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In recent months, Congress has been working on a $3.5 trillion spending and tax package that Democrats and the White House hope to pass through the budget reconciliation process this fall. This legislation would advance many of President Biden’s economic and social policies

Last week, the U.S. House Ways and Means Committee held markup sessions for portions of the $3.5 trillion reconciliation bill. The provisions approved by the committee include 12 weeks of paid family and medical leave for workers, a mandate for small businesses to enroll employees in tax-deferred retirement accounts, and childcare grants to states to expand access to childcare.

To pay for the social and economic policies in the reconciliation package, Democrats are proposing a series of tax increases and changes. Last week, the House Ways and Means Committee released draft legislation extending the recently expanded child tax credit and extending a number of energy credits for 10 years. Today, the committee released the rest of its tax proposals, which include the following proposed provisions: 

For Corporations

  • Increase the top rate to 26.5 percent from 21 percent for corporations with incomes of $5 million while reducing the rate to 18 percent for corporations with incomes less than $400,000. This is a more modest increase from the 28 percent included in the president’s proposals. The committee’s proposal would be a change from the current flat rate to a progressive corporate tax rate as follows:
    • $0 to $399,999 – 18 percent
    • $400,000 to $5 million – 21 percent
    • More than $5 million – 26.5 percent

      Corporations that are taxed as personal service corporations are not eligible for the graduated rates and instead are subject to a flat 26.5 percent rate. These tax increases are proposed to be effective for taxable years beginning after December 31, 2021.
  • Increase minimum tax on U.S. companies’ foreign income to 16.5 percent from 10.5 percent, along with several other changes to the international tax regime. A transition rule is provided for taxable years that include but do not end on December 31, 2021. In contrast, the president’s proposal would result in a U.S. effective global minimum tax rate of 21 percent, assuming the president’s proposed income tax rate of 28 percent. 
  • Tighten thresholds for deducting executive compensation by moving up the effective date of the amendment to Section 162(m) in the American Rescue Plan Act of 2021 (ARPA) to tax years following December 31, 2021. The ARPA expanded the set of applicable employees under §162(m) to include the eight most highly compensated officers other than the principal executive and principal financial officers for a taxable year, beginning in tax years after December 31, 2026.
  • Delay the effective date of requirement to amortize R&D expenses (versus immediately deducting) to taxable years beginning after December 31, 2025. Under current law, the amortization requirement is scheduled to begin in taxable years beginning after December 31, 2021.
  • Increase the Work Opportunity Tax Credit (WOTC) to 50 percent of the first $10,000 in wages paid to an employee in his or her first or second year of employment who falls in one of the WOTC targeted groups (other than summer youth employees). This change would apply to qualifying employees hired after date of enactment and before January 1, 2023.

For Individuals

  • Create a new 3 percent surtax on individuals with modified adjusted gross income exceeding $5 million ($2.5 million for a married individual filing separately), a provision not included in the president’s proposals. This is proposed to be effective for tax years beginning after December 31, 2021.
  • Expand the Net Investment Income Tax (NIIT) to cover net investment income derived in the ordinary course of a trade or business for taxpayers with taxable income greater than $400,000 for single filers or $500,000 for joint filers, as well as for trusts and estates. Essentially, this change would subject all earnings from pass-through businesses to either the 3.8 percent self-employment Medicare tax or the 3.8 percent NIIT, regardless of whether the income is from a passive or nonpassive activity. The proposed effective date is tax years beginning after December 31, 2021.
  • Increase the top ordinary income tax rate to 46.4 percent (39.6 percent top individual tax bracket + 3.8 percent NIIT + 3 percent surtax). The proposed top bracket would start at taxable income levels of $400,000 for single ($450,000 married filing joint); this is lower than under the president’s plan, which would have the top rate kick in at $452,700 and $509,300, respectively (adjusted annually for inflation). As a result, more high-income Americans would be subject to the top rate under the committee’s proposal. The proposed effective date is for taxable years beginning after December 31, 2021.
  • Limit the maximum §199A qualified business income deduction to $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. The proposed effective date is for taxable years beginning after December 31, 2021.
  • Increase the top capital gains rate to 31.8 percent (25 percent statutory rate + 3.8 percent NIIT + 3 percent surtax). This proposal is lower than the 43.4 percent top capital gains rate proposed by the president for those with adjusted gross incomes exceeding $1 million ($500,000 married filing separately). The proposed effective date for a 25 percent capital gain rate is September 13, 2021. The proposed legislative text currently provides that any transactions completed on or before September 13, 2021, or subject to a binding written contract on or before September 13, 2021 (even if the transaction closes after September 13), are subject to the current 20 percent top capital gains tax rate. Any capital gains recognized after September 13, 2021, are proposed to be subject to the new top 25 percent rate. 
  • Temporarily allows certain S corporations to reorganize as partnerships without triggering tax. The eligible S corp would need to completely liquidate and transfer substantially all its assets and liabilities to a domestic partnership during the two-year period beginning on December 31, 2021.
  • Increase holding period to receive long-term capital gain treatment for carried interest from three to five years, effective December 31, 2021. The current three-year holding period rule would continue to apply for real property trades or businesses and taxpayers with adjusted gross income less than $400,000. Under the president’s proposal, the carried interest would be eliminated if a partner’s taxable income exceeds $400,000.
  • Amend §461(l) to permanently disallow excess business losses, i.e., net business deductions in excess of business income, for noncorporate taxpayers. The provision allows taxpayers whose losses are disallowed to carry those losses forward to the next succeeding taxable year. This provision was not included in the president’s proposals. These changes are proposed to apply retroactively to tax years beginning after December 31, 2020.
  • Limit the exclusion on qualified small business stock under §1202 for taxpayers with adjusted gross incomes of $400,000 or more, or any estate or trust. Under the proposed provision, the special 75 percent and 100 percent exclusion rates would not be available to these taxpayers; however, the baseline 50 percent exclusion would remain available to all taxpayers. This provision was not included in the president’s proposals. The amendments made by this section are proposed to apply to sales and exchanges after September 13, 2021, subject to a binding contract exception.
  • Cut the estate and gift tax lifetime exemption in half from the current inflation adjusted $10 million per person ($11.7 million in 2021) to an inflation adjusted $5 million. The proposed change would apply to estates of decedents dying and gifts made after December 31, 2021. This provision is not included under the president’s proposal, which instead seeks to reform the taxation of capital income by creating a realization event at death. 
  • Require grantor trusts to be included in a decedent’s taxable estate when the decedent is the deemed owner of the trusts. Currently, taxpayers can use grantor trusts to push assets out of their estate while controlling the trust closely. This provision was not included in the president’s proposals but would be effective only for future trusts and future transfers made after enactment of this provision. 
  • Impose new contribution limits and increase the minimum required distributions for high-income taxpayers when the total value of an individual’s IRA and defined contribution retirement accounts generally exceed $10 million as of the end of the prior taxable year. This provision was not included in the president’s proposals. The proposed effective date is December 31, 2021.
  • Eliminate the so-called “back-door” Roth IRA strategy for taxpayers with taxable income exceeding $400,000 ($450,000 for joint filers). Currently, taxpayers may make nondeductible contributions to a traditional IRA, and then convert the traditional IRA to a Roth IRA, regardless of income level. This provision would eliminate this opportunity for distributions, transfers, and contributions made in taxable years beginning after December 31, 2031. Furthermore, this provision would prohibit all employee after-tax contributions in qualified plans and prohibit after-tax IRA contributions from being converted to a Roth IRA regardless of income level for distributions, transfers, and contributions made after December 31, 2021.
  • Prohibit IRAs from holding securities that require accredited investor status, effective for tax years beginning after December 31, 2021, with a two-year transition period for IRAs already holding these investments.
  • IRAs that hold an interest in a domestic international sales corporation (DISC) or foreign sales corporation (FSC) that receive a commission or other payments from an entity owned by the beneficial owner of the IRA will be considered a prohibited transaction for purposes of the §4975 tax on prohibited transactions. This provision would apply to stock or other interests acquired or held by the IRA on or after December 31, 2021.
  • Deny charitable contribution deductions for contributions of conservation easements by partnerships and pass-through entities if the deduction amount exceeds 2.5 times the sum of each partner’s basis in the partnership that relates to the donated property. These arrangements often are referred to as syndicated conservation easements, which were previously identified by the IRS as listed transactions. This provision provides an exception for donations of property that meets the requirements of a three-year holding period rule, and for contributions by family partnerships. The effective date of this provision would be retroactive to contributions made after December 23, 2016.

The House Ways and Means Committee also proposes to expand IRS enforcement through an additional $78.9 billion over 10 years, treat cryptocurrency the same as other financial instruments with respect to the wash sale rules, and increase the excise tax on tobacco and nicotine.

There also appear to be a few significant omissions in the committee’s proposals. For example, there is no mention of a full or partial repeal of the current $10,000 cap on state and local tax deductions, which some House Democrats have identified as a “must have” to get their vote on the package. House Ways and Means Committee Chair Richard Neal issued a statement indicating they are continuing to work with colleagues in the House and Senate on “meaningful SALT relief.” In addition, there are a few key notable omissions from the committee’s proposal as compared to the proposals of the president, including:

  • Fifteen percent minimum tax on corporations with worldwide book income in excess of $2 billion
  • Limitation on like-kind exchanges
  • Carbon tax and carbon polluter import fee

The House Ways and Means Committee will hold markup sessions this week to vote on these proposed tax provisions. A majority vote in committee is required for the bill to advance to the House floor for a vote.

In the meantime, the Senate also has been working on its own proposed tax changes to include in the $3.5 trillion budget reconciliation package. Most of these changes have been released by Senate Finance Committee Chair Ron Wyden in a series of proposed legislative text. You can read a summary of the proposed bills here. Most recently, Sen. Wyden also released proposals to tighten partnership tax rules and impose a 2 percent excise tax on corporate stock buybacks.

The outlook of the proposals outlined by the House and Senate, as well as the overall package, is subject to change as congressional negotiations are in progress. House Democrats can only lose three votes to pass this bill along party lines in the House, and Senate Democrats need all 50 Senate Democrats to vote yes on the proposed package to pass the bill in the Senate. 

Sen. Joe Manchin recently called for a “strategic pause” on advancing the Democrats’ $3.5 trillion spending package due to concerns over rising inflation and a mounting national debt. Sen. Manchin continues to express his objection and proposes to decrease the size of the package to closer to $1.5 trillion. Other senators also continue to express their own objections to the proposals, saying they’ll only vote for the bill if certain provisions are included. For example, Sen. Mark Warner wants to include more for housing assistance to close the racial wealth gap and to only raise the corporate rate to 25 percent.

We are continuing to monitor this tax legislation, which we expect will continue to advance through Congress this fall. In the meantime, reach out to your BKD Trusted Advisor™ to discuss how the proposed changes could affect you or your business. 

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