After almost 40 hours of debate over four days, the House Ways and Means Committee on September 15 approved a tax package that would increase rates on high-net-worth individuals and corporations and affect cross-border activity and pass-through entities, advancing the tax elements of the Biden administration’s “Build Back Better” agenda.
The package advanced on a largely party-line 24-19 vote – no Republicans voted for it, and only one Democrat, Rep. Stephanie Murphy, D-Fla., voted against it.
As the next step in the legislative process, the legislation now goes to the House Budget Committee, where it will be combined with bills from other House committees and eventually brought before the full House for a vote as the reconciliation legislation.
2021 Individual Tax Proposals
In keeping with the Biden budget proposal, the House’s tax proposals contain tax increases for higher income individuals and limitations on certain tax benefits and deductions. Noted below are some of the key potential tax changes and their proposed effective dates.
Increase to top income tax rate
- New 39.6% rate applied to taxable income over $450,000 for married, joint filers and $400,000 for single filers. This provision would be effective for tax years after Dec. 31, 2021.
Increase to top capital gains tax rate
- New 25% rate applied to net long-term capital gains and qualified dividends for individuals with taxable income over $450,000 married, filing jointly and $400,000 single filers. The new, higher rate is effective for net long-term capital gains recognized and qualified dividends received on or after Sept. 13, 2021, so if enacted, for 2021, the top rate of 20% applies on or before Sept. 12, 2021 and the top rate of 25% applies on or after Sept. 13, 2021. In addition, in most cases, the 3.8% net investment income tax applies on top of capital gains and dividends subject to the 20% or the 25% rate.
Surcharge on high income individuals
- New 3% tax applies to individuals with adjusted gross income greater than $5,000,000 (2,500,000 for married, separate filers) and trusts and estates with an AGI of $100,000 or more. This provision would be effective for tax years after Dec. 31, 2021.
Limitation on deduction of Qualified Business Income (QBI) for higher-income individuals
- The annual deduction of up to 20% for the QBI for owners of certain S corporations, LLCs, partnerships, and sole proprietorships is capped at $500,000 for joint filers and $400,000 for singles. Effective for tax years 2022 through 2025.
Eliminates the 100% and 75% qualified small business stock (QSBS) exclusions and requires a 50% exclusion effective for sales on or after Sept. 13, 2021 (with an exception for binding sale contracts in effect on Sept. 12, 2021). This provision applies to taxpayers with AGI of $400,000 or more, and to all trusts and estates regardless of AGI.
Modification of carried interest rules for partnership interests held in connection with the performance of services
- The holding period is extended from three years to five years to obtain long-term capital gain treatment. The three-year holding period is retained for real property trades or businesses and taxpayers with and AGI less than $400,000. Effective for tax years beginning after Dec. 31, 2021.
Application of the net investment income tax (NIIT) to the trade or business income of high-income individuals
- The 3.8% NIIT is expanded to income derived in the ordinary course of a trade or business for taxpayers with taxable income greater than $500,000 for joint filers and $400,000 for single filers. Effective for tax years beginning after Dec. 31, 2021.
- Under this proposal, higher-income S corporation shareholders who are active in the S corporation’s business would become subject to the 3.8% NIIT on their share of the S corporation’s income passed through to them.
Permanent disallowance of excess business losses
- Business losses in excess of $524,000 joint and $262,000 single (with annual inflation adjustments) are disallowed in the year incurred and carried forward to subsequent years. The excess business loss provision, originally enacted with the 2017 Tax Cuts and Jobs Act, was scheduled to expire after 2025. This proposal removes the expiration date.
Note that neither the Biden budget nor the House Ways and Means Committee proposal included any changes to the annual $10,000 cap on the itemized deduction for state and local taxes (SALT). Nonetheless, many legislators continue to press for modifications to the SALT cap.
Retirement Plan Provisions
There are also several potential changes to how individuals can save money for retirement. Here are key proposals that everyone should be aware of:
- The proposals impose limitations and restrictions on higher-income taxpayers (AGI greater than $450,000 for joint filers and $400,000 for single filers) and those with large retirement account balances. Most of the proposals are effective for distributions, transfers and contributions made in tax years beginning after Dec. 31, 2021.
- Eliminates the ability to convert traditional IRAs and qualified plan balances to a Roth plan for higher-income taxpayers.
- Close “back-door” Roth IRA strategies including a prohibition on employee after-tax contributions in qualified plans from being converted in a Roth IRA or 401(k) regardless of income level.
- Prohibits any additional further contributions to a Roth or traditional IRA for a taxable year if the total value of an individual’s IRA and defined contribution accounts exceed $10 million at the end of the prior year.
- New minimum distributions requirements would apply to individuals with aggregate traditional IRA, Roth IRA, and defined contribution balances exceeding $10 million and $20 million. For those with balances between $10 million and $20 million at the end of the prior year, the current year minimum distribution is 50% of the amount in excess of $10 million. For those with balances of more than $20 million at the end of the prior year, the current year minimum distribution is (1) 100% of the amount in excess of $20 million and then, (2) 50% of remaining excess over $10 million or $5 million.
- The proposals include new restrictions on the types of assets that can be owned within an IRA and the ability of the IRA to invest in an entity in which the owner is an officer or director.
2021 Gift, Estate, and Trust Provisions
Among the most significant proposed changes in the tax code relate to passing assets to family members and others in the form of gifts and trusts. Here are a few of the major proposals that could affect estate planning if they are enacted:
Decrease in the gift and estate, and generation skipping tax exemption
- The current individual $11.7 million (as adjusted annually for inflation) lifetime gift, estate, and GST exemption is scheduled to be reduced by 50% on January 1, 2026. The proposal is to accelerate the 50% exemption reduction to January 1. 2022.
- For those considering making cumulative lifetime gifts in excess of roughly $6 million, there may be a tax motivation to complete the gifts prior to end of 2021 — but if the gift is through a grantor trust it must be completed before date of enactment as noted below.
Income taxation on sales to grantor trusts
- Currently, the sale of assets to a grantor trust does not trigger income tax to the grantor. Under the proposal, sales of assets to a grantor trust would be taxable to the owner. This provision is effective for grantor trusts created on or after the date of enactment. Existing trusts would be grandfathered, but if an additional asset is added to a grandfathered grantor trust, a portion of the trust would be subject to the new rules.
Estate taxation of grantor trusts
- The estate tax provisions of this proposal are effective for trusts created on or after the date of enactment or grandfathered trusts, to that portion of the trust attributable to contributions on or after the date of enactment.
- When the deemed owner of the grantor trust dies, the assets of the grantor trust are includable in the gross estate of the deemed owner.
- Distributions from the grantor trust to someone other than the grantor are treated as a taxable gift from the grantor to the person receiving the distribution.
- If the trust ceases to be a grantor trust during the grantor’s life, it will be treated as a taxable gift by the grantor of all of the trust’s assets.
Elimination of valuation discounts for transfers of nonbusiness assets
- Valuation discounts would not be allowed for family entities funded with marketable securities. This proposal is effective for transfers after the date of enactment.
Business and International Tax Provisions
The corporate tax proposals include increases to the corporate tax rates and a number of changes to complex tax provisions that apply to multinational businesses as noted below.
Higher corporate tax rates
- The proposal replaces the current corporate tax flat rate of 21% with a rate structure of 18% on the first $400,000 of taxable income, 21% on income up to $5 million, and a rate of 26.5% thereafter. The benefit of the lower tax brackets is phased out for corporations with taxable income in excess of $10 million. The new graduated rates would be applicable for taxable years beginning after Dec. 31, 2021, with transition rules for fiscal-year corporations.
Certain S Corporations to Reorganize as Partnerships Without Tax
- This provision would allow certain S Corporations (those that were S Corporations on May 13, 1996, and all times thereafter) to reorganize tax-free as partnerships if the S Corporation liquidation is completed to a domestic partnership between Dec. 31, 2021, and Dec. 31, 2023. We will follow the development of this provision through the legislative process as it creates an attractive opportunity for older S Corporations.
Modification in inclusion of global intangible low-taxed income (GILTI)
- Under the proposal, a US shareholder’s GILTI is determined on a country-by-country basis rather than by a global blending regime.
- The Section 250 deduction percentage for GILTI is lowered from 50% to 37.5%.
Dividends from foreign corporations
- The proposal would limit the dividend received deduction to dividends received from controlled foreign corporations (CFCs). Under current law the deduction is allowed for dividends received from “specified 10%-owned foreign corporations.”
- US shareholders of a foreign corporation could jointly elect to treat a foreign corporation as a CFC to be eligible for the dividend received deduction.
Foreign tax credit (FTC) limitation
- The proposal would require a US shareholder’s FTC limitation be computed on a country-by-country basis. This would prevent excess FTCs from higher tax jurisdictions from being credited against income from lower-taxed jurisdictions.
- The current 20% haircut for foreign taxes attributable to GILTI inclusions would be decreased to 5%.
- Any excess FTCs would be allowed to be carried forward for five years with no carryback allowed.
Limitation on Deduction of Interest by Certain Domestic Corporations Which Are Members of an International Financial Reporting Group
- This provision limits the interest deduction to the lesser of the domestic corporation’s allocable share of the group’s interest expense or the IRC Section 163(j) amount whichever limitation is more restrictive. These changes apply to taxable years beginning after Dec. 31, 2021.
Research and Experimental Expenditures
- The proposal would delay the effective date of a requirement to amortize R&D expenditures to taxable years beginning after Dec. 31, 2025. Under current law, the requirement to amortize R&D expenditure (as opposed to deducting in the year incurred) is scheduled to begin in taxable years beginning after Dec. 31, 2021.