During the week of September 13th, the House Ways and Means Committee issued a tax proposal involving rather expansive changes to the Code in terms of increased tax rates primarily aimed at high-net-worth taxpayers and corporations.
While some of the proposals fall in line with prior Biden proposals, there are also more aggressive changes aimed at raising revenue by $2.1 trillion. It is issued on the heels of the infrastructure package recently passed by the Senate.
There is one salient favorable provision regarding conversions of S corporations to partnerships noted below. Other proposed changes are more technical, such as regarding partnerships and tax allocations.
Here are some of the highlights:
INDIVIDUAL INCOME TAX
- Top Marginal Individual Income Tax Rate. Effective 1/1/22. Increased to 39.6%. Applies to married individuals filing jointly with taxable income over $450,000; heads of households with taxable income over $425,000; unmarried individuals with taxable income over $400,000; married individuals filing separate returns with taxable income over $225,000; and estates and trusts with taxable income over $12,500.
- Capital Gains Rate. Effective 9/14/21: Increased to 25% for transactions after that date. In combination with the existing 3.8% Medicare tax and the 3% surcharge described below, this yields an effective capital gains rate of 31.8% for taxpayers with income in excess of $5 million (Biden proposed $1 million) or $2.5 million for a married individual filing separately.
- NIIT. Effective 1/1/22: Expands the net investment income tax to cover net income derived in the ordinary course of a trade or business for taxpayers with taxable income in excess of $400,000 (single filer) or $500,000 (joint filer), as well as for trusts and estates.
- Surcharge on Ordinary Income Effective 1/1/22: Tax up to 3% of a taxpayer’s modified adjusted gross income in excess of $5 million or $2.5 million for a married individual filing separately.
- Deferred Compensation: Effective 1/1/22 IRA contributions would be prohibited if an individual’s defined contribution account exceeded $10 million. Required distributions out of such accounts would also be mandated. Roth IRA rollovers would also be prohibited for certain high-income individuals.
- Intentionally Defective Grantor Trusts. Effective with the date of enactment: Deems sales between grantors and grantor trusts as regarded. This would largely eliminate the use of sales to intentionally defective grantor trusts as estate tax planning vehicles.
BUSINESS INCOME TAX
- Corporate Tax Rate. Effective for taxable years starting after 12/31/21, replaces the flat corporate income tax with a graduated rate structure: 18% on the first $400,000 of income; 21% on income to $5 million; and 26.5% on income above that threshold. The graduated rate phases out for corporations with net taxable income of over $10 million.
- Qualified Business Income Deduction (QBI). Effective for tax years after 2021, IRC Sec 199A or the qualified business income 20% deduction provisions, are amended to provide for maximum allowable deductible amounts of $400,000 (single filer), $500,000 (joint filer) and $10,000 for trusts and estates.
- Carried Interest. Effective for tax years after 2021, proposal seeks to increase the holding period required for long term capital gains treatment from the current 3 years to 5 years for gain attributable to an applicable partnership interest (this includes real estate). The provision also has other components which include addressing holding periods for tiered partnerships.
- Qualified Small Business Stock (QSBS) or IRC § 1202 Stock. Effective 9/13/2021 (though subject to a binding contract exception) proposal amends IRC § 1202 to limit eligible taxpayers to those with AGI below $400,000 and essentially rolls back the statute for such taxpayers to pre-Obama levels.
- S Corporation to Partnership Conversions. Effective for tax years after 2021, as an exception to the general trend, it is proposed that for a two-year period beginning on December 31, 2021, certain S corporations created prior to May 13, 1996 can reorganize as domestic partnerships without triggering certain taxes.
- Constructive Sales. After the date of enactment, it is proposed that digital assets be included in anti-abuse rules previously applicable only to financial assets.
- GILTI and FDII. Increases the amount that must be included annually for income from a CFC by reducing IRC Sec 250 deduction for GILTI and FDII. There is also further increase to base erosion minimum tax. However, this applies to very large corporations with average revenues of approximately half a billion.
- Foreign Tax Credit: Mandates country by country reporting for foreign tax credit – significantly limiting availability of the tax credit for those with multijurisdictional foreign income. On the other hand, the current 80% limitation for GILTI basket income would be increased to 95%.
- Portfolio Interest. After enactment, it proposed that for any e.g., nonresident taxpayer holding U.S. corporate obligations, if also owning more than 10% by vote or value will not be eligible for the portfolio interest exemption. This impacts withholdings.
ESTATE AND GIFT TAX
- Estate, Gift and GST Tax Exclusion. The exclusion which is currently at $11.7 million per person is scheduled to be phased out in 2026. The proposal seeks to accelerate the phaseout to tax year 2022 back to an inflation-adjusted $5 million base (about $6.02 million per person). Per prior guidance, gifts made prior to reduction should remain eligible for the higher exclusion.
- Grantor Trusts. Assets included in a grantor trust would be includible in a taxpayer’s estate. Similarly, if grantor status is terminated, corpus treated as a gift.
- Valuation Discounts. The Proposal would eliminate valuation discounts for certain transfers of interests that have “nonbusiness assets” or essentially passive assets.
- Internal Revenue Service. Budget increase $78.9 billion over 10 years to strengthen tax-enforcement activities, increase voluntary compliance, and modernize information technology to support enforcement.
- Treasury. Additional $410 million for necessary expenses for the Treasury Inspector General for Tax Administration to provide oversight of the IRS.
- Tax Court. Additional $157 million allocated to the Tax Court (perhaps anticipating results of increased enforcement).
Of course, these proposals are subject to change or amendment as they make their way through Congress. However, they do provide some further insight as to Congressional response to Biden’s proposals and the likely direction for tax changes. Most importantly, they underscore the need, especially in the current year, for tax planning.
For more information, contact your Wager, Ferber, Fine & Ackerman tax advisor who can walk you through the planning needed to navigate this particularly time in the tax world.