The House Ways and Means Committee released an 18 page summary of the tax reform portion of the hundreds-of-pages-long proposal unveiled over the weekend. After months of speculation on what it would contain, the proposal includes both expected provisions and a few surprises. We’ve made an effort to condense those 18 pages into a brief summary that focuses on those proposed items that may directly impact many of our clients.
As we all well know, horse-trading will continue up on the Hill. While this first version sheds more light on what’s on the table (and what has been left off…or kept in a pocket and saved for later), the final Act will inevitably look different. Our takeaways: be mindful of tax implications (but don’t let the tax tail wag the dog), continue to implement strategies that make sense over the long-term, and keep our eyes lifted to see what eventually comes down the pike. To our friends in the financial, tax, and legal professions, we send both our sympathies and encouragement.
Effective after September 13, 2021
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- The top long-term capital gains rate would be increased to 25% from 20%, effective this year at a taxable income of $445k (Single (“S”))/$501k (Married Filing Jointly (“MFJ”)).
- For binding contracts entered into on or before Sept. 13, 2021, any resulting capital gain recognized from the agreed-upon transaction will be considered as realized on or before Sept. 13th, assuming no material modifications were made to the contract after Sept. 13th. Other requirements may apply.
- The top long-term capital gains rate would be increased to 25% from 20%, effective this year at a taxable income of $445k (Single (“S”))/$501k (Married Filing Jointly (“MFJ”)).
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Effective on January 1, 2022
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- Top ordinary income tax rate goes back up to 39.6% from 37%. This rate applies to a lower taxable income threshold of $400k (S)/$450k (MFJ), where 37% starts at $523k (S)/$628k (MFJ) today. This top rate will apply to trusts and estates with taxable income over $12,500.
- The new capital gains rate of 25% would be aligned with the 39.6% ordinary income tax rate starting in 2022.
- Net Investment Income Tax (3.8% surtax) would now also cover pass-through income derived in the ordinary course of trade or business (other than wages on which FICA tax is already imposed) for households with taxable income of >$400k (S)/$500k (MFJ).
- Qualified Business Income max deductions would be limited to income of $400k (S)/$500k (MFJ).
- A new 3% tax would be levied for taxpayers with modified adjusted gross income (“MAGI”) of greater than $5M (MFJ). The tax is applied to income above that threshold.
- MAGI is defined as adjusted gross income reduced by any investment interest expense deduction.
- Roth or Traditional IRA contributions would be prohibited if the total value of an individual’s IRA + defined contribution accounts (401ks, etc.) are generally > $10M as of the end of the previous year, only applying to individuals with taxable income of $400k+ (S)/$450k+ (MFJ) in that year.
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- If combined account balances >$10M, a minimum distribution is required the following year IF taxpayer’s income is as described above. The minimum distribution is described as “50% of the amount by which their prior year’s aggregate…balances exceed the $10M limit.”
- If combined account balances >$20M, an additional minimum distribution is required and must come out of Roth buckets in the lesser of the amount over $20M or the aggregate balance of all Roth buckets. Then determine the amounts required under the 50% rule.
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- All employee after-tax contributions into qualified plans would be prohibited.
- Roth conversions of after-tax IRA contributions would be disallowed regardless of income. (Note: with the exception of the income-based rule effective in 2032 – see below – this does not indicate that conversions of pre-tax dollars would be disallowed, only conversion of dollars that would otherwise not be taxed in the conversion.)
- IRAs would be prohibited from holding a security if the issuer of the security requires the IRA owner to have a certain minimum level of assets or income, education, or credential (for example, accredited investor or qualified purchaser requirements).
- IRAs holding such investments would lose their IRA status after a 2-year transition period for IRAs already holding these investments.
- The current $11.7M unified credit (for estate/gift/generation-skipping tax) will revert back to the 2010 level of $5M (adjusted for inflation, bringing it to ~$6M).
- The special estate value reduction available for qualified real property used in a family farm or business would increase from $750k to $11.7M.
- Commodities, currencies, and digital assets would be subject to the wash sale rules.
- Flat corporate tax would be changed to a graduated rate structure based on income, with the top rate being increased to 26.5%:
- <$400k – 18%
- $400k-$5M – 21%
- $5M+ – 26.5%
- If income is $10M+ OR if the business is a Personal Services Corporation, no graduated rates apply (fully taxed at a flat 26.5%)
- Top ordinary income tax rate goes back up to 39.6% from 37%. This rate applies to a lower taxable income threshold of $400k (S)/$450k (MFJ), where 37% starts at $523k (S)/$628k (MFJ) today. This top rate will apply to trusts and estates with taxable income over $12,500.
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Effective January 1, 2032
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- Roth conversions for IRAs & employer plans would be eliminated for taxpayers with taxable income of more than $400k(S)/$450k(MFJ), applying to distributions, transfer, and contributions made after 12/31/2031.
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Timing Unclear (“Date of Enactment” to be determined)
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- Any transfer of non-business assets by a taxpayer should not be afforded a valuation discount for transfer tax purposes (with few exceptions). This includes a look-through rule providing that, for a passive asset that consists of 10%+ interest in another entity, the holder is treated as holding that share of the underlying entity directly.
- Grantor trusts that are “closely controlled” by the grantor would be pulled back into a decedent’s taxable estate. Transactions between grantor trusts and their owner would be deemed equivalent to “owner and third party” transactions. This applies to “trusts created on or after the date of enactment of this Act”, and “to any portion of a trust established before the date of the enactment of this Act which is attributable to a contribution made on or after such date.”
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Retroactive
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- The charitable deduction for contributions of conservation easements by passthrough entities would be denied if the contribution exceeds 2.5x the sum of each partner’s adjusted basis in the partnership relating to the entity. Certain exclusions & rules apply. Retroactive “as of” dates depend on certain criteria.
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Honorable Un-Mentioned
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- No change to the cost basis step-up at death rules
- No change to the State & Local Income Tax (“SALT”) deduction cap of $10,000 per year
- No change to the estate/gift/generation-skipping tax rate of 40%
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