Summary of House Ways & Means Mark-up Draft 2021 Tax Legislation
Articles by: Richey May, Sep 21, 2021
The following is a briefing from our tax team about the proposed 2021 Tax Legislation currently making its way through the House of Representatives. If passed, the proposed changes may affect our clients as individuals and as businesses. If you have questions about the proposed changes and what they may mean for you, contact us at firstname.lastname@example.org to speak to one of our tax professionals about your particular case.
On September 13, 2021, House Democrats on the Ways and Means Committee circulated a discussion draft of legislative text. This draft contains the tax provisions they are currently considering in the budget reconciliation legislation in order to fund some of the $3.5 trillion dollar budget resolution. Nothing is final at this time.
The proposals below may change and there may be additional tax provisions added. To the extent that tax legislation is passed, the draft legislation proposes changes to the law will generally be effective for tax years beginning after December 31, 2021, except for changes related to long-term capital gains as noted below. The increase to the tax rate on long-term capital gains and qualified dividends is to be effective for sales and exchanges made after September 13, 2021 unless pursuant to a binding contract that was entered into prior to this date.
Currently, the limitation on the itemized deduction for State and Local Taxes is $10,000 (SALT limitations). It was announced that changes are being discussed. It is very likely that any final legislation will increase the dollar limitation or eliminate it entirely. Recently, a group of members of the House have indicated they won’t support any legislation that does not repeal the limit completely.
Individual Taxes – Changes Proposed:
Proposal is to increase the top marginal tax rate on individuals from 37% to 39.6%. The provision as proposed increases the top marginal individual income tax rate to 39.6%. This top rate applies to married filing joint individuals with taxable income over $450,000 (married filing separate $225,000), heads of household filers with taxable income over $425,000, single taxpayers with taxable income above $400,000, and trusts and estates with taxable income over $12,500. These changes would apply to taxable years beginning after December 31, 2021.
Surcharge on High Income Individuals, Trusts, and Estates: This provision adds a tax equal to 3% of a taxpayer’s modified adjusted gross income (AGI) in excess of $5,000,000 ($2,500,000 for a married individual filing separately) and estates or trusts with modified AGI in excess of $100,000. These changes would apply to taxable years beginning after December 31, 2021.
Proposal to increase the top tax rate on long-term capital gains from 20% to 25%: The top tax rate on long-term capital gains would be increased to 25% from the current rate of 20%. This rule would also apply to qualified dividends that are subject to the long-term capital gains tax rate under present law. The net investment income tax of 3.8% would also continue to apply to long-term capital gains and qualified dividends making the top rate for “high income earners” potentially as high as 28.8% (25% capital gains tax rate plus 3.8% NII tax). The effective date of this change would be for sales and exchanges after September 13, 2021.
Proposal to Expand Net Investment Income Tax: Under current rules, trade or business income derived by individuals with income greater than $200,000 (or $250,000, in the case of a joint return) are subject to a 3.8% tax on net investment income (NII). NII tax does not apply to self-employment earnings and it does not currently apply to a trade or business that is not a passive activity for the taxpayer. The current proposal would eliminate the exception for non-passive trade or business income that is not subject to self-employment taxes for those taxpayers whose modified AGI is greater than $400,000 for single taxpayers or $500,000 for married filing joint taxpayers ($250,000 for married filing separate). These amounts are defined as high income threshold amounts. The 3.8% NII tax on income above the threshold amounts is phased in as the taxpayer’s modified AGI exceeds these thresholds so that it partially applies if the taxpayer’s modified AGI exceeds the threshold by less than $100,000 ($50,000 for married filing separate). The disposition of a partnership interest or shares of an S-Corp would also be included in the new definition of NII for high income earners.
If this proposal is enacted without modification, this would be a significant change for S-Corporation shareholders who materially participate in the business that have modified AGI above the threshold amounts. Currently, such shareholders are only subject to Social Security and Medicare taxes on their wages with the potential for the additional 0.9% Medicare tax on the wages only. This change would subject some portion of their K-1 ordinary trade or business income to the 3.8% NII tax based upon their modified AGI.
Limitation on Deduction of Qualified Business Income for Certain High Income Individuals: Under current law, subject to some limitations, individual taxpayers are able to deduct 20% of their qualified business income (QBI deduction). This provision is to expire and would no longer apply for taxable years beginning after December 31, 2025. The proposed change will simply limit the total amount of QBI deduction that can be claimed each year to $500,000 for married filing joint returns ($250,000 married filing separate), $400,000 for single taxpayers, and $10,000 for a trust or estate. No other changes to this provision are currently proposed.
Limitations on Excess Business Losses for Noncorporate Taxpayers: The deduction for trade or business losses is currently limited to the sum of trade or business income and gains plus $250,000 ($500,000 for married filing joint) with such amounts indexed for inflation each year. For tax year 2021, these amounts are $262,000 ($524,000 for married filing joint). Disallowed losses were treated as net operating losses (NOLs) for purposes of determining NOL carryforwards. This provision was scheduled to expire and no longer apply to tax years beginning after December 31, 2026.
The current proposal would remove the scheduled expiration making these rules permanent. In addition, any disallowed business loss would be treated as a business loss incurred in the next year rather than a NOL carryforward.
Change in Lifetime Estate & Gift Tax Exemption: In 2021, the estate & gift tax exemption is $11.7 million. For a couple, using the portability provisions, their combined exemption is $23.4 million. Currently, this amount is indexed for inflation each year through 2025. The amount then reverts back to the 2017 level of $5 million as indexed for inflation to 2026. The current proposal would reduce this amount beginning in 2022 to $5 million (approx. $5.5 million after inflation adjustment calculations) per person.
Other Individual Tax Provisions (not detailed here): Extension of enhanced Child Tax Credit and monthly advance payments through 2025, changes to the Child & Dependent Care Credits (and employer dependent care assistance permanent increase to $10,500 – such as 125 plans), Premium Tax Credits (marketplace health care subsidies), Earned Income Credit expansion, and creation of a tax credit for qualified caregiver expenses.
Corporate Tax Rate:
The current draft legislation would establish a graduated rate structure. The tax rate on the first $400,000 of taxable income would be subject to an 18% tax rate; 21% tax rate for taxable income from $400,000 to $5 million; and a rate of 26.5% for taxable income in excess of $5 million. The lower tax rate benefits on the first $5 million would also phase out for corporations with more than $10 million of taxable income. Personal services corporations are not eligible for graduated rates and are thus taxed at 26.5% on all taxable income.
There are also various proposed changes to international tax rules and a proposed minimum tax based upon worldwide book income for large corporations with book income in excess of $2 billion annually.
Modification of Rules Relating to Retirement Plans:
Contribution Limit for Individual Retirement Plans of High-Income Taxpayers with Large Account Balances: The current proposal will prohibit single or married filing separate taxpayers with taxable income over $400,000 ($450,000 married filing joint) from further contributions to a Roth or traditional IRA if the sum of such individual’s IRA and defined contribution retirement accounts (e.g. – 401(k) plans, etc.) exceed $10 million at the end of the prior tax year.
Increase in Minimum Required Distributions for High-Income Taxpayers with Large Retirement Account Balances: Current law requires taxpayers to withdraw a “required minimum distribution” from their IRAs and other qualified retirement plans each year beginning with the year they are age 72 (previously age 70). The proposal for certain high income earners is to require additional minimum distributions when the combined balance of their traditional IRAs, Roth IRAs and other defined contribution retirement accounts exceed $10 million. The required minimum distribution generally is 50% of the amount that the combined total of these accounts exceeds $10 million. This new requirement applies when the taxpayer’s taxable income exceeds amounts listed in item 1 above (i.e. – $400,000 for single taxpayers and married filing separate; $450,000 for married filing joint). Additional minimum distributions apply if the sum of the retirement plan accounts exceeds $20 million.
Prohibition of Investment of IRA Assets in Entities in Which the Owner Has a Substantial Interest: Basically, this new provision as proposed will prohibit IRA investments after December 31, 2021 into non-publicly traded businesses if the IRA owner has a 10% or greater ownership of the business, or is an officer or director of such business. Additional rules prohibit IRA investments into any entity that requires the IRA owner to have a specified minimum amount of income or assets, have completed a specified minimum level of education, or hold a specific license or credential.
Under transitional rules, existing IRA investments that are not permitted under these new rules may only exist through December 31, 2023. If such investments continue after this date, the IRA account will cease to be a tax exempt trust.
Other Tax Provisions:
Tax Carried (Profits) Interests as Ordinary Income: Current law increases the holding period for long-term capital gain treatment to 3 years for partners who received their partnership interest in return for the performance of services (i.e. – a profits interest). It applies to certain types of partnerships that are primarily involved in investment activities that generate capital gains and losses.
The proposal, would increase the 3 year holding period rule to a 5 year holding period. It would retain the 3 year holding period rule for real property trades or businesses and taxpayers with an AGI less than $400,000.
Limitation on Special Rules for the Sale of Certain Qualified Small Business Stock (Section 1202 Gains): Current law provides for exclusion of 50%, 75% or 100% of the capital gain from the sale of certain qualified small business stock depending upon when the qualified stock was acquired. The proposed law change would eliminate the 75% and 100% exclusion provisions for taxpayers with AGI that equals or exceeds $400,000. All taxpayers would remain eligible for the 50% exclusion of gains from the sale of certain qualified small business stock. These rules would apply to sales and exchanges after September 30, 2021.
Wash Sale Rules & Constructive Sales Treatment for Appreciated Financial Positions: Currently, taxpayers are prohibited from including tax losses on the sale of stock and other securities if they retain an interest in the asset sold. Generally, this provision applies if the same stock or security is acquired within 30 days before or after the sale that generated the loss. The disallowed loss is added to the basis of the acquired stock or security. The proposed change would extend the wash sale loss rules to commodities, currencies and digital assets for tax years beginning after December 31, 2021.
In addition, there are rules that treat an appreciated financial position in stock, debt instrument or partnership as if these assets were sold when a taxpayer enters into certain offsetting positions such as a short sale, forward contract, etc. of the same or substantially identical property. These provisions would be extended to commodities, currencies and digital assets such as cryptocurrencies.
Business Interest Expense Limitations: The proposal is to modify the current provisions that can limit business interest expense to business interest income and a percentage of adjusted taxable income. Under the revised rules, these limitations will be determined at the partner and shareholder level rather than the entity level for partnerships and S Corporations. In addition, interest expense that is disallowed will have a limited carryforward of 5 years rather than an unlimited carryforward period. These changes would be effective for tax years beginning after December 31, 2021.
Temporary Rule to Allow Certain S Corporations to Reorganize as Partnerships Without Tax: This proposal allows any corporation that was an S Corporation on May 13, 1996 to completely liquidate without triggering tax if it transfers substantially all of its assets and liabilities to a domestic partnership during the two-year period beginning on December 31, 2021.
If you have questions about the proposed changes and what they may mean for you, contact us at email@example.com to speak to one of our tax professionals about your particular case.