On September 13, 2021, the first draft of new tax legislation was released to the public by House Ways and Committee Chairman Richard Neal. Penned by House Democrats in an effort to aid the budget reconciliation process and contribute to President Biden’s “Build Back Better” program, the draft includes updated tax requirements for high-net-worth individuals and corporations. Proponents of the legislation, as well as initial estimates by the Joint Committee of Taxation (JCT), suggest it has the potential to result in over $2 trillion in additional federal revenue over the next 10 years.
Although the current draft proposes a number of significant changes to tax requirements in the U.S., it is crucial to note that the legislation is still firmly in its infancy and remains subject to ongoing negotiations. And while the initial proposals won’t need Republican support to pass in conjunction with the budget reconciliation process, they will require the approval of moderate Democrats in the House and Senate, many of whom are expected to take issue at certain turns and suggest critical amendments before the bill can ultimately pass. More specifically, the rates at which individual and corporate taxes would be increased under the current proposal, in addition to the amount of funds allocated for spending as a part of relief efforts, will likely be reduced as the process moves forward and the bill matures.
With the above considerations in mind, here are a few key features of the legislation as it currently stands:
Corporate and Individual Tax Rates – The current bill would increase the Top Marginal Individual Tax Rate from 37% to 39.6% and would apply to unmarried individuals earning over $400,000, as well as to that of married individuals earning over $450,000 jointly. The U.S. corporate tax rate would also increase under the initial proposal, from 21% to 26.5% for companies reporting annual income exceeding $5 million. Changes to both corporate and individual tax rates would become effective and apply to tax years beginning after December 31, 2021.
Taxes on Capital Gains – The draft bill raises the top tax rate on capital gains and qualified dividend income from 20% to 25%. This change has been designed to impact sales occurring after the date of the bill’s introduction on September 13, 2021. Under the current draft, the increase will not impact gains recognized before the introduction date, or anticipated gains pursuant to binding contracts entered into prior to the introduction of the legislation.
Expansion of Net Investment Income – The proposed bill also expands the taxability of net investment income to include gains and income received from businesses where an individual material participates. Currently, individuals can exclude this income from the net investment income tax. If passed, this will impact unmarried individuals with income over $400,000 and joint filers with over $500,000. This change would become effective for tax years beginning after December 31, 2021.
3% Surtax on Gross Income Over $5M – Individuals, trusts and estates will see an additional 3% surtax on adjusted gross income exceeding $5 million effective after December 31, 2021. The surtax would also apply to adjusted gross income exceeding $2.5 million for married individuals filing separately, as well as income exceeding $100,000 related to an estate or trust.
Reversion of Estate and Gift Tax Exemption Limits – While the current rule allows for exemptions on gift and estate taxes up to $11.7 million per individual ($23.4 million per married couple), the proposed bill attempts to end the rule four years ahead of its original expiration date of December 31, 2025, and revert back to the 2010 level of around $6 million per individual (after indexed for inflation) effective January 1, 2022.
Carried Interest Holding Period – The draft bill states that, in general, profits interest (or carried interest) owners will be subject to a five-year holding period in order to qualify for long-term capital gain tax rates (currently there is a three-year holding period requirement). There is a three-year holding period carve out for certain real estate businesses. The proposal also specifies that Section 1231 gains (gains associated with the sale of business property) will be subject to the longer holding period requirements. Current law has a carve out that excludes certain Section 1231 gains from the longer holding period.
Section 1202 Qualified Small Business Stock – The proposal reduces the Section 1202 gain exclusion from 100% to 50%. The taxable (non-excluded) portion of the gain will be subject to tax at a 28% tax rate as opposed to the proposed 25% capital gain tax rate. Similar to the capital gain tax rate change, this is effective for most sales occurring after September 13, 2021.
Changes to Grantor Trust Taxation – The draft bill creates significant changes to the use of grantor trusts. The provisions include any appreciation on a gift made to a grantor trust would be included in the grantor’s estate (with a credit adjustment for the gift tax exemption used at the date of gift). Gift tax would be incurred on most distributions from a grantor trust to a trust beneficiary and sales of certain assets to a grantor trust could create federal income tax as if it was sold to a third party. All of these changes would be effective as of the date of the bill’s enactment and would apply to grantor trusts created on or after that date or contributions to existing grantor trusts made on or after that date.
The above provides only a brief glimpse into the over 500-page proposal, a more detailed summary of which has been provided by the House Ways and Means Committee and can be reviewed here. Again, all of the proposed changes are representative of legislation that is still in its fairly early stages, and what the final bill looks like will ultimately be the result of ongoing negotiations between moderate House and Senate Democrats and the bill’s original authors. As talks continue and modifications are introduced, we will keep an eye on the situation and provide critical updates as the legislation matures.
If you have questions, contact your tax advisor or fill out our contact us form for further discussion.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.