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Proposed Tax Changes in $3.5 Trillion Spending Package

2021-09-17T13:05:49+00:00

On Wednesday, September 15 the House Ways and Means Committee approved and advanced the Democrat’s $3.5 trillion social spending package, which would significantly increase taxes on high-income individuals and corporations if it is passed into law. We are monitoring the status of this legislation and will have a more in-depth analysis as it makes its way through Congress. For now, here is an overview of some of the major provisions addressed:

Corporate Income Tax Rate: the spending package would increase the top corporate tax rate to 26.5 percent for income above $5 million. The 21 percent tax rate would remain for income between $400,000 and $5 million, and the rate would decrease to 18 percent for income below $400,000. The graduated tax rate benefit would phase out for corporations making more than $10 million, and personal services corporations would not be eligible to use the graduated rates.

Qualified Small Business Stock Limitation: the 75 percent and 100 percent exclusions for gains realized from the sale of qualified small business stock would not apply for taxpayers with an adjusted gross income of $400,000 or more. The 50 percent exclusion would still be available.

Temporary S Corporation Reorganization: S corporations that were established prior to May 13, 1996 (when the “check the box” entity classification rules were published) would be allowed to liquidate completely and transfer substantially, all of their assets and liabilities to a domestic partnership without triggering a tax. The temporary period for reorganizations would be a two-year period beginning on December 31, 2021.

Individual Income Tax Rate: the top individual income tax rate would return in 2022 to 39.6 percent for income over $450,000 for married joint filers and $400,000 for single filers.

Capital Gains Tax Rate: the top tax rate for long-term capital gains and qualified dividends would increase to 25 percent for individuals, effective September 13, 2021 (the date of introduction). Gains recognized after this date, to the extent they do not relate to transactions entered into prior to this date, would be subject to a 25 percent tax rate if they would have previously been subject to a 20 percent tax rate. After December 31, 2021, the 25 percent tax rate would continue to apply for individuals in the 39.6 percent tax rate.

Carried Interest Holding Period Changes: fund managers subject to the carried interest rules would be subject to a five-year holding period to qualify for long-term capital gains tax rates, effective in 2022. The holding period was previously increased to three years.

New Surtax: the package contains a new 3 percent surtax on individuals with a modified adjusted gross income of $5 million, or $2.5 million for married individuals filing separately. Trusts and estates with income of $100,000 or more would also be subject to the surtax.

Qualified Business Income Deduction: would set a maximum allowable deduction of $400,000 for individuals and $500,0000 for married couples for the 20% Section 199A qualified business income deduction. This 20% deduction effectively would increase the top tax rate on business income from 29.6% to 39.6% on the excess amount over the cap.

Net Investment Income Tax: trade or business income that is not subject to FICA taxes, which is generally income from pass-through entities, would be subject to the 3.8 percent tax on net investment income even if the owner materially participates in the business.

Estate and Gift Tax Exemption: the unified estate and gift tax exemption would be cut in half, to approximately $6 million, for 2022. This accelerates the decrease which was expected to occur in 2026.

Grantor Trust Changes: irrevocable grantor trusts are a common estate planning tool, allowing individuals to transfer assets out of their estate while remaining responsible for the income taxes assessed on the income earned by the trust. The legislation would not only cause the assets of the trust to be included in the grantor’s estate, and treat distributions from grantor trusts as taxable gifts, but would also impose an income tax on any sales made by the grantor to the trust. Transactions between the grantor and a grantor trust have generally been ignored for income tax purposes. These provisions would apply to grantor trusts, other than revocable grantor trusts, created on or after the date the legislation is ultimately enacted. These potential changes would significantly impact estate planning with many common types of trusts, including Grantor Retained Annuity Trusts (GRATs), Irrevocable Life Insurance Trusts (ILITs), and Spousal Lifetime Access Trusts (SLATs).

Retirement Plan Contributions and Distributions: the spending package would prohibit additional contributions to individual retirement accounts (IRAs) if the total value of an individual’s IRAs and defined contribution retirement accounts generally exceed $10 million as of the end of the prior taxable year. This limit would be applied to single filers with taxable income over $400,000, and joint filers with taxable income over $450,000. An additional minimum distribution would also apply where an individual’s combined traditional IRA, Roth IRA, and defined contribution retirement account balances exceed $10 million at the end of a taxable year. The additional minimum distribution would generally be 50 percent of the amount that the balance exceeds the $10 million limit. If the balance exceeds $20 million, the individual would generally need to distribute the excess over $20 million prior to applying the 50 percent distribution requirement.

Roth Conversions: since 2010, individuals have been able to convert retirement accounts to Roth IRAs irrespective of the income limitations currently in place for ordinary contributions to Roth IRAs. This package would eliminate conversions for single filers with taxable income over $400,000 and joint filers with taxable income over $450,000.

Notably, the spending package does not include any provisions eliminating the step-up in basis that occurs to an individual’s assets when they die, as was previously proposed by President Biden. The spending package also omits changes to the $10,000 cap on the state and local tax deduction, though it is expected that this will be added later. The House is expected to take action on the package when it returns from recess next week, with hopes to pass the legislation before the end of the month. We also expect that there will be changes made to the legislation prior to passage.

We strongly encourage you to reach out to your HBK Tax Advisor to discuss how these tax changes may impact your tax situation. In addition, if you are considering establishing a trust, or have previously established a grantor trust, we urge you to contact us so that we may determine whether any immediate planning is necessary in order to mitigate the potential tax consequences of the grantor trust changes.

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About the Author(s)

Amy is a Principal and the Chair of the Tax Advisory Group at HBK CPAs & Consultants. The Tax Advisory Group is a group of highly specialized professionals who provide tax training to our team members, oversee compliance with tax policies in order to mitigate risk to the firm, and provide tax planning and consulting services for our clients.

Amy is the Co-National Director of the Nonprofit Solutions group. She also leads the HBK's diversity and inclusion initiative.

Amy specializes in estate, gift, trust, individual, and nonprofit taxation. She is skilled at researching complicated tax issues, consulting on complex estate plans, and providing guidance for our clients to ensure they are in compliance with their tax filing responsibilities.

Amy enjoys sharing her knowledge and passion for tax planning with clients and other professionals. She is a frequent speaker at bar association and estate planning council events, and has authored many articles discussing tax planning techniques and compliance issues.

Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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