The House Ways and Means Committee on Monday released legislative text for proposed tax changes to be incorporated in the budget reconciliation bill known as the “Build America Back Better” act.
How Will This Legislation (if enacted) Affect Taxes Paid?
The proposed legislation would raise tax rates for corporations and individuals and make many other changes to the Internal Revenue Code.
What Are the Highlights of this Legislation?
As is typical of most legislation, there are numerous provisions. Since the vast majority of our clients are individual taxpayers, S Corporations, or partnerships, we focused only on those types of taxpayers in analyzing this proposed legislation. Keep in mind that S Corporations and partnerships are flow-through tax entities, meaning that the income reported on the K-1s from those entities gets reported on the owner’s individual income tax return.
Individual & Estate Taxpayer Highlights
Tax rates: The proposal would increase the top marginal individual income tax rate to 39.6%. This marginal rate would apply to married individuals filing jointly with taxable income over $450,000; to heads of household with taxable income over $425,000; to unmarried individuals with taxable income over $400,000; to married individuals filing separate returns with taxable income over $225,000; and to estates and trusts with taxable income over $12,500.
Capital gains: The proposal would increase the 20% tax rate on capital gains to 25%. A transition rule would provide that the current statutory rate of 20% would continue to apply to gains and losses for the portion of the tax year prior to Sept. 13, 2021. Gains recognized later in the same tax year that arise from transactions entered into before Sept. 13, 2021, pursuant to a written binding contract would be treated as occurring prior to Sept. 13, 2021.
Net investment income tax: The proposal would expand the net investment income (NII) tax to cover net investment income derived in the ordinary course of a trade or business for taxpayers with greater than $400,000 in taxable income (single filers) or $500,000 (joint filers), as well as for trusts and estates.
Qualified business income deduction: The proposal would set the maximum allowable deduction under Sec. 199A at $500,000 in the case of a joint return, $400,000 for an individual return, $250,000 for a married individual filing a separate return, and $10,000 for a trust or estate.
Limitation on excess business losses: The proposal would permanently disallow excess business losses (i.e., net business deductions in excess of business income – think NOLs) for non-corporate taxpayers.
Unified credit: The proposal would revert the unified credit against estate and gift taxes to $5 million per taxpayer, adjusted for inflation.
High-income surcharge: The proposal would impose a tax equal to 3% of a taxpayer’s modified AGI (MAGI) in excess of $5 million (or in excess of $2.5 million for a married individual filing separately). For this purpose, MAGI would mean AGI reduced by any deduction allowed for investment interest (as defined in Sec. 163(d)). (AGI meaning adjusted gross income.)
Contributions to IRAs: The proposal would prohibit further contributions to a Roth or traditional IRA for a tax year if the total value of an individual’s IRA and defined contribution retirement accounts generally exceeds $10 million as of the end of the prior tax year. The limit on contributions would only apply to single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of household with taxable income over $425,000 (all indexed for inflation).
Required Minimum Distributions (RMDs): For high-income taxpayers, as defined above, if an individual’s combined traditional IRA, Roth IRA, and defined contribution retirement account balances generally exceed $10 million at the end of a tax year, a minimum distribution would be required for the following year. The minimum distribution would generally be 50% of the amount by which the individual’s prior-year aggregate traditional IRA, Roth IRA, and defined contribution account balance exceeds the $10 million limit. To the extent that the combined balance amount in traditional IRAs, Roth IRAs, and defined contribution plans exceeds $20 million, that excess would be required to be distributed from Roth IRAs and Roth designated accounts in defined contribution plans up to the lesser of (1) the amount needed to bring the total balance in all accounts down to $20 million or (2) the aggregate balance in the Roth IRAs and designated Roth accounts in defined contribution plans.
Roth conversions: The proposal would eliminate Roth conversions for both IRAs and employer-sponsored plans for single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of household with taxable income over $425,000 (all indexed for inflation).
“Back door” Roth IRA strategies currently allow taxpayers who exceed existing Roth income limits to make nondeductible contributions to a traditional IRA, and shortly thereafter, convert the nondeductible contribution from the traditional IRA to a Roth IRA. Current law also allows taxpayers to contribute to a Roth 401(k) plan regardless of income limits (including making non-Roth after-tax contributions) and convert such contributions to a Roth IRA. The proposal would prohibit applicable taxpayers from engaging in these “back door” Roth IRA strategies.
To eliminate these strategies, the proposal would prohibit Roth conversions, for both IRAs and employer-sponsored plans, for applicable taxpayers, as defined above. The proposal would be effective for distributions, transfers and contributions made in taxable years beginning after December 31, 2031 (10 years from now). However, for taxable years beginning after December 31, 2021, the proposal would prohibit all employee after-tax contributions in tax-qualified retirement plans and would prohibit after-tax IRA contributions from being converted to Roth IRAs regardless of income level.
Paid family leave and medical leave: The proposal would end the employer credit for wages paid to employees during family and medical leave to tax years beginning after 2023, instead of the current 2025 expiration date.
S corporation reorganization: The proposal would allow eligible S corporations to reorganize as partnerships without triggering tax. An eligible S corporation would be any corporation that was an S corporation on May 13, 1996 (prior to the publication of current-law check-the-box regulations).
Tax Tip #1
Please keep in mind that this is proposed tax legislation that has not been enacted into law. However with the Democratic Party controlling the White House, the Senate and the House, the likelihood of passage is far greater than if one of the branches of Congress was controlled by another party.
Tax Tip #2
Far too many taxpayers start thinking of taxes during the tax filing season instead of during the calendar year. Proposed tax legislation is an important reminder as to why it is very important to do tax planning before year end. Tax planning not only includes income tax planning, but also gift and estate tax planning.
Tax Tip #3
Consider accelerating ordinary income to 2021 when projected tax rates will be lower.
Tax Tip #4
Consider making gifts up to the 2021 estate tax basic exclusion amount, $11,700,000.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.