09/28/2021
Prospective Legislative UPDATE: President Biden’s Build Back Better Act Implications and Considerations
Select Key Updates on Proposed Legislation
On September 13, the House Ways and Means Committee, the chief tax-writing committee in the House of Representatives, advanced legislation containing part of the budget bill for President Biden’s Build Back Better agenda. The draft legislation, which could be subject to further modifications, calls for changes to US estate and gift tax, an increase in income taxes for businesses and households over certain income thresholds, and a stop to popular tax planning techniques. Some of the proposed changes include the following:
Tax Changes Affecting an Individual’s Income Taxes Tax Changes Affecting Businesses and their Owners Tax Changes Affecting Transfer Taxes, Trusts and Estates
Increase of the top tax bracket for ordinary income from 37% to 39.6% applicable to single (S) taxpayers with $400,000 of taxable income, $450,000 for Married Filing Jointly (MFJ) taxpayers (compared to $628,300 under current law). Return to progressive corporate income tax framework with increase in graduated corporate taxes to 26.5% (currently at 21%) applying to corporate income above $5 million. Reduce the Estate and Gift Tax Exemption from $11,700,000 per person to $5,000,000 (indexed for inflation) commencing in 2022 (accelerating the “Sunset” by 4 years).
Increase the top tax rate on long-term capital gains and qualified dividends to 25% and lower the income threshold for the 25% bracket (28.8% with the 3.8% net investment income tax). Limit of the maximum allowable Section 199A passthrough deduction to $500,000 for MFJ taxpayers / $400,000 for S taxpayers. Grantor trusts will be included in the taxable estate of the trust creator at his/her death.
Apply a 3% surcharge on modified adjusted gross income over $5 million ($2,500,000 for Married Filing Separately (MFS) taxpayers). Exclude taxpayers with AGI over $400,000 from the 75% and 100% Qualified Small Business Stock exclusion rates. The baseline 50% exclusion in Sec. 1202(a)(1) would remain available for all taxpayers. Distributions from grantor trusts will be deemed gifts.
Prohibit contributions to a Roth or a Traditional IRA once a total retirement account balance exceeds $10 million for those S taxpayers with more than $400,000 of taxable income, $425,000 for head of households (HOH), and $450,000 for MFJ. Temporarily enable certain S corporations to reorganize as a partnership without triggering tax. Changing a grantor trust to a non-grantor trust will be considered a gift of the entire trust. Applicable to future trusts and future transfers to prior trusts from the date of the Act’s enactment. Any new contributions follow the new rules.
Mandate new required minimum distributions for individuals whose combined IRA and 401(k) retirement accounts exceed $10 million at year’s end. Mandatory withdrawal in an amount of at least 50% of the excess the following year. Withdrawal from Roth IRAs and 401(k)s first for those with accounts over $20 million. Extend the holding period for carried interest from 3 to 5 years. Sales between grantors and grantor trusts will be treated as if between third parties, meaning that installment sales to grantor trusts will no longer be a viable strategy.
Eliminate Roth conversations for IRAs and employer-sponsored plans for taxpayers with $400,000 (S) of taxable income or $450,000 (MFJ) or $425,000 (HOH) as of 12/31/2031. Eliminate Backdoor Roth IRA and Mega Backdoor Roth IRA strategies and after-tax contributions to employer plans. Expand the base of the 3.8% Net Investment Income Tax (NIIT) to apply to active business income for passthrough businesses (elimination of the “Gingrich-Edwards Tax Loophole”) for taxpayers with greater than $400,000 for S or $500,000 for MFJ. Eliminate valuation discounts for transfers of “non-business” assets. Thus, passive assets held to produce income and not used in the active conduct of a trade or business.
Extend the American Rescue Plan Act (ARPA) Child Tax Credit expansion through 2025, the entire credit will be refundable on a permanent basis. Make permanent the active pass-through loss limitations enacted under the 2017 Tax Cuts and Jobs Act (TCJA). Limit of the maximum allowable Section 199A passthrough deduction to $10,000 for a trust or estate.
Make permanent the expansion of Earned Income Tax Credit under ARPA. Increase of the top tax bracket for ordinary income from 37% to 39.6% applicable to trusts with over $12,500 of taxable income.
Make permanent the Child and Dependent Care Tax Credit modifications under ARPA.
Additional Notes:
• Top ordinary income tax rate would be 46.4% (39.6% + 3.8% NIIT + 3% surtax).
• Top capital gains rate would be 31.8% (25% statutory rate + 3.8 % NIIT + 3 % surtax).
• Additional funding to the IRS to expand enforcement and treatment of cryptocurrency as other financial instruments with respect to the wash sale rules.
• The Senate’s own proposed tax changes propose to tighten partnership tax rules and impose a 2% excise tax on corporate stock buybacks.
Notably absent from the package was...
• Any limitations on like-kind exchanges.
• No repeal of basis step-up at death and no forced realization event at death.
• No alteration to the $10,000 cap on the deductibility of state and local income taxes. However, some Democrats have pledged that they will advocate for such tax relief in the final bill.
• No mention of Dynasty trusts. However, the Sensible Taxation and Equity Promotion (STEP) Act, which mirrors the Biden Green book (which provides general explanation of the administration’s fiscal year 2022 revenue proposals), would discourage long-term trust planning by taxing every 21 years unrealized gains of assets held in trust. The Green book proposal, on the other hand, would limit such taxation to every 90 years, although the testing period would begin January 1, 1940 (triggering realization in existing trusts by Dec. 31, 2030, at the earliest). Additionally, the 90-year recognition period would apply to partnerships and other “non-corporate” entities. It is possible that elements of both proposals find their way into final legislation.
What planning can be done now?
It is not yet clear what will make it to the final law. However, wealthy persons wanting to engage in planning may consider taking the following actions now should the proposed changes become law (which could be mere weeks from now):
• Make gifting and utilizing the heightened exemption to complete estate planning objectives a top priority.
• Fund grantor trusts to the extent a grantor trust is appropriate to achieve an existing estate planning need.
• Complete gifts of nonbusiness assets held in limited liability companies (LLCs), partnerships and other private entities to take advantage of valuation discounts which may no longer be available to non-active entities.
• Accelerate any ordinary income (including Roth conversions) with flexible timing into 2021, and pair the timing of it with any deductions, specifically any charitable contributions that would have been made in future years.
