On September 13, 2021, the House Ways and Means Committee released a summary of its proposed tax changes that includes various tax increases as well as various changes to deductions and credits. Here is a summary of the changes that have been proposed and how they could effect you and your business.

Increases in Tax Rates

Corporate Tax Rates

The proposal would increase the corporate income tax rate from a flat 21% to a graduated structure beginning at 18% (for income up to $400,000) up to a top rate of 26.5% (for income above $5 million). Corporations with income in excess of $10 million would be subject to a flat rate of 26.5% on all income as the benefit of the lower marginal rates is phased out gradually from $5 million to $10 million. This is lower than the original proposal by the Biden Administration, which had proposed a corporate tax rate of 28%.

Individual Tax Rates

The committee has also proposed to increase the top individual tax rate to 39.6% (same as prior to the TCJA was enacted in December 2017) from the current 37%. The new top rate would be effective for married taxpayers with taxable income over $450,000, and unmarried taxpayers with taxable income over $400,000.

Additionally, included in the proposal is a new 3% surtax which would apply to taxpayers with income in excess of $5 million.

The resulting changes proposed would result in a top tax rate of 46.4% when also taking into consideration the additional Medicare tax of 3.8%.

Capital Gains Tax Rates

In addition, the proposal includes an increase of the top tax rate for long term capital gain and qualified dividend income. Currently the top rate is 20%, but this would increase to 25% under the proposal outlined by the House. The resulting net tax rate would be 28.8% when also taking into consideration the additional Medicare tax of 3.8%. While most of the provisions in the proposed legislation would not be effective until 2022, the increase in the capital gains rate would be effective as of September 13, 2021, the date the proposal was officially announced.

Retirement Plans

Contribution Limits

The House proposal would prohibit taxpayers with balances of more than $10 million in their retirement accounts from making any further contributions. This would only apply if the taxpayers' income exceeds $400,000 ($450,000 if filing jointly).

Rollovers & Conversions

Currently taxpayers who are prohibited from contributing directly to a Roth IRA can instead make a "backdoor Roth contribution" by first making a nondeductible contribution to a traditional IRA and then converting this amount to a Roth. The proposed legislation would prohibit conversions for any taxpayers who taxpayers with income in excess of $400,000 ($450,000 if filing jointly). Additionally, it would also prohibit any after tax contributions to employee retirement plans which can be used to perform a "mega backdoor Roth contribution". The proposal would prohibit these types of conversions starting in 2022.

Required Minimum Distributions

In accordance with the proposed contribution limits for large retirement accounts, the proposed legislation would require distributions from accounts that exceed $10 million. The required distribution would be 50% of the sum of any aggregate balance in excess of $10 million. In addition, if the aggregate balance of retirement accounts exceeds $20 million, the taxpayer must distribute any amounts above $20 million to the extent that they are in a Roth account.

Other Provisions

Net Investment Income Tax

Currently the Net Investment Income Tax (NIIT) applies to any net investment income of taxpayers with income in excess of $200,000 ($250,000 if filing jointly, $125,000 if filing separately). The current law does not impose the NIIT on income derived in the ordinary course of a trade or business. However, the House proposal would impose the NIIT on any net investment income from a trade or business for taxpayers with income in excess of $400,000 ($500,000 if filing jointly, $250,000 if filing separately).

Qualified Business Income

The proposed legislation would set a limitation on the maximum qualified business deduction which was introduced as part of the TCJA in 2017. The maximum allowable deduction would be set at $400,000 ($500,000 if filing jointly, $250,000 if filing separately). Additionally, the maximum allowable deduction would be set at just $10,000 for trusts and estates.

Excess Business Losses

The House proposal would do away with the ability for a noncorporate taxpayer to claim an excess business loss. Following the passage of the TCJA in 2017, taxpayers were allowed to deduct excess business losses of up to $250,000 (or $500,000 if filing jointly), with the limitation amount adjusted annually for inflation. In response to the Covid-19 pandemic, the CARES Act removed the limitation retroactively for 2018 and 2019, as well as for 2020. For 2021, the limitation is $262,000 ($524,000 if filing jointly). If the proposal is enacted, the deduction for excess business losses would be disallowed starting in 2022, any excess losses would instead be carried forward to the subsequent tax year.

Estate & Gift Tax Exemption

The proposed law would reverse the increase in the estate & gift tax exemption amount that was enacted as part of the TCJA in 2017, which would result in cutting the current exemption amount in half to roughly $6.2 million when indexed for inflation. Taxpayers with estates that exceed the lower threshold amount may want to act quickly to make a gift to an irrevocable trust in order to take advantage of the current higher exemption amount. The effective date for changes to estate planning provisions is as of enactment, thus it's important to act soon as taxpayers may not have until the end of the year as the proposal could be enacted sooner.

Qualified Conservation Contributions

The proposed legislation would deny the charitable deduction for contributions of conservation easements by certain pass through entities if the amount of the allocable contribution exceeds 2.5 times the basis of the partner. Important to note, this particular proposal would be retroactive to December 23, 2016. Conservation easements have been a popular mechanism that has been employed as a tax shelter whereby taxpayers receive a tax deduction for the loss in value of a property when it is donated for the purpose of conservation of the land, often receiving a deduction well in excess of the amount that the taxpayers originally invested in the property.

Cryptocurrency Transactions

Previously, based on rules published by the IRS, digital currencies (also known as cryptocurrencies) such as Bitcoin have been treated as property, rather than stocks, thus they have not been subject to the "wash sale" rules. The House proposal would require digital currencies to be treated the same as stocks for purposes of computing capital gains and losses. Currently, investors in digital currencies can sell their holdings for a loss and immediately buy them back while still being able to realize the loss for tax purposes. This would no longer be possible under the House proposal starting in 2022.

International Provisions

The House proposal would change the deductions for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI) to 21.875% and 37.5%, respectively. This would result in an effective GILTI rate of 16.5625% and an effective FDII rate of 20.7%. The increase in the GILTI tax rate is less than the 21% rate proposed by the Biden Administration, but it is still higher than the current GILTI rate of 10.5%.

Additionally, there are proposed changes to the foreign tax credit rules. Specifically, the provision would require the determination of the limitation of the foreign tax credit to be determined on a country-by country basis. This potentially would result in prohibiting the use of excess foreign taxes paid in certain high-tax jurisdictions to offset income in jurisdictions with substantially lower taxes.

Questions?

If you have any questions about any of the proposed tax law changes or if you would like to be informed of any new developments, please contact us.