Build Back Better Act

On September 13, 2021, the House Ways and Means Committee released its tax law proposal to be incorporated in the budget reconciliation bill, also known as the “Build Back Better Act” (the “Bill”). The Bill contains many tax provisions, mostly targeted toward the goal of increasing tax revenue for the Federal government, but is merely a proposal by the House Ways and Means Committee. Its provisions could change greatly or fail altogether in the coming weeks as Congress negotiates this and many other budgetary considerations. Whether the entire proposal or any portions of it become the law, below are just a few of some highlights of the tax provisions of the proposed Bill.

The effective date for most (but not all) of the proposed tax provisions would be after December 31, 2021, and would be permanent changes unless otherwise noted.

Please note that this is for informational purposes only, and is not intended to be tax advice. Clients should contact their tax advisors if they have any questions or concerns regarding how this or any other proposed Bill may impact their personal tax situation.

Corporate Tax Rate

Prior to the “Tax Cuts and Jobs Act of 2017” (TCJA), corporate taxable income was subject to a graduated rate structure with a maximum rate of 35%. The TCJA enacted a flat 21% corporate tax starting in 2018.

The Bill would reintroduce a graduated corporate tax rate structure. The first $400,000 of taxable income would be taxed at 18%; taxable income over $400,000 but not over $5 million would be taxed at 21%; and taxable income over $5 million would be taxed at 26.5%. Taxable income over $10 million would be subject to an additional tax equal to 3% of the amount over $10 million. The additional tax would be capped at $287,000.

Top Marginal Individual Income Tax Rate

The top individual income tax rate was temporarily reduced from 39.6% to 37%, from 2018 through 2025, as part of the TCJA.

The Bill would increase the top marginal individual income tax rate to 39.6%, starting in 2022. This marginal rate would apply to taxable income over $400,000 for unmarried filers, $425,000 for head of household filers, $450,000 for married taxpayers filing jointly, $225,000 for married taxpayers filing separate returns, and $12,500 for estates and trusts with taxable income. These amounts would be adjusted for inflation after 2025.

Increased Capital Gains Rates

The Bill would increase the top capital gains rate on assets held for a year or more from 20% to 25%. The 25% rate would apply only to those subject to the top marginal individual income tax rate (which would be increased to 39.6% as noted above).

NOTE: This provision of the Bill would apply to taxable years ending after September 13, 2021. A transition rule would apply to taxable years that include September 13, 2021.

Net Investment Income Tax (NIIT) Applicable to Small Business Income

The Bill would subject the active income of high-income partners and S-corporation owners that is not already subject to FICA or SECA tax to the 3.8% NIIT. The high-income thresholds would be $250,000 (married filing separately), $400,000 (single or head of household), and $500,000 (married filing jointly).

Limitation on Deduction for Qualified Business Income

The Bill would limit the dollar amount of the 20% Section 199A deduction for pass-through business income. Specifically, the deduction amount would be limited to $500,000 for married taxpayers filing jointly, $250,000 for married taxpayers filing separately, $10,000 for an estate or trust, and $400,000 for any other taxpayer.

Surcharge on High Income Individuals, Estates and Trusts

The Bill would create an additional income tax on individuals, estates, and trusts on modified adjusted gross income (MAGI) in excess of specified thresholds. The tax would be applied at a flat rate of 3% and would apply to MAGI in excess of $2.5 million for married taxpayers filing separately, $100,000 for estates and trusts, and $5 million for all other non-corporate taxpayers. Taxes paid under this provision would not be treated as income taxes paid for purposes of the alternative minimum tax that may still apply to individuals.

Termination of Temporary Increase in Estate and Gift Tax Exemption

The TCJA temporarily increased, from 2018 through 2025, the basic exemption for the estate and gift tax by doubling the basic exemption from $5 million to $10 million. This amount is adjusted for inflation, resulting in a basic exemption of $11.7 million for individuals and $23.4 million for married taxpayers in 2021.

The Bill would lower the exemption amount to approximately $6.03 million per individual.

Rules Applicable to Grantor Trusts

A grantor trust is a trust where the grantor is treated as the owner of the trust and retains the rights and benefits of the assets in the trust. Because the grantor and the grantor trust are treated as a single entity for tax purposes, transactions between the grantor and the grantor trust are disregarded. The Bill would include the value of any assets held in a grantor’s trust at the grantor’s death in a grantor’s taxable estate and apply any transfers from the grantor trust to a beneficiary of the grantor trust made during the grantor’s life as if made by the grantor.

NOTE: This provision of the Bill would effective as of the date of enactment. Note also that this proposed provision could impact certain life insurance trusts.

Limitations with Respect to Large Retirement Account Balances

Taxpayers can contribute to their individual retirement accounts (IRAs) regardless of the balance in the accounts. This provision would disallow contributions for accounts with assets over $10 million. It would apply to married couples with taxable income over $450,000 (single taxpayers over $400,000 and heads of household over $425,000). There is also a provision for reporting on employer defined contribution plans for accounts with more than $2.5 million.

Increased RMDs for Large Retirement Accounts

Under current law, taxpayers are generally required to begin making withdrawals (“required minimum distributions” or RMDs) from traditional IRAs when they are 72 years old (this does not apply to Roth IRAs). This provision would require individuals with a combined traditional IRA, Roth IRA, and employer defined contribution plan of over $10 million to make withdrawals of 50% of the excess over $10 million. This rule would apply to taxpayers with taxable income in excess of the amounts listed above.

A traditional IRA allows a deduction of contributions and taxation of withdrawals, while a Roth IRA does not allow the deduction or impose the tax on withdrawals, but exempts the earnings from tax if certain conditions are met. Employer defined contribution plans can be in the traditional or Roth form. The provision would also require withdrawals to be made from Roth IRAs and employer plans when the amounts in all accounts exceed $20 million reduce the amount to $20 million up to the amounts in these plans.

Treatment of Conversions to Roth IRAs

Contributions to Roth IRAs and the deductibility of contributions to traditional IRAs are limited by income, although individuals can make nondeductible contributions to traditional IRAs regardless of income. For a nondeductible IRA, the withdrawals are partially exempt to recover the taxpayer’s contribution proportional to the withdrawal. Current law allows conversions from traditional to Roth IRAs without an income limit, so that taxpayers can invest in a nondeductible traditional IRA and then convert it to a Roth IRA (so called “back-door Roths”).

This provision would eliminate the conversion of nondeductible IRAs and employer plans to Roth accounts.

For high-income taxpayers, as described above, transfers could only be made from Roth plans. This provision would apply beginning in 2032.

Limitation on IRA Investments in Controlled Businesses

An IRA owner cannot invest in a partnership, corporation, trust, or estate that is 50% owned. This provision would reduce that ownership to 10% for assets that are not publicly traded and disallow investments when the owner is an officer. Violating these rules would cause an account to lose IRA status. There is a two-year transition period for existing IRAs