Deduction under IRC Section 199A (QBI)
The maximum allowable QBI deduction would be limited to $500,000 on a joint return and $400,000 on a single return effective for tax beginning after December 31, 2021.
Adjusted Gross Income Surtax
For tax years beginning after December 31, 2021, the proposals would include an additional 3% tax on modified adjusted gross income (adjusted gross income less any investment interest deduction under Section163(d)) in excess of $5 million and $100,000 for an estate or trust.
Section 1202 Stock Gain Exclusion
For sales or exchanges after September 13, 2021, the allowable gain exclusion for sale of qualifying stock under IRC section 1202, for taxpayers with adjusted gross income in excess of $400,000, would be limited to 50% of the gain realized. Under current law, that exclusion is 100% of the gain realized up to a maximum exclusion of $10 million.
Excess Business Loss Provisions for Individuals
The Tax Cuts and Jobs Act (TCJA) created a limitation on the ability of non-corporate taxpayers to use business losses to offset non-business income. Under current law that limitation is $500,000, as adjusted for inflation. This provision of the TCJA was scheduled to sunset after December 31, 2027. The tax proposals would remove the sunset provision thereby making the limitation permanent.
Estate and Gift Provisions
Estate and Gift Tax Exemption
The current Estate and Gift Tax Exemption amount is $11.7 million. For tax years beginning after December 31, 2021, the proposals would return the exemption amount to the 2010 level of $5 million indexed for inflation.
Modification of Grantor Trust Rules
The proposals make many changes to the existing Grantor Trust rules for future Grantor Trusts and future transfers to Grantor Trusts, which will make it harder to use grantor trusts for estate tax planning purposes.
First, the assets of a grantor trust will generally be included in the estate of the grantor upon the grantor’s death.
Second, if grantor trust status is terminated, prior to the death of a grantor, or a distribution is made from the Grantor Trust, the value of the trust or the value of the distribution will generally be treated as a gift.
Third, the proposals provide that grantor trust status will be disregarded for purposes of any transfer or sale between a grantor and the grantor trust which will cause the sale to be subject to income tax.
Valuation Discounts for Nonbusiness Assets
The proposal provides that no valuation discounts, including lack of control and lack of marketability, are permitted for the transfers of nonbusiness assets. Nonbusiness assets are passive investment assets that are not used in the active conduct of a trade or business. This provision would apply to transfers after the date of enactment.
PLANNING NOTE: In light of these proposed changes, especially the reduction in the amount of the lifetime estate and gift tax exemption, taxpayers should review their estate plans to see if it makes sense to make additional gifts before the reduction in the lifetime exemptions amount on December 31, 2021.
Retirement Plans and ROTH IRA Proposals
The proposal contain several provisions aimed at wealthy taxpayers with large balances in tax favored retirement accounts and Roth IRAs. The provisions are generally effective for tax years beginning after December 31, 2021. The proposals target taxpayers with taxable income in excess of $450,000, married joint and $400,000, single filers.
Taxpayers with combined retirement account balances in excess of $10 million would no longer be able to make contributions to retirement accounts.
A new minimum distribution rule would apply, regardless of the taxpayers age, if the value of the retirement accounts exceed $10 million. The required distribution would generally be 50% of the amount in excess of $10 million.
For tax years beginning after December 31, 2031, taxpayers that exceed the income levels discussed above would not be permitted to do ROTH conversions from existing IRAs or employer sponsored retirement accounts. This provision closes the so-called “back door” Roth IRA.
For tax years beginning after December 31, 2021, IRAs would no longer be able to hold investments which are offered to accredited investors because the investments have not been registered under federal securities laws. The proposals also include provisions that prevent an IRA from investing in a business in which the IRA owner holds a greater than 10% interest or in a business in which the IRA owner is an officer.
Tax Changes NOT Included in the Ways and Means Proposals
- Taxation of all carried interest income as ordinary income;
- Elimination of the step-up in tax basis under IRC section 1014 for assets included in a decedent’s estate;
- Limitation on the ability to use the Section 1031 exchange rule to defer the gain from the sale of real estate;
- Changes to the limitation on the state and local tax deduction (the SALT cap);
- Mark to market rules requiring capital gains taxes on an individual’s assets.
The Keiter team is closely monitoring these and other possible tax and regulation changes. If you have questions on executive tax planning and saving opportunities, please contact your Keiter Opportunity Advisor or Email | Call: 804.747.0000
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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.