On September 13, 2021, the U.S. House and Ways Committee released the initial draft of the tax reform provisions that are intended to help fund programs under President Joe Biden’s Build Back Better plan. While changes to the proposed tax reform are expected during the budget reconciliation process, the following blog post explores key provisions that will impact individuals, businesses and trusts.
Individual Tax Provisions
Increased Top Marginal Individual Income Tax Rate
Increases the top marginal tax rate to 39.6%. The increased marginal tax rate would apply to married individuals filing jointly with taxable income over $450,000, to unmarried individuals with taxable income over $400,000, and to married individuals filing separate returns with taxable income over $225,000. The increased marginal tax rate would be effective for tax years beginning after December 31, 2021.
Increased Capital Gains Rate for Certain High-Income Individuals
Increases the top capital gains rate from 20% to 25%. The increased rate would apply to taxable years ending after the date of introduction of the Act (September 13, 2021). A transition rule provides that the preexisting statutory rate of 20% would continue to apply to gains incurred prior to September 13, 2021.
Surcharge on High-Income Individuals, Trusts and Estates
Assessment of an additional tax equal to 3% of a taxpayer’s modified adjusted gross income in excess of $5,000,000 (or in excess of $2,500,000 for a married individual filing separately). The surcharge would apply to taxable years beginning after December 31, 2021.
Application of Net Investment Income Tax to Trade or Business Income
Expansion of the net investment income tax to cover net income derived in the ordinary course of a trade or business for taxpayers with greater than $400,000 in taxable income (single filer) or $500,000 (joint filer), as well as for trusts and estates.
Partnership Interests Held in Connection with the Performance of Services
Extends from three to five years the holding period required for gain attributable to an applicable partnership interest to qualify for long-term capital gain treatment. The provision also retains the three-year holding period for real property trades or business and individuals with an AGI less than $400,000
Limitations for Section 1202 Gains
Eliminates the 75% and 100% exclusion rates for gains realized from certain qualified small business stock sales for taxpayers with adjusted gross income equal to or exceeding $400,000. The 50% exclusion remains available for all taxpayers. This change would apply to sales and exchanges after September 13, 2021.
Limitation on Deduction of Qualified Business Income for High-Income Individuals
Amends IRC Section 199A by setting the maximum allowable deduction at $500,000 in the case of a joint return, $400,000 for an individual return, $250,000 for a married individual filing a separate return, and $10,000 for a trust or estate. The amendments made by this section apply to taxable years beginning after December 31, 2021.
Limitation on Non-Corporate Taxpayer Losses
Would permanently disallow excess business losses (e.g., net business deductions in excess of business income) for non-corporate taxpayers. Taxpayers whose losses are disallowed can carry such losses forward to the next succeeding taxable year. This change would apply to taxable years beginning after December 31, 2021.
Limitations on High-Income Taxpayers with Large Retirement Plans
Would prohibit contributions to a Roth or traditional IRA for a taxable year if the total value of an individual’s IRA and defined contribution retirement accounts exceed $10 million as of the end of the prior taxable year. The limit on contributions would apply to single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation).
Change in Required Minimum Distributions for High-Income Taxpayers
Individuals whose combined traditional IRA, Roth IRA and defined contribution retirement account balances exceed $10 million at the end of a taxable year would be required to take a required minimum distribution for the following year. This minimum distribution is only required if the taxpayer’s taxable income is above the thresholds described in the section above (e.g., $450,000 for a joint return). This provision is effective for tax years beginning after December 31, 2021.
Elimination of “Back-Door” Roth IRA Strategies
Would eliminate Roth conversions for both IRAs and employer-sponsored plans for single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation). This provision applies to distributions, transfers, and contributions made in taxable years beginning after December 31, 2021.
Limitation on Conservation Easement Deductions Made by Pass-Through Entities
Would deny the charitable deduction for contributions of conservation easements by partnerships and other pass-through entities if the amount of the contribution (and therefore the deduction) exceeds 2.5 times the sum of each partner’s adjusted basis in the partnership that relates to the donated property. This general disallowance rule does not apply to donations of property that meet the requirements of the 3-year holding period rule and contributions by family partnerships. The provision would apply to contributions made after December 23, 2016.
Business Tax Provisions
Increase in Corporate Tax Rate
Replaces the flat corporate income tax with a graduated tax rate structure. The rate structure provides for a rate of 18 percent on the first $400,000 of income, 21 percent on income up to $5 million, and a rate of 26.5% on income thereafter. The benefit of the graduated rate phases out for corporations making more than $10 million.
Limitation on Business Interest Deductions
Would modify the interest expense limitation rules currently applicable to partnerships and S corporations by applying to the individual partner or shareholder rather than to the partnership or S corporation as an entity.
Temporary Allowance for Tax-Free Reorganization of S Corporations to Partnerships
Allows eligible S corporations to reorganize as partnerships without triggering tax. An eligible S corporation is any corporation that was an S corporation on May 13, 1996. The eligible S corporation must completely liquidate and transfer substantially all of its assets and liabilities to a domestic partnership during the two-year period beginning on December 31, 2021.
Estate and Trust Provisions
Reduction in Unified Credit
Would eliminate the temporary increase in the unified credit against estate and gift taxes, reverting the credit to its 2010 level of $5 million per individual, indexed for inflation.
Rules Applicable to Grantor Trusts
Would provide for the inclusion of grantor trust assets in a decedent’s taxable estate when the decedent is the deemed owner of the trust. The provision would also treat sales between grantor trusts and its deemed owner as sales between an owner and third party. These changes would be applicable only to future trusts and transfers.
Valuation on Transfer of Non-business Assets
Would prohibit the use of a valuation discount (for transfer tax purposes) when a taxpayer transfers non-business assets. This change would apply only to future transfers.
The Act provides for a number of extensions and enhancements to individual and business tax credits, including:
- Extension of the Child Tax Credit advanced monthly benefit through 2025.
- The Child and Dependent Care Tax Credit would be modified to make the credit fully refundable, increase the maximum rate to 50%, and increase the AGI phase-out threshold to $125,000.
- Increase Work Opportunity Tax Credit to 50% for the first $10,000 in wages paid (through December 31, 2023) for targeted groups.
- The New Markets Tax Credit would be made permanent (previously scheduled to expire in 2025).
- The New Energy Efficient Home Credit would be extended through 2031.
As changes to the proposed tax reform are expected in the coming months, Moore Colson is committed to keeping you informed of the key items that will impact you and your business. Subscribe here to receive our news and alerts as they are released. You can also contact us to speak with our Tax Services team about your situation.
Andy Starnes, CPA, is a Partner and Tax Services Practice Leader Moore Colson. Andy’s specialties include corporate tax compliance and planning, business consulting and multi-generational planning with a focus on the construction, professional services and staffing industries.
Jonathan Levens, CPA, is a Partner with Moore Colson’s Tax Services practice. Jonathan’s primary focus is on tax compliance and consulting services for private equity-owned as well as closely-held businesses and their owners in the manufacturing and distribution, retail, service, restaurant, healthcare, staffing and financial services industries.
Joe Wright, CPA, is a Director in the Tax Services practice. In this role, Joe’s primary focus is on tax compliance and planning services for closely-held businesses and their owners. Joe works with clients in the construction, real estate, transportation, hospitality and manufacturing industries.