After almost two months of wrangling, cajoling, and threatening, the Democrats in the House and Senate, have almost agreed upon a cutdown version of the original $3.5 trillion “social spending and climate” plan.
In September, the House Ways and Means Committee released its first try at the Build Back Better Act. On October 28, 2021, a second version costing a substantially reduced $1.75 trillion is in writing – all 1684 pages. The latest version of HR 5376, as reported by the Committee on the Budget, is here. A section-by-section summary of the October 28, 2021 version of the Build Back Better Act is here.
WHAT WILL OUR CLIENTS WANT TO KNOW?
There will be lots of client questions, but these four are essential and will be asked.
- Are my tax rates going up?
- Are my capital gains taxed as ordinary income?
- What happened to my retirement planning?
- Will I have to redo my whole estate plan?
Short Answer: If the most recent version is passed (and that is a big if), mainly the answer for our clients is “no, no, nothing, and no.” Most of the proposed tax increases for the clients that we advise were eliminated.
Let’s take a closer look —and find out how the details have changed.
Are my tax rates going up?
No, not so far. The first Ways and Means draft included increasing the top tax rate for individuals from 37% to 39.6%. The rate increase is not in this version. Rates aren’t up, but your taxes may increase because of a change to the way the net investment income tax is applied. Currently, a 3.8% tax applies to net investment income – generally interest, dividends, and capital gains. The proposal would modify the 3.8% tax to apply to business income from pass-through entities for taxpayers with greater than $400,000 in taxable income (single filer) or $500,000 (joint filer), as well as for trusts and estates.
Taxes on the uber-wealthy are going up if this version of the Act passes intact. Tax on the unrealized gain in capital assets held by billionaires was dropped and replaced with a surcharge on individuals with modified adjusted income over $10 million. The surcharge would be 5% of a taxpayer’s modified adjusted gross income in excess of $10,000,000 and an additional tax of 3% of a taxpayer’s modified adjusted gross income above $25,000,000. Modified adjusted gross income means adjusted gross income reduced by any deduction allowed for investment interest.
Are my capital gains taxed as ordinary income?
No, not yet. President Biden proposed taxing capital gains at ordinary income tax rates when the taxpayer’s income exceeded $1 million. The first Ways and Means draft did not tax capital gains as ordinary income but instead proposed to increase the top rate from 20% to 25%. The October 28th version of the proposed legislation has eliminated all mention of taxation changes to capital gains.
What happened to my retirement planning?
Nothing so far. The first Ways and Means draft included proposals to limit contributions to IRA and pension plans for high-income taxpayers with account balances exceeding $10 million. Required minimum distributions would have been required for account balances that exceeded $10 million. “Back Door” Roth IRA rollovers would have been eliminated. The October 28th proposal makes no changes to IRAs and retirement plans.
Must I redo my entire estate plan?
No, not yet. The House Ways and Means draft included a drastic reduction to the estate tax exemption from its current $11,700,000 to $5 million adjusted by inflation (estimated to be an exemption of $6.2 million for decedents dying in 2022). The latest proposal does not include a change to the exemption. Also dropped were proposal changes to the ability to make transfers to defective grantor trusts and the ability to value partial or non-voting ownership interests in LLCs and other entities at a discount. Also included in the disappearing act were changes that would have eliminated the following:
- Grantor Retained Annuity Trusts
- Specific Charitable Lead Annuity Trusts
- Qualified Personal Residence Trusts
- Spousal Limited Access Trusts
- Exchanging assets tax-free between grantors and trusts
Client Recommendation | Tax planning: Recommend that your clients schedule an appointment with their estate planners as changes are coming, but maybe not as fast as some feared.
OTHER PROPOSED CHANGES
The proposed legislation would include commodities, currencies, and digital assets in the wash sale rules. The wash sale rule in §1091 prevents taxpayers from claiming tax losses while retaining an interest in the loss asset. The amendments made by this section apply to taxable years beginning after December 31, 2021. The proposed legislation would include digital assets in the constructive sale rules, anti-abuse rules previously applicable to other financial assets. The constructive sale rules in §1259 treat the adoption of certain offsetting positions to previously owned positions as sales of the previously owned position. These rules prevent taxpayers from locking in investment gains without realizing a taxable gain. The amendments made by this section apply to constructive sales after the date of enactment and contracts entered into after the date of enactment.
IRS Enforcement Changes
The proposed legislation would provide $80 billion of additional funding to the IRS. $45 billion is designated for enforcement. Public statements from the administration, including Treasury Secretary Yellen, expect the enforcement to be aimed primarily at the wealthy taxpayer. For this purpose, “wealthy” is considered to be a taxpayer with more than $400,000 in taxable income.
With the extra funding, the President hopes to provide $400 billion to help finance a part of the legislation’s $1.75 trillion cost. CBO has projected that $80 billion of funding could generate $200 billion of additional tax revenue. The discrepancy has not been explained.
Family Tax Credits
The proposed legislation would extend the Child Tax Credit for one year through 2022. Thirty-nine million qualifying families would receive $300 monthly for a child under six and $250 per month for a child 6 to 17. The proposal would extend The American Rescue Plan Act changes to the earned income tax credit for one year through 2022, providing up to $1,100 to 17 million low-income workers. The child and dependent care credit expansion provided for in the Rescue Act was not extended into 2022. Instead, funding would be provided to states to provide free and subsidized childcare certificates for low-income workers. The family leave credit was dropped in this version of the proposed legislation.
Clean Energy Tax Credits
The proposed legislation would provide $320 billion for clean energy tax credits to apply to transmission, storage, manufacturing, residential homes, passenger vehicles, and commercial vehicles.
Let’s take a closer look —at the details of three of the several proposed energy credits.
The Nonbusiness Energy Property Credit
The nonbusiness energy property credit would be extended to property placed in service before the end of 2031. Starting in 2022, the provision would modify and expand the credit by:
- Increasing the percentage of the credit for installing qualified energy efficiency improvements from 10% of the cost to 30%
- Replacing the $ 500-lifetime cap on credits with a $1,200 annual credit limitation.
Refundable Credit for Qualified PLug-in Electric Vehicles
An expanded refundable credit for qualified plug-in electric drive personal use motor vehicles would be created by the legislation. The amount of credit would be equal to the base amount of $4,000 plus an additional $3,500 for vehicles placed into service before January 1, 2027, with battery capacity no less than 40 kilowatt-hours and a gasoline tank capacity not greater than 2.5 gallons, and for vehicles with a battery capacity of no less than 50-kilowatt hours thereafter. The amount of credit would be increased by $4,500 if the vehicle’s final assembly is at a union facility in the United States. The amount of credit is increased by $500 if the vehicle model is powered by battery cells that are manufactured within the United States. The provision includes an AGI phaseout and a cap on the suggested retail price of the vehicle. Used electric vehicles purchased from a dealership for personal use would qualify for a reduced credit capped at $4,000 or 50% of the cost of the vehicle. AGI phaseouts apply.
Credit for Qualified Commercial Electric Vehicles
The legislation would create a new credit for qualified commercial electric vehicles. The amount of credit for a qualified commercial electric vehicle would be equal to 30% of the cost of such a vehicle. A leasing company may elect to determine the credit using the structure of the individual credit under §36C if the vehicle is leased to an individual. Tax-exempt entities would have the option of electing to receive direct payments.
Health Care Coverage
The proposed legislation would extend the American Rescue Plan affordability percentages used for premium tax credits through 2025 for individuals eligible for assistance with household incomes below 400% of the federal poverty level (FPL) and provides premium tax credits for taxpayers with household incomes above 400% of the FPL.
The proposed legislation would reduce ACA premiums for 9 million low-income individuals in states where Medicaid was not expanded by an average of $600 per person annually. It would expand Medicare coverage to hearing aids beginning January 1, 2023. Dental and Vison coverage are not included in the modification to coverage. Medicare would not be able to negotiate lower drug prices with pharmaceutical companies.
The Ways and Means Committee draft included increased corporate tax rates from 21% to 26.5%. The October 28th version of the Build Back Better Act does not include increased corporate tax rates. Instead, the corporate alternative minimum tax (AMT) proposal would impose a 15% minimum tax on adjusted financial statement income for corporations with such income in excess of $1 billion. The proposal would also impose a 1% excise tax on a publicly-traded US corporation for the value of any of its stock that the corporation repurchases during the taxable year. GILTI and FIDII deductions would be reduced to 24.8% and to 28.5%, yielding a 15% GILTI rate and a 15.8% FDII rate. The proposal would require foreign tax credit determinations be made on a country-by-country basis.
Qualified Small Business Stock
The proposed legislation would amend §1202(a) to provide that the special 75% and 100% exclusion rates for gains realized from certain qualified small business stock will not apply to taxpayers with adjusted gross income equal to or exceeding $400,000. The baseline 50% exclusion in 1202(a)(1) remains available for all taxpayers. The amendments made by this section apply to sales and exchanges after September 13, 2021, subject to a binding contract exception.
Research and Experimental Expenditures
The proposed legislation would delay the start of amortization of the research and experimental expenditures to taxable years beginning after December 31, 2025 (was after December 31, 2021).
Excess Business Losses
The proposed legislation would make permanent §461(l), which disallows excess business losses for non-corporate taxpayers. The §461(l) limits were due to expire after 2026.