On September 13, 2021, the House Ways and Means Committee released draft legislation that proposes a series of tax increases and tax cuts, which will undergo a round of markups by the committee over the next few days. Most tax proposals were anticipated; however, the House provided a few surprises.
The draft legislation is expansive and covers a wide range of taxpayers and tax scenarios. As such, this alert focuses on those key proposals that we felt were most relevant to privately-held businesses and individual taxpayers. As always, if you have questions as you review this information or would like to discuss how it impacts you, please contact your Kreischer Miller relationship professional or any member of our Tax Strategies team.
These tax proposals remain fluid, and we expect further changes before anything is formally signed into law. We will be diving deeper into all of the proposed tax law changes at our November 16, 2021 Tax Planning Webinar. Mark your calendars now; we will be sending a formal invitation for this event in the next few weeks.
Income Tax Provisions
The current maximum tax rate on capital gains is 20%. The proposed legislation would increase the capital gains rate to 25% for taxable years ending after September 13, 2021. Transitional rules are proposed for taxable years that include September 13, 2021, taxing net gains realized before September 13, 2021, at 20%. Gains arising from a transaction pursuant to a binding written contract in effect before September 13, 2021, (and not materially modified thereafter) would remain eligible for the 20% rate.
Planning opportunity: Consider deferring realization of some capital losses until 2022 to offset capital gains that would otherwise be taxed at 25% if the proposal is signed into law.
Top Marginal Individual Income Tax Rate
The top marginal individual income tax rate now is 37%. The draft legislation would raise the top marginal tax rate to 39.6% for taxable income over $450,000 for married individuals filing jointly and surviving spouses, $425,000 for head of households, $400,000 for single individuals, $225,000 for married individuals filing separately, and $12,500 for estates and trusts. The proposal would be effective for taxable years beginning after December 31, 2021.
Planning opportunity: Consider accelerating ordinary income to 2021 if the proposal is signed into law.
Net Investment Income Tax
Under the current rules, net investment income does not include income derived in the ordinary course of a trade or business or income attributable to the disposition of property earned outside of a passive activity. The proposed legislation would eliminate those carveouts and others, while broadening the type of income subject to net investment income tax (NIIT). NIIT applies to the greater of “specified net income” or net investment income for high income individuals, estates, and trusts. “Specified net income” includes net investment income even if derived in the ordinary course of a trade or business and other gross income and net gains attributable to the disposition of property, even if earned outside of a passive activity or the trade or business of trading financial instruments or commodities
The proposed provision would apply to taxpayers whose modified adjusted gross income exceeds $500,000 for married individuals filing jointly and surviving spouses, $250,000 for married individuals filing separately, $12,500 for estates and trusts, and $400,000 for all other tax filers. The proposal would be effective for taxable years beginning after December 31, 2021.
Qualified Business Income
The qualified business income deduction, which is a 20% deduction on income from certain pass-through entities, is currently is not limited by a maximum allowable deduction. The proposal would introduce such a cap, limiting the maximum allowable qualified business income deduction to $500,000 for married individuals filing jointly and surviving spouses, $250,000 for married individuals filing separately, $10,000 for estates and trusts, and $400,000 for all other taxpayers. The proposal would be effective for taxable years beginning after December 31, 2021.
Excess Business Loss Limitation
Under a temporary provision, excess business losses of non-corporate taxpayers in excess of $500,000 for joint filers ($250,000 for all other taxpayers) are disallowed and treated as net operating losses in the following year; however, the provision is set to expire on December 31, 2025. The proposal would make the temporary provision permanent and modify how a disallowed excess business loss (EBL) is treated. Instead of treating the disallowed loss as a net operating loss in the following year, the EBL would be treated as a deduction attributable to a taxpayer’s trades or businesses when computing the EBL in the subsequent year. The proposal would be effective for taxable years beginning after December 31, 2020.
Surcharge on High-Income Individuals
There is currently no surcharge imposed on high-income individuals. The proposal would impose a 3% surcharge on modified adjusted gross income in excess of $2,500,000 for married individuals filing separately, $100,000 for estates and trusts, and $5,000,000 for all other individuals. The proposal would be effective for taxable years beginning after December 31, 2021.
Transfers Between Deemed Owner and Irrevocable Grantor Trust
Transfers between a deemed owner and his or her irrevocable grantor trust are nontaxable events. The proposal would disregard grantor trust status when determining whether a transfer between a deemed owner and his or her grantor trust is a sale or an exchange, possibly resulting in a taxable event. The proposal would apply to trusts created on or after the date of the enactment of this provision and to any portion of a trust established before the date of enactment that is attributable to a contribution made on or after such date.
Planning opportunity: Consider sales to intentionally defective grantor trusts.
Estate and Gift Tax Provisions
Estate Tax Basic Exclusion Amount
The estate tax basic exclusion amount is $11,700,000 for 2021. The proposal would terminate the temporary increase in the basic exclusion amount, returning that amount to $5,000,000, indexed for inflation. Under this proposal, the basic exclusion amount in 2022 is anticipated to be $6,030,000. The proposal would apply to estates of decedents dying and gifts made after December 31, 2021.
Planning opportunity: Consider making gifts up to the 2021 estate tax basic exclusion amount, $11,700,000.
When a deemed owner of a grantor trust dies, the assets of that grantor trust (other than a fully revocable trust) are generally not included in the deemed owner’s estate. The proposal would require that assets in a grantor trust be included in the gross estate of the deceased deemed owner. Additionally, the proposal would treat distributions (other than to the deemed owner or spouse) during the life of the deemed owner and the termination of grantor trust status during the life of the deemed owner as completed gifts.
The proposal would apply to trusts created on or after the date of the enactment of this provision and to any portion of a trust established before the date of enactment that is attributable to a contribution made on or after such date.
Planning opportunity: Consider terminating grantor trust status or making a gift to a grantor retained annuity trust (GRAT) or spousal lifetime access trust (SLAT).
Valuation discounts, such as marketability discounts and minority interest discounts, are allowed for transfers of nonbusiness assets for estate and gift tax purposes. The proposal would eliminate valuation discounts for certain transfers of nonbusiness assets for estate and gift tax purposes. Nonbusiness assets are defined as passive assets that are held for the production or collection of income and are not used in the active conduct of a trade or business. The proposal would apply to transfers after the date of the enactment of this Act.
Planning opportunity: Consider making gifts that will be eligible for valuation discounts.
“Back Door” Roth IRAs
“Back door” Roth IRA strategies currently allow taxpayers who exceed existing Roth income limits to make nondeductible contributions to a traditional IRA, and shortly thereafter, convert the nondeductible contribution from the traditional IRA to a Roth IRA. Current law also allows taxpayers to contribute to a Roth 401(k) plan regardless of income limits (including making non-Roth after-tax contributions) and convert such contributions to a Roth IRA. The proposal would prohibit applicable taxpayers from engaging in these “back door” Roth IRA strategies.
To eliminate these strategies, the proposal would prohibit Roth conversions, for both IRAs and employer-sponsored plans, for applicable taxpayers, as defined above. The proposal would be effective for distributions, transfers and contributions made in taxable years beginning after December 31, 2031 (10 years from now). However, for taxable years beginning after December 31, 2021, the proposal would prohibit all employee after-tax contributions in tax-qualified retirement plans and would prohibit after-tax IRA contributions from being converted to Roth IRAs regardless of income level.
The proposal also includes the following noteworthy provisions:
- Repeal of the temporary limitation on personal casualty losses.
- Expansion of the wash sale rules to include foreign currency, commodities, and digital assets.
- Retirement plans – limitations on IRA investments and changes to RMDs for large ($10 million+) retirement accounts
The proposed legislation does not include a repeal of the $10,000 limit on the state and local tax deduction for individual taxpayers, nor does it include provisions to eliminate the step-up in basis upon death. It is unclear whether those provisions will be added to this proposed legislation or included in other legislation. Recent news reports suggest that these two provisions do not have solid support among Democratic leaders.
We will continue to monitor these developments and provide updates as they become available. Again, if you have any questions about these or any other tax matters, please contact your Kreischer Miller relationship professional or any member of our Tax Strategies team.
Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect, or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.