OFFICIAL PUBLICATION OF THE NEBRASKA SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS

Pub. 3 2021 Issue 5

Tax-Increases-proposed

Counselor’s Corner: Tax Increases Proposed for High-Income Individuals & Businesses

Nebraska Society of Certified Public Accountants
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On Sept. 13, 2021, the House Ways and Means Committee released proposed legislation that includes several proposed tax increases focused on high-income individuals and corporations. The proposed tax changes are to be incorporated in the budget reconciliation bill known as the “Build Back Better Act.” It would increase the top capital gains rate from 20% to 25%, raise the top individual marginal tax rate from 37% to 39.6%, and impose a 3% surtax on individuals’ income above $5 million. Any final piece of legislation will have to be enacted into law. This article, which is current as of Sept. 15, 2021, summarizes some of the major tax provisions included in the proposed legislation.

Individuals

 
  • Increase the Top Federal Marginal Rate from 37% to 39.6%.
    The proposed top federal marginal rate of 39.6% would apply to married individuals filing jointly with taxable income over $450,000; to heads of household with taxable income over $425,000; to unmarried individuals with taxable income over $400,000; to married individuals filing separate returns with taxable income over $225,000; and to estates and trusts with taxable income over $12,500. The proposed effective date is for taxable years beginning after Dec. 31, 2021.
  • Increase the Top Federal Long-Term Capital Gains Rate from 20% to 25%
    Historically, proceeds from the sale of capital assets held for over one year have been taxed at favorable long-term capital gains rates. The top federal long-term capital gains rate (which under current law does not apply to anyone earning less than $400,000) would be increased from 20% to 25%. The proposed effective date for the 25% long-term capital gain rate is Sept. 13, 2021. Under a proposed transition rule, federal long-term capital gains recognized later in the same tax year that arise from transactions entered into before the date of introduction pursuant to a written binding contract would be treated as occurring prior to Sept. 13, 2021.
  • Lengthened Holding Period for Carried Interests
    Private equity, real estate, and venture capital fund managers often structure their performance-based compensation as a tax-favored “carried interest.” The holding period to receive long-term capital gain treatment for carried interest would be increased from three to five years, effective Dec. 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.
  • Expansion of the Net Investment Income Tax
    The net investment income tax (NIIT) would apply to net investment income derived in the ordinary course of a trade or business for taxpayers with greater than $400,000 in taxable income (single filers) or $500,000 (joint filers), as well as for trusts and estates. This change would essentially subject all earnings from pass-through businesses to the 3.8% NIIT or 3.8% self-employment tax, regardless of whether the income is from passive or active activity. The proposed effective date for this change is for tax years beginning after Dec. 31, 2021.
  • Limitation of the Qualified Business Income Deduction
    The qualified business income (QBI) deduction generally allows eligible self-employed and pass-through business owners to deduct up to 20% of their QBI. The maximum allowable QBI deduction under Section 199A would be limited to $500,000 for joint returns, $400,000 for individual returns, $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 Dec. 31, 2021.
  • Limitation of the Small Business Stock Exclusion
    The special 75% and 100% exclusion rates under Section 1202 would not be available to taxpayers with adjusted gross incomes of $400,000 or more, or any estate or trust. The baseline 50% exclusion would remain available to all taxpayers. The amendments made by this section are proposed to apply to sales and exchanges after Sept. 13, 2021, subject to a binding contract exception.
  • Limitation on Excess Business Losses
    Section 461(l) would be amended to permanently disallow excess business losses (i.e., net business deductions in excess of business income) for noncorporate taxpayers. The proposed effective date would apply retroactively to tax years beginning after Dec. 31, 2020.
  • Surtax on High-Income Individuals, Trusts, and Estates
    A surtax equal to 3% of a taxpayer’s modified adjusted gross income in excess of $5 million (or in excess of $2.5 million for a married individual filing separately) would be imposed. For an estate or trust, the surtax would equal 3% of adjusted gross income in excess of $100,000. The proposed effective date is for taxable years beginning after Dec. 31, 2021.
  • Changes to the Treatment of Grantor Trusts
    Grantor trusts, a common estate planning vehicle used to push assets out of an estate while still being able to control the assets, would be included in a decedent’s taxable estate when the decedent is the deemed owner of the trusts. In addition, instead of being disregarded and non-taxable, a sale between a grantor retained trust and its deemed owner would be treated as a taxable sale. This would apply to new trusts created after Sept. 13, 2021, and any new contributions to existing trusts after Sept. 13, 2021.
  • Increase the Required Minimum Distributions from Retirement Accounts
    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 would be increased. The proposed effective date is Dec. 31, 2021.
  • Modifications to Estate Tax Valuation Rules
    The valuation rules would ignore discounts from partial ownership or lack of control of an asset in determining its value. This rule would apply to passive assets, but not active businesses, like a family-owned and operated business. The valuation rules would apply to transfers made after the date of the enactment.
  • Decrease the Estate and Gift Tax Lifetime Exemption
    The estate and gift tax lifetime exemption would be cut 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 Dec. 31, 2021.

 Corporations

  • Increase the Top Federal Corporate Tax Rate from 21% to 26.5%
    The following graduated corporate rate schedule with a top rate of 26.5% would be imposed.
    • $0 to $399,999 – 18%
    • $400,000 to $5 million – 21%
    • More than $5 million – 26.5%

Corporations that are taxed as personal service corporations are not eligible for the graduated rates and instead are subject to a flat 26.5% rate. These tax increases are proposed to be effective for taxable years beginning after Dec. 31, 2021.

  • S Corporation Reorganization
    Certain S corporations would be allowed to reorganize as partnerships without triggering taxable income. The eligible S corporation would need to completely liquidate and transfer substantially all its assets and liabilities to a domestic partnership during the two-year period beginning on Dec. 31, 2021.
Jeff-Schaffart
Nicholas-Bjornson

For more information, contact Jeff Schaffart or Nicholas Bjornson at Koley Jessen at jeff.schaffart@koleyjessen.com or nicholas.bjornson@koleyjessen.com, respectively. Schaffart solves complex tax and legal issues by providing timely, pragmatic advice to private equity sponsors, general counsel, management teams, and business owners. Bjornson’s practice focuses on federal, state, and international taxation of corporations, partnerships, and individuals.

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