Tax Changes in 2022 Revenue Proposal

by: Smith and Howard

July 6, 2021

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The Treasury Department recently released details of the tax proposals included in the Biden Administration’s fiscal year (FY) 2022 Budget. These details can be found in the “Green Book,” a 114-page document that provides information on tax proposals within the American Jobs Plan and the American Families Plan.

A summary of the tax changes and how they compare to current law is provided below.

Current LawFiscal Year 2022 Revenue Proposals
Corporate tax rate is 21%.Increase corporate tax rate to 28%.
Top individual tax rate of 37% applies to $622,050 for joint filers, $523,600 for single filers.Increasing top individual tax rate to 39.6% applies to $509,300 for joint filers, $452,700 for single filers.
Top long-term capital gains tax rate of 20% (23.8% if net investment income tax applies).Increasing top long-term capital gains tax rate to 43.4% (including the net investment income tax); but only to the extent that taxpayer’s income exceeds $1 million ($500,000 for single); retroactive to “date of announcement” (April/May 2021).
Qualified Business Income Deduction allows owners of S corporations and partnerships as well as sole proprietors a 20% deduction of qualified business income.End special qualifying rules (real estate) and only allow deduction for taxpayers with less than $400,000 of income.*
Taxes on gains from the sale of real property (real estate and land) can be partially or completely deferred in a 1031 exchange (like-kind exchange).Limit yearly tax deferral of real property to $500,000 ($1,000,000 for joint).
Investing capital gains into Qualified Opportunity Zones Funds (QOFs) will defer taxation of those gains until 2026; if investment is made before end of 2021, 10% of the gain will be forgiven with the potential of permanent gain exclusion if investment is held for at least 10 years.No changes proposed.
Assets passed to recipients at death get a step-up in basis to fair market value, and thus, appreciation isn’t subjected to income tax.Transfers of appreciated assets by death triggers gain recognition on the difference in fair market value and the decedent’s basis ($1 million per-person exclusion from recognition)
Recipients of gifted assets receive the donor’s basis in the asset(s); no gain recognition until asset is soldTransfers of appreciated assets by gifting triggers gain recognition on the difference in fair market value and donor’s basis ($1 million per-person exclusion from recognition); this includes gifts/transfers into or distributed in-kind from certain trusts and partnerships.
Estate tax exemption of $11.7 million for 2021 (reverts to $5 million after 2025). Top estate tax is 40%.$3.5 million estate and GST tax exemption, $1 million gift tax exemption; increase top rate to 45%.
A taxpayer that receives “carried” or profits interests in a partnership in exchange for services performed will pay tax on their share of income allocated each year and income will maintain its character, i.e. if the partnership reports capital gains, the partner will pay the preferred capital gains rate on their allocated share if the underlying asset was held 3 years or longer. Additionally, if a partner sells their “carried interest” in a partnership, the gain will generally be long-term if the interest was held for 3 years or longer (holding period is only 1 year for gains related to real property used in trade or business).A taxpayer with a carried interest in a partnership and total taxable income over $400,000 will pay tax at the ordinary rate, regardless of the character of income at the partnership level for an unlimited duration of time and the income would be subject to self-employment tax. Additionally, it is suggested in the proposals that gains recognized from a partner’s sale of “carried interest” would generally be taxed at ordinary rates if the partner is above the income threshold of $400,000.*

*       Biden campaigned on this proposal, but it wasn’t included in the FY 2022 Revenue Proposal.

**     The FY 2022 Revenue Proposal does not address the treatment of gains related to real property used in trade or business.

Key Takeaways

  1. Holding appreciated assets until death to achieve step-up in basis for heirs and avoid income tax is no longer a sound strategy.
  2. Under the proposed provision to tax transfers of property at death or by gift, the taxpayer will be deemed to have sold the transferred asset, resulting in a taxable gain with no proceeds from the deemed sale to pay the capital gains tax.
  3. The proposed provision that results in gain recognition when gifting to trusts (other than revocable wholly owned grantor trusts) limits the benefits and flexibility of transferring income producing property into intentionally defective grantor trusts (IDGTs).
  4. Installment sales will become an effective strategy in keeping annual income close to, if not under $1 million, and thus avoiding exposure to top long-term capital gains rates of 43.4%.
  5. Like-kind exchanges may no longer be a viable option to defer large gains (more than $500k/$1M depending on filing status). Qualified Opportunity Zones investments remain a viable option for partial gain deferral and exclusion of gain in the future.
  6. Changes to the tax code are imminent, regardless of whether most of the proposals brought forth in FY 2022 Revenue Proposals come to fruition – recall that many provisions of the Tax Cuts and Jobs act are set to expire after 2025.

The tax team at Smith and Howard is closely following all proposed tax changes from the Biden Administration and will communicate updates as they are announced. If you have any questions and would like to contact a member of our tax practice, please complete this contact form.

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