As negotiations within the U.S. Congress continue over the most recent bill proposed by President Biden, known as the Build Back Better Act (BBBA), many taxpayers are concerned about what they can do now to plan for the changes. The uncertainty around the proposed changes and timing of some changes makes it difficult for tax professionals to effectively prepare tax planning strategies with their clients. This means that there could be many iterations of the plan and ongoing communication with tax professionals and their clients. However, many clients benefit from discussions on the current proposal and looking at both worst case and best-case scenarios. Below is a list of some of the proposed changes in the bill and possible tax implications, including some recent updates from Washington.
Tax Rate Increases for High-Income Individuals
As it stands today, the highest ordinary income tax rate for individuals is 37%. The proposed legislation would eliminate the 37% bracket and replace it with a maximum rate of 39.6% which was the highest bracket before the Tax Cuts and Jobs Act of 2017. This marginal rate applies to joint filers with taxable income over $450,000, to single filers with taxable income over $400,000, to married filing separately with taxable income over $225,0000, for head of household filers with taxable income over $425,000, and to estates and trusts with taxable income over $12,500.
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The capital gain rate is also on the docket for increase by the BBBA. Under current law the maximum rate for long-term capital gain tax is 20%. The new law is proposing a maximum rate of 25% and is lowering the income threshold that causes the maximum rate to be used. While the other rate proposals are for periods beginning post 2021, the capital gain rate increase is proposed to be effective for transactions after September 13, 2021 which is the date of introduction of the BBBA.
Furthermore, the BBBA includes a new tax or surcharge on high-income individuals, estates, and trusts. This addition imposes a tax equal to 3% of a taxpayer’s modified adjusted gross income in excess of $5,000,000 (or $2.5M for married filing separate), and $100,000 for estates and trusts. Modified adjusted gross income is defined as adjusted gross income which is reduced by investment interest expense. The surcharge would be in effect for tax years beginning after December 31, 2021.
There are also a couple of changes related to income from pass-through entities:
- Net Investment Income Tax (NIIT): The BBBA contains a provision to expand the net investment income tax to include income derived in the ordinary course of business for taxpayers with taxable income above a certain level. For single filers this provision kicks in with taxable income over $400,000, and for joint filers it is for taxable income over $500,000. This provision also is in effect for trust and estates; however, the NIIT will not apply to income that is already subject to FICA (i.e. wages and/or guaranteed payments).
- Qualified Business Income Deduction (199A): Under current law there is no limitation on deduction allowed for 199A. The BBBA would amend section 199A and set a maximum allowable deduction for taxable years beginning after December 31, 2021. The maximum deduction is $400,000 for single taxpayers, $500,000 for joint filers, $250,000 for married filing separate, and $10,000 for trust or estate returns.
Retirement Plan Changes
- Limit on Contributions: The BBBA would disallow contributions to traditional and Roth IRA accounts if the individual is a “high-income taxpayer” and has a retirement plan with balances in excess of $10M. In this case “high-income taxpayer” is defined as one who is subject to the new 39.6% maximum tax rate.
- RMD: Required minimum distributions would increase to 50% for high-income taxpayers with aggregate vested balances between $10M and $20M. This minimum distribution is only required if the taxpayer’s taxable income is above thresholds described in the section above (e.g. $450,000 for joint filers). The minimum distribution is generally 50% of the amount that the taxpayers aggregate balance in traditional IRA, Roth IRA, and defined contribution accounts exceeds the $10M limit. If the aggregate balance exceeds $20M, the excess amount must be distributed from Roth IRA and other Roth designated accounts in defined contribution plans up to the lesser of: (1) the amount to bring aggregate balance to $20M or; (2) the aggregate balance in the Roth IRA or Roth designated defined contribution plans.
- Roth IRA conversions: In 2010 the AGI limitation used for Roth contributions was repealed, allowing anyone to contribute to a Roth IRA through a conversion from a traditional retirement account. The BBBA closes this “back-door” Roth IRA strategy and imposes a limit on the conversion for taxpayers with $400,000 in taxable income for single filers, $450,000 for married filers, and $425,000 for head of household filers (all indexed for inflation). This change becomes effective for distributions, transfers, and contributions made in tax years beginning after December 31, 2031. Additionally, all employee after-tax contributions into qualified plans would be disallowed. These plans are also prohibited from conversion to Roth accounts effective for distributions, transfers, and contributions made after December 31, 2021.
Additional Changes to Estates & Trusts
There are many proposed changes to the estate and trust area of tax. The most impactful changes for most taxpayers include changes to the estate exclusion amount, grantor trust provisions, and valuation discounts.
First, the exclusion amount for estate and gift tax is currently set at $10M indexed for inflation from 2017 through 2026. For 2021, the lifetime estate and gift tax exclusion is at $11.7M. The proposed adjustment by the BBBA would accelerate the timing of the reduction of the $10M threshold from 2026 (under the TCJA) to 2022. Beginning in 2022, the basic lifetime exclusion would be restored unified to 2010 levels, indexed for inflation. With retroactive inflation adjustments, the lifetime unified credit would likely be adjusted to approximately $6M. This causes significant planning issues as most tax planning of gifts and estates has been done to use the $10M by 2026. However, with the accelerated deadline this may be difficult to attain.
Next, the provision adds a section which will pull grantor trusts into a decedent’s taxable estate when the decedent is the “deemed owner” of the trust. This is significant because prior to the BBBA, taxpayers were able to use grantor trusts to effectively remove the value contained within the grantor trusts from their estate while keeping a certain level of control of the trust. This allowed taxpayers to invest funds and report income from the trusts on their personal income tax returns. Additionally, the provision adds new section 1062, which would treat sales between the grantor trust and their deemed owner as third-party sales. Previously, these sales were disregarded for income tax purposes. The provisions only apply to future trusts and future transfers, or contributions made to a trust after the enactment of the BBBA.
Lastly, the changes proposed to valuation discounts would effectively eliminate any discount on assets deemed to be nonbusiness assets as defined under IRC. Sec. 2031(d). Nonbusiness assets include “any passive asset which is (1) held for production or collection of income and (2) is not used in the active conduct of a trade or business.” A look-through rule is applied here as well which provides that a passive asset which includes a 10% interest in another entity, the holder is treated as holding its ratable share of the assets of that entity directly. This means those assets of the lower tiered entity would be considered nonbusiness assets and therefore no discount would be applied. There is an exception for passive assets that are used in hedging transactions or as working capital of a business.
Corporate Tax Rate
The rates for corporate income tax is also proposed to increase from a fixed 21% to a graduated rate up to a maximum of 26.5%. The current proposal shows 18% for the first $400,000 of income; 21% up to $5M of income, and a rate of 26.5% thereafter. This graduated rate is phased out for corporations making more than $10M. Under existing law, a fiscal year corporation would prorate the taxes applicable to it when a rate change is effective in the middle of its tax year. It would appear that this proration would also apply to the proposed changes under BBBA causing corporations to use the 21% rate through December 31, 2021 and the graduated system from enactment through its fiscal year end. It is also noted in the BBBA that personal service corporations will not be eligible for graduated rates.
It is important to note that this list is not exhaustive and there are many other provisions related to international operations and taxation including modifications to Global Intangible Low Tax Income (GILTI), foreign tax credit limitations, and interest expense deductions for members of international financial reporting groups.
New Developments
While Congress continues to battle on which provisions will be included in the final bill, there has been significant movement in recent days which indicates some of the items above may be disregarded. Specifically, items associated with increase in tax rates for corporate and individual taxpayers, including capital gains, have come under heavy opposition and it appears there are alternatives being considered.
One suggested change is a possible provision termed the “annual tax on billionaires’ unrealized capital gains”. This would be an annual tax on the unrealized capital gains on liquid assets held by billionaires. While they are currently in the process of writing the proposal the thought is that it would affect people with $1 billion in assets or $100M in income for three consecutive years.
Other possible changes to the bill could include an excise tax on stock buybacks, and a possible 15% minimum corporate tax rate. This means that while the highest rate would be 21% the minimum would require companies to pay a minimum of 15% despite other tax breaks they may be taking advantage of.
Until we are sure what the outcome of the new Build Back Better Act is, be sure to continue to follow-up with your personal tax advisor.
“Citrin Cooperman” is the brand under which Citrin Cooperman & Company, LLP, a licensed independent CPA firm, and Citrin Cooperman Advisors LLC serve clients’ business needs. The two firms operate as separate legal entities in an alternative practice structure. Citrin Cooperman is an independent member of Moore North America, which is itself a regional member of Moore Global Network Limited (MGNL).
Jessica Sawyer is a partner in Citrin Cooperman’s Providence office, with over 15 years of public accounting experience. She is skilled in tax consulting and specializes in corporate, partnership, and individual taxation in various industries including manufacturing and distribution, construction, real estate, and technology and life sciences.
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