On September 15, 2021, the House Ways and Means Committee approved a proposal of tax provisions to be included in the Build Back Better Act. The tax provisions include changes to businesses and individuals.
Note: As of this writing (October 7, 2021), this is a proposal, not legislation. There is ongoing conversation in Washington, DC to develop and vote on this and other important legislation. The House must vote on the provisions and the Senate is likely to make changes prior to passage; timing remains uncertain. This update provides highlights of each main category within the proposal as well as our insights on planning considerations in the event legislation is passed in its proposed version.
Smith and Howard’s tax team will provide a detailed analysis once the legislation is finalized and signed by the president.
Increased Tax Rates
Individual Income Tax Rates
Top marginal rate would increase from 37% to 39.6%.
Brackets would be compressed.
A 3% surtax on income above $5,000,000 would be implemented.
Capital Gains and Qualified Dividend Rates:
Top long-term capital gains rate would increase from 20% to 25%.
Top capital gains rate bracket would begin at the highest marginal income tax bracket for individuals.
Lower income bracket structure of 0% and 15% in existing law would be retained.
Would apply to net capital gains and dividends for tax years ending after September 13, 2021.
Pre-September 14, 2021 capital gains would still be taxed at 20% (current rate structure).
Capital gains/qualified dividend rates changes would be effective 9/14/2021, which would mean gains after 9/13/2021 would be subject to higher rates.
Attention should be paid to the “binding contract” rule for sales. If contract is signed prior to the date of enactment, those transactions would still be subject to the lower pre-reform rate structure.
Corporate Income Tax Rates
This proposal would replace the current flat rate of 21% with the proposed tax rates below:
$0 to $400,000
$400,001 to $5,000,000
$5,000,001 to $10,000,000
$10,000,001 to $19,566,666
Personal service company income tax rate would be 26.5%. Effective for taxable years ending after September 13, 2021.
Personal Holding Company and Accumulated Earnings would have a flat income tax rate of 25%. Effective for taxable years ending after September 13, 2021.
IRC 1202 exclusion limited for taxpayers in highest tax bracket.
Increased Tax Rates for owners of S Corporations/Partnerships
Owners of S Corporations and partnerships would be subject to a net investment income tax (Obamacare 3.8% rate) on “active trade or business income” above certain income thresholds.
The 20% flowthrough deduction would be limited to the first $2,500,000 of income, equating to a maximum flowthrough benefit of $500,000.
Certain S corporations established prior to May 13, 1996 may convert to partnership tax free. Partnership benefits include:
754 basis adjustments
Multiple classes of stock/profits interest
Excess business loss provision (less than $500,000 increase to Net Operating Losses (NOLs) under IRC 461) set to expire in 2026 would be made permanent.
Carried Interest rule for partnerships (IRC 1061) would have a 5-year hold on certain partnership interests, so called “carried” interest.
International Provisions (FDII + GILTI)
Current law states a domestic corporation receives a deduction of 37.5% of its foreign-derived intangible income (FDII) and a 50% deduction for its global intangible low-taxed income.
These are scheduled to be reduced to 21.875% and 37.5%, respectively, for tax years beginning after 2025.
The proposed legislation would accelerate the step down of these favorable deduction rates to the 21.875% (FDII) and 37.5% (GILTI) for tax years beginning after 2021.
Lower exemption amount to $5,000,000 (inflation adjusted, currently estimated to be $6,000,000).
Basis step-up and portability remain in the law under the proposed legislation.
Limits accumulations for high income participants or participants with aggregate retirement plan balances over $10,000,000.
Forced distribution/taxation mechanics, new Required Minimum Distribution rule:
50% account balance over $10,000,000.
100% account balance over $20,000,000.
ROTH balances first.
IRA contributions not allowed for large accounts with balances that exceed $10,000,000 at the end of the prior year.
No ROTH conversions after 2031 for taxpayers with adjusted taxable incomes exceeding $450,000, $425,000 and $400,000.
Net Investment Income Tax
Expand scope of taxpayers subject to the net investment income (NII) tax.
S corporation shareholders, limited partners, and LLC members would no longer be exempt from the 3.8 % tax.
Proposal is effective for tax years beginning after 2021.
Qualified Business Income Deduction
Limit dollar amount for deduction for a taxable year to not exceed $500,000 for joint filers, $250,000 for married filers filing separately, $400,000 for single filers, or $10,000 for estates and trusts.
The proposal would be effective for taxable years beginning after December 31, 2021.
Child Tax Credit
Changes made to the child tax credit under ARPA would extend to 2022. These changes include:
Full refundability of the credit;
Advance payment of the credit (for the full year instead of six months);
Increase in the age limit of a qualifying child;
Increase in the amount of the credit to $3,000 ($3,600 for children under six);
Two-stage phaseout of the credit amount and the increased credit amount; and
Allowance of the credit to U.S. possessions.
Additional modifications to the child tax credit include:
An increase for the $3,000 and $3,600 amounts due to inflation, beginning in 2022, and full refundability of the credit extended to 2025 and beyond, not including any monthly or advance payment of the credit.
Traditional tax planning involves use of deferral/timing strategies as well as permanent tax savings strategies, some of which are outlined below.
Deferral Strategies: Existing law provides opportunities to defer income and reduce or spread tax liability over time. It is important to understand the details and nuances of these strategies so that you receive the benefit while staying in compliance. Among the strategies we can advise on are:
Accelerated depreciation (100% bonus in 2021 and 2022)
Timing of bonus payments
Retirement plan payments
Defined Contribution Plan
Defined Benefit Plan
Permanent Savings: Many opportunities for tax savings have been included as permanent tax law. As with deferral strategies, we can help you find the savings opportunities that work best for your situation while keeping you in compliance. Permanent tax savings opportunities available include:
Expansion of Work Opportunity Tax Credit (50% of first $10,000 in qualified wages).
Employee Retention Tax Credit available for 2021.
Research and Development Tax Credit now permanent.
Section 179D now permanent – if building for governmental purposes, allocate deduction back to contractor/allocation letter agreement.
If tax rates higher in 2022 than 2021, consider deferring equipment purchases.
Repairs and maintenance expense better than depreciation/no recapture later.
Change to tax law brings unique opportunities to plan. We encourage clients to contact us soon to discuss ways you may be able to take advantage of these potential changes for your personal or business tax situation.
Although the ongoing debate in Congress on the bipartisan infrastructure bill and President Biden’s larger Build Back Better plan seems never-ending, history has proven that there will eventually be agreement and legislation. It is prudent to understand the possible elements of future legislation as well as deferral and permanent opportunities so that you are prepared to minimize your tax liability as much as feasible.
This article was contributed to by Mark E. Abrams. 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. Meanwhile, we invite our clients to contact your S+H tax professional for planning discussions. Whether you’re a current client or exploring opportunities for tax savings for you and/or your business, please contact our tax team at our “Contact an advisor” button below this article and we’ll get back with you within 24 hours.
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