What’s In the Latest Draft of Proposed Tax Law Changes? by Jeffrey M. Mutnik, CPA/PFS
Posted on October 04, 2021
On September 25, the House Budget Committee voted to approve the latest round of recommended changes to the U.S. tax code as part of the president’s $3.5 trillion Build Back Better Act. The draft legislation calls for higher taxes, but at rates that are not as high as previously proposed. In addition, it fails to address 1031 exchanges and stepped-up-tax-basis applied to assets transferred at death, seemingly preserving both these tax-advantaged income and estate planning strategies. However, taxpayers will be surprised to find the tax package introduces some new provisions that may require rethinking and adjusting existing planning strategies before any new law goes into effect.
Higher Individual Tax Rates
The top ordinary income tax rate would increase from 37 percent for individuals earning more than $523,600 (and $628,300 for married couples filing jointly) to 39.6 percent for individuals earning more than $400,000, married couples making more than $450,000, and trusts and estates with taxable income above $12,500. The 39.6 percent top rate is the same rate that was in place prior to the enactment of the tax Cuts and Jobs Act in 2017.
Expanded Net Investment Income Tax (NIIT)
The House proposes to expand the application of the existing 3.8 percent net investment income tax (NIIT) to include the active pass-through business income of individual taxpayers with more than $400,000 in taxable income (or $500,000 for joint filers).
New Surcharge on Wealthy Individuals, Trusts and Estates
Wealthy taxpayers and trusts and estates would be subject to a 3 percent surcharge on modified adjusted gross income (MAGI) that exceeds $5 million.
Higher Taxes on Capital Gains
The top tax rate on long-term capital gains would increase from 20 percent to 25 percent, plus the additional 3.8 percent NIIT. The proposal calls for the higher rate to become effective on Sept. 13, 2021, but allows taxpayers to apply the old rate to investment gains and losses that resulted from a transaction initiated before that date.
Lower Federal Gift and Estate Tax Exemption
The generous exemptions from the federal estate tax that were introduced by the TCJA in 2017 will expire four years earlier than planned. Effective Jan. 1, 2022, the current exemptions of $11.7 million for individuals and $23.4 million for married couples would revert to their pre-TCJA levels of $5 million for individuals and $10 million for married couples filing jointly, adjusted for inflation. Estates and gifts exceeding these thresholds would continue to be taxed at 40 percent.
New Restrictions to Retirement Accounts
Individuals with taxable income of more than $400,000 (or $450,000 for married couples filing joint tax returns) would be prohibited from making additional, excess contributions to traditional IRAs and Roth IRAs when the balance of their combined retirement accounts (including 401(k)s) at the end of the previous year exceeded $10 million. Moreover, the prosed law calls for these high-income taxpayers, regardless of their age, to take from their retirement plans a required minimum distribution (RMD) equal to 50 percent of the account balance that exceeds $10 million. These provisions would eliminate the use of backdoor Roths and Roth IRA conversions beginning in tax year 2032.
New Restrictions for Grantor Trusts
Sales between grantor trusts and their deemed owners would be treated in the future as taxable third-party sales, thereby eliminating the benefits of using grantor retained annuity trusts (GRATs) and intentionally defective grantor trusts to freeze estates. Appreciated asset grantors/owners transfer to a grantor trust would be subject to capital gains tax and included in the grantor’s taxable estate.
Limited Benefits of the QBI Deduction for Pass-Through Businesses
The proposal would introduce a cap to the Section 199A qualified business income (QBI) deduction introduced by the TCJA for taxpayers who own interests in pass-through entities. For individual taxpayers, the maximum allowable deduction would be limited to $400,000, or $500,000 for married couples filing joint tax returns and $10,000 for trusts and estates.
At the present time, there is no certainty as to which provisions of the House’s latest tax proposal will be enacted into law. Consequently, it behooves taxpayers, especially those with high income, to meet with the trusted advisors and CPAs to weigh their options for preserving wealth and maintaining tax efficiency in the future.
About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director of Taxation and Financial Services with Berkowitz Pollack Brant Advisors + CPAs, where he provides tax- and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.