All of the following tax proposal highlights are subject to significant change within the House of Representatives, and possibly more importantly, in the Senate, where each Democrat senator has significant leverage on whatever may pass in the final legislation, and in conference between both chambers. The highlights below are summarized from the draft legislation released by the House Ways & Means Committee last week. Although subject to substantial change in the coming weeks, the basic trajectory seems clear that it is highly likely that many of these provisions will be included in the final legislation. This includes significant income tax rate increases for individuals and corporations, most of which would be effective as of January 1, 2022—with the notable exception that the House legislation intends to make capital gain tax rate increases effective for gains realized on or after September 13, 2021, the date the legislation was introduced.
As the legislation progresses, now’s the time to be working with your tax advisors to determine whether there are opportunities for you or your business to take advantage of existing (lower) tax rates—for example, by accelerating income into 2021 or deferring deductions into 2022. If you are planning on doing significant gifting in 2021, you should already be working with your estate/gift advisors.
All references below to “the draft” are to the House Ways & Means draft legislation released on September 13, 2021.
Personal Tax Highlights
- The individual federal maximum effective tax rate would top out at 46.4% based on three components in the draft. The maximum marginal rate would be 39.6% (versus current law 37%), but in addition, a 3% high-income surcharge can apply, and the 3.8% NIIT (net investment income tax) may also apply.
- The 39.6% rate applies to taxable income in excess of: $450,000 for married filing joint (MFJ) and surviving spouses; $425,000 for head of households; $400,000 for single filers; $225,000 for married filing separately (MFS); and $12,500 for estates and trusts. All of these rate changes are effective for tax years beginning after 12/31/2021.
- The draft includes a new 3% surcharge on high-income individuals. The surcharge applies to modified adjusted gross income (AGI) in excess of: $2,500,000 for MFS; $100,000 for estates/trusts; and $5,000,000 for all other individuals (including MFJ). The surcharge is effective for tax years beginning after 12/31/2021.
- The NIIT tax of 3.8% is expanded in its application in the draft. The expansion is effective for tax years beginning after 12/31/21 and would apply to taxpayers with modified AGI in excess of: $500,000 for MFJ and surviving spouses; $250,000 for MFS; $12,500 for estates/trusts; and $400,00 for all other taxpayers. NIIT, as revised in the draft, would apply to the greater of net investment income or “specified net income,” which would include net investment income even if earned in a trade or business and gains from property disposed outside a passive activity.
- The draft would increase the capital gains statutory rate from 20% to 25%. For high-income taxpayers (modified AGI in excess of $5 million or $2.5 million if MFS), the actual federal capital gains rate would be 31.8%; that is the new 25% rate, plus the 3% surcharge, plus the 3.8% net investment income tax.
- Taxpayers are currently eligible for 50%, 75%, and 100% exclusions of gains from the sale of qualified small business stock (QSBS). The draft would eliminate the 75% and 100% exclusions for sales of QSBS sold after 9/13/21 and acquired after 2/17/09 (unless a nonmodified binding contract is in place as of 9/13/21). This provision applies to taxpayers with AGI of $400,000 or more and to all estates/trusts.
- The draft would increase the holding period from 3 to 5 years to obtain long-term capital gain treatment on “carried interests” (with certain exceptions for real property) for those with AGI in excess of $400,000, effective for tax years beginning after 12/31/21.
- The draft would place a cap on the section 199A qualified business income deduction, limiting the maximum deduction to $500,000 for MFJ and surviving spouses; to $250,000 for MFS; to $10,000 for estates/trusts; and to $400,000 for all other taxpayers. The proposed change would be effective for tax years beginning after 12/31/21.
- The excess business loss provision set to expire on 12/31/25 is permanently extended in the draft and modified retroactive to 2021 (effective for tax years beginning after 12/31/20). Excess business losses above $500,000 for MFJ and $250,000 for all other filers previously treated as a net operating loss in the following year are under the draft treated as a trade/business deduction in the following year, subject to the following year excess business loss computation.
- The draft proposes significant reductions to the estate and gift lifetime exemption effective for decedents dying and gifts made after 12/31/21. Under this proposal, the per person/spouse lifetime exemption is expected to be approximately $6,030,000 for 2022 ($5 million adjusted for inflation); down from $11,700,000 in 2021.
- The draft legislation from the House did not include elimination of the tax basis step-up at death in existing law, but discussion of eliminating or modifying this benefit is ongoing.
- The draft proposes to restrict valuation discounts effective as of the date of enactment of the final legislation. The proposal would eliminate marketability and minority discounts for estate and gift purposes for defined “nonbusiness” assets.
- The draft contains provisions relating to grantor trusts, intended to curtail use of Grantor Retained Annuity Trusts (GRATs), sales to Intentionally Defective Grantor Trusts (IDGTs) and the popular Spousal Lifetime Access Trusts (SLATs). It may be possible to establish and fund these types of trusts before enactment of the new law.
- Note that the draft House legislation did not include any modification to the $10,000 limit on state and local tax deductions, but it is still being discussed in the House and Senate.
Corporate Tax Highlights
- The House proposal increases the top C corporation tax rate for tax years beginning after 12/31/2021 to 26.5% (from the current 21%). Instead of a flat 21% rate, the House proposal contains graduated rates of 18% for up to $400,000 of taxable income; 21% for $400,001-$5 million; and 26.5% for over $5 million. The graduated rate benefit phases out for corporations with taxable income over $10 million. Personal service corporations are subject to a 26.5% flat rate.
- Reduces the section 250 FDII deduction to 21.8755 and GILTI to 37.5%, which combined with the top rate of 26.5% results in an effective FDII rate of 20.75 and an effective GILTI rate of 16.5625%. The changes are effective for tax years beginning after 12/31/21.
- Base erosion tax (BEAT) rates are modified to 10% for tax years beginning after 12/31/21; to 12.5% for tax years beginning after 12/31/23; and to 15% for tax years beginning after 12/31/25.
- Accelerates section 162(m) executive compensation deduction limitations to tax years beginning after 12/31/2021.
- Increases the Work Opportunity Tax Credit to 50% of the first $10,000 of qualifying wages in the first or second year of employment for employees hired post-enactment through 1/1/2023.
- Allows S corporations that were S corporations on May 13, 1996, and at all times thereafter, to elect to convert to partnership status without triggering taxable gain if accomplished during the two-year period beginning 12/31/2021. This relates to the check-the-box provisions enacted in 1996 that were not made available to S corporations.
- The House proposal would extend the expensing of section 174 research and experimental costs to expenses paid or incurred in years beginning before 2026. This expensing provision was set to expire for tax years beginning after 2021. Taxpayers would continue to be able to choose in lieu of expensing capitalization/amortization over five years (section 174) or 10 years (section 59(e)).
If you have any questions about this legislation, our team is here to help.
Disclaimer: The information contained in this communication, including attachments and enclosures, is not intended to be a complete analysis of all related issues. Nor is it sufficient to avoid tax-related penalties. It has been prepared for informational purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and Perkins & Company, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.