The House Ways and Means Committee released discussion drafts that detail various tax increases or incentives for their version of President Biden’s “Build Back Better” infrastructure plan. These discussion drafts are organized into two “Committee Print” summaries, with one pertaining to green energy and social safety incentives, and the other pertaining to corporate and individual tax increases.
So far, none of these proposals include any changes to the $10,000 state and local tax deduction cap. They also do not include the President’s proposal to end the step-up in basis of assets inherited from a decedent under Section 1014, or the President’s proposal to curtail like-kind exchange benefits for exchanges of real estate under Section 1031. As we summarize the key provisions that are included in these discussion drafts, it is important to remember that negotiations are ongoing and that the final version of any legislation will undoubtedly differ from its current state. Unless otherwise noted, the proposals would apply to taxable years beginning after Dec. 31, 2021.
Increase in Top Marginal Individual Income Tax Rate.
The top tax rate for individuals would increase to 39.6%, and would be applicable to married individuals filing jointly with taxable income over $450,000 ($225,000 married filing separately), to heads of households with taxable income over $425,000, and to unmarried individuals with taxable income over $400,000.
Income Tax Surcharge on High Income Individuals, Trusts, and Estates.
Individuals, estates, and trusts would be subject to an additional 3% income tax on modified adjusted gross income in excess of $5,000,000 ($2,500,000 for married taxpayers filing a separate return). Modified adjusted gross income means adjusted gross income, minus any deduction allowed for investment interest expense.
Increase in Capital Gains Rate for Certain High Income Individuals.
The capital gains tax rate would be increased to 25%, and it appears that the effective date for this new tax rate would be Sep. 13, 2021 (the date of introduction of the new legislation). Gains recognized prior to this date, or gains recognized after this date but that arise pursuant to a written binding contract prior to this date, would still be subject to the 20% rate.
Extension and Modification of the Child Tax Credit.
The temporarily expanded child tax credit, which previously was increased for 2021 from $2,000 to $3,600 for each child ages 0-5, or from $2,000 to $3,000 for each child ages 6-17, would be extended for four years through 2025 as part of “social safety” incentives. The credit would continue to be available through monthly installments, and would be fully refundable regardless of whether taxpayers ultimately owe federal income tax. The credit would revert to $1,000 per child after 2025.
Permanent Extension of Expanded Child and Dependent Care Tax Credit.
The temporarily expanded child and dependent care tax credit, which previously increased for 2021 the cap on qualifying expenses from $3,000 for one child ($6,000 for more than one child) to $8,000 for one child ($16,000 for more than one child), would be made permanent as part of “social safety” incentives. Previous increases to the credit rate would also be made permanent.
Application of Net Investment Income Tax (NIIT) to Trade or Business Income of Certain High Income Individuals.
The NIIT would be expanded to cover any trade or business income (i.e., not just passive sources of trade or business income) for single taxpayers with more than $400,000 of taxable income, or married taxpayers filing a joint return with more than $500,000 of taxable income. Wages would still not be subject to the NIIT.
Limitation on Deduction of Qualified Business Income for Certain High Income Individuals.
The qualified business income deduction under Section 199A would be capped at $400,000 for single filers or $500,000 for married taxpayers filing a joint return, or $250,000 for married taxpayers filing a separate return. Trusts and estates would see a smaller $10,000 maximum deduction.
Limitations on Excess Business Losses of Noncorporate Taxpayers.
The Excess Business Loss Limitation under Section 461(l), which is scheduled to expire after Dec. 31, 2027, would be made permanent. This limitation pertains to the ability of individuals to deduct business losses in excess of certain levels during a given year. The levels are $250,000 for all taxpayers other than married taxpayers filing a joint return, who instead reference a $500,000 level.
Green Energy Incentives.
Some notable green energy incentives include a modification and extension of the nonbusiness energy property credit through 2031, where the credit percentage for installing qualified energy efficiency improvements would be increased from 10% of the cost to 30%, and where the lifetime cap on credits would be increased to $1,200. The residential energy-efficient property credit pertaining to solar electric, solar water heating, and other devices (which would now include battery storage technology) would also be extended at the full 30% credit rate through 2031, with phase downs in the credit rate during 2032 and 2033, and an expiration of the credit after 2038. A new refundable tax credit would also be created for plug-in electric vehicles acquired and placed in service before 2027, with the credit potentially equal to 50% of the vehicle purchase price (subject to a purchase price cap of $55,000 for cars, $64,000 for vans, $69,000 for SUVs, and $74,000 for pickup trucks).
Termination of Temporary Increase in Unified Credit for Estate and Gift Tax.
The doubled estate and gift unified credit would be terminated, and the 2010 credit level of $5,000,000 per individual (indexed for inflation) would be restored.
Termination of Favorable Grantor Trust Rules.
Grantor trusts that are treated for income tax purposes as owned by the grantor would be includable in the grantor’s gross estate for estate tax purposes. Sales between a grantor trust and the grantor would also be treated for income tax purposes as sales between the grantor and a third party (i.e., fully recognized transactions).
Termination of Valuation Discount Rules for Certain Transfers of Nonbusiness Assets.
For transfer tax purposes, transfers of nonbusiness assets (passive assets held for investment and not used in the active conduct of a trade or business) would not be eligible for a valuation discount based upon the recipient having a minority ownership interest. There are exceptions that would apply for working capital needs and for hedging transactions. This provision would apply after the date of enactment of the new legislation.
Contribution Limit for Individual Retirement Plans of High-Income Taxpayers with Large Account Balances.
Taxpayers would be prohibited from contributing to IRAs (Roth or Traditional) or to a defined contribution plan if the account balance of the plan exceeded $10 million at the end of the prior taxable year. This restriction would not apply to single taxpayers (or married taxpayers filing separately) with taxable income less than $400,000, married taxpayers filing a joint return with taxable income less than $450,000, or heads of household with taxable income less than $425,000.
Increase in Minimum Required Distributions for High-Income Taxpayers with Large Retirement Account Balances.
Taxpayers with account balances and taxable incomes above the aforementioned thresholds would also be subject to a required minimum distribution from the retirement account equal to 50% of the amount by which the balance exceeded $10 million. If the combined balance of all the taxpayer’s IRAs, Roth IRAs, and defined contribution plans exceeds $20,000,000, then the taxpayer would be required to take a distribution from these plans generally in an amount sufficient to bring the balance down to $20 million. Taxpayers would generally be required to take this distribution from Roth accounts first.
Repeal of “Backdoor” Roth IRA Conversions.
The ability for individuals to make nondeductible contributions to a traditional IRA and then shortly thereafter convert the traditional IRA to a Roth IRA would be repealed. Furthermore, for single taxpayers (or married taxpayers filing separate returns) with taxable income over $400,000, married taxpayers filing joint returns with taxable income over $450,000, or heads of households with taxable income over $425,000 (all indexed for inflation), the ability to convert any portion of a traditional IRA to a Roth IRA would be repealed altogether. For all other individuals regardless of income level, the ability to make Roth IRA conversions would be repealed only for the portion of traditional IRAs comprised of nondeductible contributions.
Prohibition of Investment of IRA Assets in Entities in Which the Owner Has a Substantial Interest.
Currently, an IRA owner cannot invest his or her IRA assets in any entity if the owner owns 50% or more of that entity. The 50% threshold would also be adjusted down to 10% for investments in non-publicly traded entities. Furthermore, the owner cannot be an officer regardless of ownership interests. IRA owners will have a 2 year window to wind down current investments that fail the new standards.
Statute of Limitations with Respect to IRA Noncompliance.
The statute of limitations on many IRA activities will be extended to six years, up from the current three-year examination period.
Corporate and Business Tax Provisions
Increase in Corporate Tax Rate.
The corporate tax rate would increase from a flat 21% rate to a maximum 26.5% rate, subject to a new graduated structure. Corporations with income up to $400,000 would actually see a tax rate cut to 18%. Corporations making more than $400,000 but not more than $5,000,000 would retain the 21% rate. The maximum 26.5% rate would apply to income in excess of $5,000,000. And the benefit of the lower graduated rates would phase out for corporations making more than $10,000,000. Personal services corporations would not be eligible for the graduated rates.
Delay of Capitalization and Amortization for Research and Experimental Expenditures.
The requirement that business capitalize and amortize certain research and development expenses (including internally-developed software costs) that was to start Jan. 1, 2022 would be postponed to Jan. 1, 2026.
Modification of Rules for Partnership Interests Held in Connection with the Performance of Services.
The three-year carried interest holding period would be extended from three to five years, in order for the holder to be eligible for long-term capital gain treatment. However, the three-year holding period would be retained for real property trades or businesses, and for taxpayers with adjusted gross income less than $400,000.
Temporary Rule to Allow Certain S Corporations to Reorganize as Partnerships without Tax.
During the two-year period beginning on Dec. 31 2021, eligible S corporations would be able to reorganize as partnerships without triggering tax. Eligible S corporations would mean those treated as S corporations on May 13, 1996 (prior to the current law “check-the-box” regulations).
Limitation on Certain Special Rules for Section 1202 Gains.
Taxpayers whose adjusted gross income exceeds $400,000 would not be eligible for the 75% or 100% gain exclusion on sales of Section 1202 qualified small business stock. Such taxpayers would still be eligible for a 50% gain exclusion, however. These changes would be effective for sales or exchanges after Sep. 13, 2021, subject to a binding contract exception.
Wash Sales Expanded to Include Crypto and Other Assets.
The wash sale rules, which currently defer losses on the sale of certain investments if the same investment is purchased within 30 days of the sale, would be expanded to include digital assets, commodities, and foreign currencies.
Modifications to Limitation on Deduction of Excessive Employee Remuneration.
The effective date for recent changes to this deduction limitation would be accelerated from Jan. 1, 2026 to Jan. 1, 2022. The recent changes pertain to corporate deduction limits for executive compensation, which were expanded (from three) to include the eight most highly compensated officers other than the principal executive and the principal financial officers.
Termination of Employer Credit for Paid Family Leave and Medical Leave.
The current tax credit for paid family and medical leave would be terminated early, for taxable years beginning after 2023. Currently, the credit will terminate for wages paid in taxable years beginning after 2025.
Enhancement of Work Opportunity Credit (WOTC) During COVID-19 Recovery Period.
The Work Opportunity Tax Credit (WOTC) would be expanded to 50% for the first $10,000 in wages, through Dec. 31, 2023, for all WOTC targeted groups except for summer youth employees.
Global Intangible Low-Taxed Income Changes.
The tax rate applicable to Global Intangible Low-Taxed Income (GILTI) would be effectively increased to 16.5625%, together with a move to country-by-country application of the GILTI rules. As part of this effective rate increase, the exemption for qualified business asset investments would be reduced from 10% to 5%.
These discussion draft provisions are the first real look at the legislation planned by Congress in response to the President’s tax agenda. The House previously set a deadline of Sept. 27, 2021, to consider the Infrastructure Investment and Jobs Act that the Senate previously passed, which is a separate bill pertaining to “hard infrastructure” initiatives. Some progressive Democrats in the House indicated that they may withhold support for that other bill unless the bill pertaining to these discussion draft provisions is also under consideration. Given the compressed timeframe remaining between now and then, the evolution of these draft provisions may change into final legislation quickly.
For more information about how these proposals may impact you or your business, please contact us.
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