On Monday, September 13, 2021, the House Ways and Committee released the initial version of the House Democrats’ tax legislation. The proposed legislation could result in more than $2 trillion in new federal revenue over the next 10 years, mainly from increased taxes on privately owned businesses, high-income individual taxpayers, and corporations. Of course, this legislation must ultimately be presented to the Senate, and additional changes are expected from the negotiation process. Highlights of some of the important provisions are below.
Individual Tax Proposals
Increase of the Top Marginal Individual Tax Rate
The legislative proposal increases the top individual tax rate from 37% to 39.6%. This increased marginal rate applies to joint filers with taxable income over $450,000, heads of households with taxable income over $425,000, and unmarried individuals with taxable income over $400,000.
Increase of the Top Capital Gains Rate
The legislative proposal retroactively increases the existing top rate on capital gains and qualified dividend income from 20% to 25%., The effective top rate would increase to 28.8% when including the separate 3.8% Net Investment Income Tax. This increased rate is to be effective retroactive to September 13, 2021 (excluding transactions that are subject to a binding contract in effect on or before this date).
Net Investment Income Tax (NIIT) on Flow-Through Business Income
An important proposal impacting flow-through business is the expansion of the 3.8% net investment income tax to cover net income derived in the ordinary course of a trade or business for taxpayers with more than $400,000 in taxable income (single) or $500,000 (joint) effective for years beginning after December 31, 2021.
Limitation on 20% “Flow-Through Deduction
The proposal reduces the Section 199A “flow-through deduction” by limiting the maximum allowable deduction to $500,000 for a joint return and $400,000 for an individual return, effectively creating another tax increase on flow-through income above $2,500,000.
High Income Surtax
The proposal includes an additional 3% surtax on individuals, trusts, and estates with modified adjusted gross income (joint filers above $5 million) for tax years beginning after December 31, 2021. A key question is whether this surtax would apply to capital gains. Clients considering large capital gain transactions (ex. selling a family business) should closely track this.
Qualified Small Business Stock Gain Exclusion
In general, Section 1202 allows taxpayers who invest in certain types of startup businesses to exclude up to $10 million of gain. The proposal limits this exclusion for taxpayers with an adjusted gross income of at least $400,000 to 50% of the gain realized.
Limitation on Excess Business Losses for Non-Corporate Taxpayers
The Tax Cuts and Jobs Act (“TCJA”) created a limitation on the ability of individual taxpayers to use business losses against non-business income. Current law provides that a taxpayer can offset up to $500,000 (as adjusted for inflation) of business losses against non-business income. This typically applies when a flow-through business owner has a loss from the business but net income from other sources. This rule was scheduled to expire after December 31, 2027. This week’s proposal removes the sunset provision, thereby permanently extending the partial disallowance of business losses to offset non-business income.
High Balance IRA Contributions
The proposal bars high-income individuals from contributing to their IRA once their retirement account balances reach $10 million. The proposal would also alter distribution requirements. These provisions would be effective tax years beginning after December 31, 2021.
Corporate Tax Rate Increase
The proposal increases the U.S. corporate tax rate from 21% to 26.5% for businesses with income above $5 million. A graduated rate applies to corporate income below $5 million. The benefit of the graduated rate phases out for corporations making more than $10 million. These tax rate changes would be effective for tax years beginning after December 31, 2021.
Expiration of Estate and Gift Tax Exemption
The proposal accelerates the expiration of the current estate and gift tax exemption from December 31, 2025, to December 31, 2021. The exemption would decrease to $5 million per individual, indexed for inflation.
The proposal limits deductions claimed by investors in “syndicated conservation easement” transactions, generally effective for contributions after December 23, 2016.
We expect there to be a flurry of activity around the tax changes this year. We will continue to monitor developments and communicate any significant changes that will impact our clients. Please reach out to your MST tax advisor if you have any questions.