October 28, 2021 Update:
Based on the President’s speech on Oct. 28, 2021, other tax provisions that could be added to the bill are:
- 15% minimum tax on the corporate profits of corporations with over $1 billion in profits reported to shareholders;
- 15% global minimum tax on the foreign profits of U.S. corporations; and
- Additional tax rates on millionaires and billionaires.
On September 13, 2021, House Ways and Means Committee Chairman Richard Neal (D-Mass.) announced that the committee would consider amendments under the Build Back Better Act. This markup signifies the beginning of the legislative process for this comprehensive bill. Although there are many tax changes proposed, PBMares has detailed a dozen tax changes that are intended to “pave the way” to allow America to Build Back Better. Proposed effective dates for all provisions are December 31, 2021, unless otherwise noted.
1. Top Individual Marginal Tax Rate of 39.6%.
The proposal would increase the top individual 37% rate to 39.6% for those with taxable incomes of over $400,000, and for those filing jointly, $450,000. This rate would be effective for income earned in 2022, which accelerates the rate projected for 2026. While the Tax Cuts and Jobs Act of 2017 lowered the top rate to 37% until 2026, at which point the 37% would expire. The projected top rate in 2026 would be 39.6% for taxable income greater than $501,250.
2. Broader Application of 3.8% Net Investment Income Tax (NIIT).
The NIIT would apply to individuals with MAGI over $400,000, regardless of if their investment activities were in an active trade or business (for those filing joint returns, with MAGI greater than $500,000). Currently, the net investment income tax applies to passive activities if an individual meets certain thresholds, but the proposal would apply an additional threshold of $500,000, without regard to the type of investment activity. This is significant because individuals who are active shareholders of S corporations, limited partners, and members of LLCs may now become subject to the net investment income tax.
3. 3% Surcharge for Incomes Greater Than $5 Million.
Currently, there is no separate income tax surcharge. The surcharge would apply for individuals, heads of households, and those filing joint returns with modified adjusted gross income (MAGI) greater than $5 million. For trusts, the 3% surcharge would apply to modified adjusted gross income greater than $2.5 million. It is important to note that the 3% surcharge is not treated as a tax imposed by Subtitle A (Income Taxes) of the Internal Revenue Code for determining Chapter 1 credit or for purposes of the alternative minimum tax. As a result, surcharge payments may not be eligible for foreign tax credits because they would not be a tax on income. There would also be a question of whether the tax would be covered under U.S. tax treaties.
4. Top Capital Gains Rate of 25%.
The 25% rate would apply to individuals with taxable income of $445,850 ($501,600 for those filing joint returns). This provision is proposed to be effective for taxable years after September 13, 2021, the date of introduction of the provision. Conforming changes would also be made to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) rules. A transition rule was proposed such that gains and losses for the portion of the taxable year before September 13, 2021, would be subject to the 20% rate, while gains and losses for the portion of the taxable year after September 13, 2021, would be separately taken into account and subject to the 25% rate.
5. No Roth IRA Conversions for Those With High Incomes.
Under present law, taxpayers may convert a traditional IRA to a Roth IRA without limitation. But under the proposal, taxpayers with adjusted taxable income greater than $400,000 ($450,000 for those filing jointly) could not convert their traditional IRA to a Roth IRA.
6. New Limitation on Qualified Business Income Deduction.
The Tax Cuts and Jobs Act provided for a 20% deduction on qualified business income from a partnership, S corporation, or sole proprietorship so that that income from these entities would be taxed at a rate comparable to the 21% tax rate for corporations. Currently, this deduction’s only limitation is that it caps at 20% of taxable income. The proposal would limit the 20% deduction to $400,000 ($500,000 for those filing jointly); as a result, more pass-through business income may be subject to higher tax rates that are not comparable with the corporate tax rate if the owner’s individual rate is much higher.
7. Three New Tax Rates for Corporations.
While C corporations are currently subject to a flat 21% tax rate, the proposal would implement a three-step graduated rate structure as follows:
- An 18% tax rate for the first $400,000 of taxable income;
- A 21% tax rate for taxable income between $400,000 and $5 million;
- A 26.5% tax rate for taxable income above $5 million.
An additional 3% rate is imposed on taxable income greater than $10 million.
8. Estate and Gift Tax Exemption Reduced to $6 Million for 2022.
The proposal would reduce the estate and gift tax exemption to $5 million, after adjustment for inflation, the exemption would be about $6 million. The Tax Cuts and Jobs Act had increased the exemption to $10 million, and this exemption was set to expire for decedents dying and gifts made after December 31, 2025. This proposal would accelerate the sunset of the current exemption.
9. Global Intangible Low-Tax Income (GILTI) Effective Tax Rate Increased to 16.5%.
Currently, the deduction for foreign-derived intangible income (FDII) is reduced from 37.5% to 21.875% for tax years beginning after December 31, 2025. The proposal would accelerate this rate for tax years beginning after December 31, 2021. The same acceleration would be implemented for the 50% deduction of GILTI that would be reduced to 37.5% for tax years beginning after December 31, 2025. The proposal would implement the 37.5% rate for tax years beginning after December 31, 2021.
Although under the final regulations, tested units of a CFC that are residents of a single foreign country are treated as a single tested unit, tested units owned by different CFCs are treated as different tested units even if they are tax residents of the same foreign country. The proposal would seem to allow more of a controlled foreign corporation’s high-tax and low-tax income to be aggregated. The proposal also allows for an increased GILTI foreign tax credit by decreasing the 20% haircut to 5%.
10. Limited Deduction for Foreign-source Dividends.
Present law allows a dividend received deduction (DRD) for a U.S. corporate shareholder that receives a dividend from a specified 10%-owned foreign corporation. The proposal would provide that the DRD would be available only if the dividend is paid by a controlled foreign corporation.
11. Worthless Partnership Interests Are Capital Losses.
Presently, if a partnership interest becomes worthless, the character of the loss depends on whether the loss is deemed to result from the sale or exchange of a capital asset and if the partner has a share of any partnership liability. The proposal would make all worthless partnership interests capital losses. Also, securities issued by partnerships that become worthless may be eligible for loss treatment under the proposal.
12. Additional Funds for the Internal Revenue Service.
The proposal specifies that funds would be provided to strengthen tax enforcement, expand audits, and modernize information technology to support enforcement. However, it explicitly states that the use of additional funds for tax enforcement is not intended to increase taxes for those with taxable income below $400,000.
If enacted, these proposals would change the tax landscape and would require many taxpayers to re-evaluate their tax positions. PBMares will continue to track the development of this legislation and how it affects our clients.