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Understanding Potential Tax Law Changes

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Dated: November 23rd, 2021

Tax 2021

In what has been a busy legislative year for Congress, one of the priority items on the table is a major alteration to the current tax code. These potential changes come in the wake of other spending packages that have been passed, including the American Rescue Plan, providing COVID-19 relief funds for Americans, and the recently passed infrastructure package.

Over the course of the year, President Biden, and members of Congress have put forth detailed proposals that, when put together, could result in significant changes to the tax code. On October 28th, President Biden unveiled a scaled back “Build Back Better” framework. On the same date, Congressional leadership released H.R. 5376, the “Build Back Better” Act, in support of President Biden’s new framework. It includes $1.75 trillion in proposed spending for social and environmental programs, and close to $2 trillion in revenue offsets, much of that in the form of new taxes. The spending proposals in this plan total approximately half of the amount outlined in President Biden’s original American Families Plan and in the House Ways and Means Committee tax package released on September 13th.

The “Build Back Better” Act received approval from the House on November 19. A vote is pending in the U.S. Senate to ratify the House bill, though some aspects of the plan could change. That would require reconciliation of the two bills between the House and Senate. While awaiting final action, understanding potential changes can help you prepare.

Who could be affected by these proposed changes?

The proposals included in the “Build Back Better” Act cover a wide range of tax laws, though the impact will be felt by a narrower group of taxpayers than was the case under previous proposals released this year. Nevertheless, the changes may be of concern to you if you meet any of these definitions:

  • Have adjusted gross income equal to or exceeding $400,000
  • Itemize deductions on your federal tax return
  • Anticipate having a modified adjusted gross income in excess of $10 million
  • Have IRAs and workplace retirement plans
  • Have current or planned trusts
  • Are an owner of a limited partnership or “S” corporation

Here are highlights of the tax provisions included in the Build Back Better Act framework laid out by President Biden (except where noted):

Tax rates for individuals

“Surcharges” on certain high income taxpayers

Current law
The highest tax rate that applies to income is 37 percent. It applies to income that exceeds:

  • $523,600 for individual tax filers.
  • $628,300 for married couples filing a joint return.
  • $314,500 for married couples filing separately.
  • $523,600 for those filing using head of household status.

Proposed changes
Although previous proposals included an increase of the top tax bracket to 39.6 percent, that change was not included in the package that passed the House.

Taxpayers with modified adjusted gross incomes (MAGI) in excess of $10 million ($5 million for individuals filing a separate return) will be subject to a 5 percent surcharge applied to income above those levels. For MAGI that exceeds $25 million ($12.5 million for individuals filing a separate return), an additional 3 percent surcharge will apply, for a total surcharge of 8 percent on income above that higher MAGI threshold amount. The surcharge would apply after December 31, 2021.

IRAs and other retirement plans

Current law
Income limitations apply to those who wish to make a Roth IRA contribution. No contributions are allowed for those with MAGI exceeding:

  • $140,000 for individual tax filers and those filing as head of household
  • $208,000 for married couples filing a joint return

Proposed changes1
Individuals with aggregate balances of $10 million+ in retirement accounts including traditional IRAs, Roth IRAs, deferred compensation and defined contribution plans at the end of the prior taxable year would be prohibited from making IRA contributions if their annual income exceeds:

  • $400,000 for single taxpayers
  • $450,000 for married taxpayers filing a joint return
  • $425,000 for those filing using head of household status

An excise tax would be imposed on “additional contributions” by high-income taxpayers who have an aggregate retirement account balance in excess of the $10 million threshold amount.

In addition, required minimum distributions (RMDs) of 50 percent will apply to the value of these accounts in excess of $10 million at the close of the prior tax year to the extent such excess is more than 200 percent of the aggregate retirement account value at the opening of the prior taxable year. These rule changes would apply after December 31, 2021.

This House bill also prohibits all employee after-tax contributions in qualified plans and after-tax IRA contributions from being converted to a Roth IRA regardless of income level, for distributions, contributions and transfers made after December 31, 2021. In effect, this provision would eliminate the so-called “mega-Roth conversion” strategy as well as the “back-door” Roth IRA, where contributions were made to a traditional IRA and then converted to a Roth IRA.

Under this bill, Roth conversions are eliminated for both IRAs and employer-sponsored plans for those with incomes that exceed the threshold levels listed above. It applies to distributions, transfers and contributions, but this part of the new law does not take effect until after December 31, 2031.

Current law
Taxpayers who claim itemized deductions are restricted to a cap of $10,000 on expense related to state and local income taxes (SALT) and property taxes. This greatly reduces the potential benefit of this deduction, particularly for individuals living in high tax states.

Proposed changes
The cap on SALT deductions would be raised to $80,000. The new rule would apply for the 2021 tax year and each year thereafter through 2030. In 2031 and beyond, the cap on SALT deductions would revert to $10,000 unless further Congressional action occurs.

Tax changes that could affect investments

Previous proposals included an increase in the top applicable tax on long-term capital gains (on the sale of assets held more than one year) from the current 20 percent level to 25 percent. However, that change did not end up in the final House package, so the top long-term capital gains tax rate remains 20 percent.

Expansion of wash sales rules

Current law
If a loss is claimed on the sale of stock or other securities, the loss is disallowed if within 30 days of the sale, the investor acquired stock or securities that are considered substantially the same.

Proposed law
This so-called “wash sale” rule would also apply to trades of commodities, foreign currencies and cryptoassets.

Tax changes that could affect estate transfers and gifting

Surtax on estates and trusts

Current law
Significant assets can be directed to trusts as a way to shelter income from current taxation. In addition, individuals can exempt up to $11.7 million (in 2021) in combined lifetime gifts and estate valuation from estate tax. This high exemption amount expires at the end of 2025, and then is scheduled to revert to about 50 percent of the current exemption level.

Proposed changes
A surtax of 5 percent would apply to the adjusted gross income of a non-grantor trust that generates income that exceeds $200,000 in a year. For any income in excess of $500,000, an additional 3 percent surtax would apply (for a total surtax of 8 percent on income over $500,000). These changes would apply after December 31, 2021.

Note that earlier proposal to accelerate the expiration date for the current unified gift and estate exemption of $11.7 million is not included in the “Build Back Better” Act.

Tax changes that could affect businesses and business owners

Expansion of Net Investment Income Tax (NIIT)

Current law
The NIIT is a 3.8 percent surtax that applies to individuals, estates and trusts with income above specific thresholds, and applies to interest, dividends, capital gains, rental and royalty income, nonqualified annuities and passive business income.

Proposed changes
The scope of NIIT would be expanded to include “specified income” derived in the ordinary course of a trade or business. This would apply to taxpayers with income exceeding:

  • $400,000 for single taxpayers
  • $500,000 for married taxpayers filing a joint return

It would also apply to trusts and estates for any income taxed at the highest marginal tax rate. Notably, NIIT will not be applied to income on which FICA and self-employment withholding taxes are already applied.

The expanded scope of NIIT will particularly impact owners of limited partnerships or S-corporations (pass-through entities) who “materially participate” in the business and who were not previously subject to the 3.8% NIIT, or to self-employment tax beyond deemed “reasonable compensation” as an employee.

Net investment income, under the new law, would include certain deemed foreign income items such as Subpart F inclusions, GILTI, Qualified Electing Fund inclusions, and Mark to Market income, when they are includable as income for regular tax purposes.

The new rules would take effect after December 31, 2021.

Corporate Profits Minimum Tax (CPMT)

Current law
The top applicable corporate income tax rate is 21 percent.

Proposed changes
The new law would impose a 15 percent alternative minimum tax (AMT) on the adjusted financial statement income of corporations that report more than $1 billion in profits to shareholders. This applies to income while preserving the value of general business credits and allowing an AMT foreign tax credit. This new law would be effective after December 31, 2022.

Surtax on corporate stock repurchases

Current law
Stock repurchases by corporations are not taxed.

Proposed changes
A 1 percent excise tax on publicly traded U.S. corporations would be applied on the value of stock that is repurchased by the corporation. This would apply on transactions occurring after December 31, 2021.

Modifications in rules for Foreign-derived intangible income (FDII) and Global Intangible Low-Taxed Income (GILTI)

Current law
The Sec. 250 deduction a domestic corporation can claim for FDII is 37.5 percent, and for GILTI, is 50 percent. There is also a 10 percent deemed tangible return on qualified business asset investment excluded from tested income, related to GILTI.

Proposed changes
The Sec. 250 deduction for FDII would be reduced to 24.8 percent, resulting in an effective tax rate of 15.8 percent on FDII. The Sec. 250 deduction for GILTI would drop to 28.5 percent. The deemed tangible return on qualified business asset income excluded from tested income for GILTI purposes would be reduced to 5 percent. This would result in an effective tax rate on GILTI income of 15.8 percent. The new rules would apply after December 31, 2022.

Modifications to Base Erosion and Anti-Abuse Tax (BEAT)

Current law
The BEAT percentage threshold stands at a 3 percent tax rate for tax years beginning before January 1, 2024. A different calculation would be used subsequent to that date.

Proposed changes
BEAT rates would be altered as follows:

  • 10 percent for tax years beginning after Dec. 31, 2021 and prior to Jan. 1, 2023
  • 12 percent for tax years beginning after Dec. 31, 2022 and prior to Jan. 1, 2024
  • 15 percent for tax years beginning after Dec. 31, 2023 and prior to Jan. 1, 2025
  • 18 percent for tax years beginning after Dec. 31, 2024.

Under the proposal the base erosion minimum tax amount would be determined without regard to any credits.

Change in definition for portfolio interest exemption

Current law
The definition of a 10 percent shareholder whose interest is exempt from portfolio interest is based on the percentage of total combined voting power of all classes of outstanding voting securities of the company. A person meeting that definition is not eligible for the portfolio interest exemption.

Proposed changes
The definition of a 10-percent shareholder under Section 871 (h)(3)(B)(i) would be based on the share of ownership by value of all shares. This is now the standard to determine if a person is not eligible for the portfolio interest exemption.

Change in qualifications for exclusion rate for 1202 stock

Current law
50 percent of the gain from the sale or exchange of qualified small business stock held for at least five years is excluded from the gross income of any taxpayer other than a corporation, subject to certain limitations. For stock purchased after Feb. 17, 2009 and held for five years, the exclusion rate rises to 75 percent. This was amended to a 100 percent exclusion rate for all qualified small business stock acquired after Sep. 27, 2010. At that time, it eliminated any Alternative Minimum Tax (AMT) calculation requirements for all qualified small business stock.

Proposed changes
The 75 percent and 100 percent exclusion provisions would be eliminated, as well as the AMT preference item rules applied in 2010, for taxpayers with adjusted gross income equal to or exceeding $400,000. This change would also apply to all trusts and estates. The effective date would be September 13, 2021.