On September 13, 2021, the House Ways and Means Committee released draft legislation that proposes a series of tax increases and tax cuts, which will undergo a round of markups by the committee over the next few days. Most tax proposals were anticipated; however, the House provided a few standouts. Here’s a summary of some of the proposals specifically impacting individuals and businesses.
The current maximum tax rate on capital gains is 20%. The proposed legislation would increase the capital gains rate to 25% for taxable years ending after September 13, 2021. Transitional rules are proposed for taxable years that include September 13, 2021, taxing net gains realized before September 13, 2021, at 20%. Gains arising from a transaction pursuant to a binding written contract in effect before September 13, 2021, (and not materially modified thereafter) would remain eligible for the 20% rate.
Top Marginal Individual Income Tax Rate
The top marginal individual income tax rate now is 37%. The draft legislation would raise the top marginal tax rate to 39.6% for taxable income over $450,000 for married individuals filing jointly and surviving spouses, $425,000 for head of households, $400,000 for single individuals, $225,000 for married individuals filing separately, and $12,500 for estates and trusts. The proposal would be effective for taxable years beginning after December 31, 2021.
Net Investment Income Tax
Under the current rules, net investment income does not include income derived in the ordinary course of a trade or business or income attributable to the disposition of property earned outside of a passive activity. The proposed legislation would eliminate those carveouts and others while broadening the type of income subject to net investment income tax (NIIT). NIIT applies to the greater of “specified net income” or net investment income for high-income individuals, estates, and trusts. “Specified net income” includes net investment income even if derived in the ordinary course of a trade or business and other gross income and net gains attributable to the disposition of property, even if earned outside of a passive activity or the trade or business of trading financial instruments or commodities. Certain foreign income is included in the definition of net investment income.
The proposed provision would apply to taxpayers whose modified adjusted gross income exceeds $500,000 for married individuals filing jointly and surviving spouses, $250,000 for married individuals filing separately, $12,500 for estates and trusts, and $400,000 for all other tax filers. The proposal would be effective for taxable years beginning after December 31, 2021.
Qualified Business Income
The qualified business income deduction currently is not limited by a maximum allowable deduction. The proposal would introduce such a cap, limiting the maximum allowable qualified business income deduction to $500,000 for married individuals filing jointly and surviving spouses, $400,000 for single taxpayers, $250,000 for married individuals filing separately, and $10,000 for estates and trusts. The proposal would be effective for taxable years beginning after December 31, 2021.
Surcharge on High-Income Individuals
There is currently no surcharge imposed on high-income individuals. The proposal would impose a 3% surcharge on modified adjusted gross income in excess of $2,500,000 for married individuals filing separately, $100,000 for estates and trusts, and $5,000,000 for all other individuals. The proposal would be effective for taxable years beginning after December 31, 2021.
Excess Business Loss Limitation
Under a temporary provision, excess business losses of non-corporate taxpayers in excess of $500,000 for joint filers ($250,000 for all other taxpayers) are disallowed and treated as net operating losses in the following year; however, the provision is set to expire on December 31, 2025. The proposal would make the temporary provision permanent and modify how a disallowed excess business loss (EBL) is treated. Instead of treating the disallowed loss as a net operating loss in the following year, the EBL would be treated as a deduction attributable to a taxpayer’s trades or businesses when computing the EBL in the subsequent year. The proposal would be effective for taxable years beginning after December 31, 2020.
Section 1202 – Qualified Small Business Stock
Taxpayers are currently eligible for 75% and 100% exclusions for sales of qualified small business stock (QSBS). In an unexpected move, the proposed legislation would eliminate the 75% and 100% exclusions for sales of QSBS acquired after February 17, 2009, and sold after September 13, 2021, unless the sale was made pursuant to a written binding contract already in place and not materially modified thereafter. The proposed provision would apply to taxpayers whose adjusted gross income equals or exceeds $400,000 and to trusts and estates.
Under the current 50% exclusion rules, the remaining 50% QSBS gain is taxed at 28%. The excluded QSBS gain is considered an alternative minimum tax (AMT) preference item, which, when considered along with the net investment income tax on the taxable half of the gain, results in an effective rate of 16.88% for QSBS acquired after September 27, 2010, and sold after September 13, 2021.
The holding period to obtain long-term capital gains treatment for gain allocated to carried interest partners is three years. The proposal would extend the holding period from three to five years. The three-year holding period would remain in effect with respect to any income attributable to real property trades or businesses and for taxpayers (other than an estate or trust) with an adjusted gross income of less than $400,000. The proposal also contains provisions to include all items that are treated as capital gain (for example, Section 1231 gain) and prevent avoidance of the holding period rules. The proposal would be effective for taxable years beginning after December 31, 2021.
Expansion of Wash Sale Provisions
Under the proposal, wash sale rules would now be applicable to foreign currency, commodities, and digital assets. The rules also would apply to acquisitions by certain related parties including the taxpayer’s spouse, dependents, taxpayers to whom the taxpayer is a dependent, entities controlled by the taxpayer or related party, 529 plans and Coverdell education savings accounts where a related party is the beneficiary, and certain 401(a), 403(a), 403(b), and 457(b) plans where the taxpayer or related party can make investment decisions. The proposal would be effective for taxable years beginning after December 31, 2021.
Graduated Corporate Tax Rate
The corporate flat tax rate of 21% would be replaced by a graduated rate under the proposal. Corporations would be taxed at 18% on their first $400,000 of taxable income, 21% on taxable income up to $5,000,000, and 26.5% on income over $5,000,000. The graduated rate would phase out for corporations with taxable income greater than $10,000,000. These changes are proposed to be effective on taxable years beginning after December 31, 2021.
Enhanced Work Opportunity Tax Credit (WOTC)
The Work Opportunity Tax Credit would be increased to 50% of the first $10,000 of wages for all WOTC targeted groups except for summer youth employees.
Delay of Effective Date of Research & Development Amortization Requirement
The effective date of the requirement to amortize research and development (R&D) expenses (vs. immediately deducting) would be delayed to taxable years beginning after December 31, 2025, under the proposal. Currently, the amortization requirement is scheduled to being in taxable years beginning after December 31, 2021.
President Biden had previously proposed the idea of limiting like-kind exchanges, but that has been omitted from the committee’s proposal. The proposed legislation also does not include a mention of a full or partial repeal of the $10,000 limit on the state and local tax deduction for individual taxpayers, nor does it include provisions to eliminate the step-up in basis upon death. It is unclear whether those provisions will be added to this proposed legislation or included in other legislation.
It’s important to note that these tax proposals have not yet been passed or finalized. As this situation continues to evolve, our teams at BerganKDV will monitor and keep you updated on any key information that may impact your tax planning. If you have any questions regarding you and your business’s tax planning strategy, BerganKDV can help. Contact us today and one of our experienced professionals will be happy to assist you.
There are also significant changes in the proposal affecting trusts and retirement plans – you can read more about these provisions here: