Ever since President Biden released his spending and tax proposals in April of this year, taxpayers have been waiting for Congress to act by beginning to propose legislation. On Monday, September 13, the Ways and Means Committee of the House of Representatives released its plan to pay for a $3.5 trillion spending package designed to expand social welfare programs. The proposal is the opening salvo in negotiations with the US Senate. Any final bill will have to be approved by both bodies and signed into law by the president. What follows is a brief summary of some of the important tax changes that will affect individual and corporate taxpayers.

Increase in Top Marginal Individual Tax Rate

The proposal increases the top marginal rate from 37% to 39.6%. The new rate applies to married individuals filing jointly with taxable income over $450,000; single individuals with taxable income over $400,000; and estates and trusts with taxable income over $12,500. The proposal has the new rate going into effect for taxable years beginning after December 31, 2021.

Increase in Capital Gains Rate

The House proposal increases the top capital gains tax rate from 20% to 25%. The new rate goes into effect as of September 13, 2021. There is an exception for individuals that entered into a capital gain transaction before this date with a written contract that is binding and closes in 2021 but after 9/13/2021.

Estate Planning:

The proposal makes a significant change to the grantor trust rules including them in estates for tax purposes.  This has a major impact on taxpayers who use these trusts to avoid estate taxes.  Common trusts affected are GRATs, SLATs and ILITs.  Taxpayers who are considering these strategies should consult their estate attorney quickly since this provision goes into effect when the president signs the bill.

Expansion of the Net Investment Income Tax

The proposal expands the definition of investment income to include income derived in the ordinary course of a trade or business for single taxpayers with income greater than $400,000 and joint fliers over $500,000. This also affects estates and trusts and goes into effect for tax years after December 31, 2021.

Surcharge on High Income Individuals

Applies a 3% tax on a taxpayer’s MAGI in excess of $5,000,000 or $2,500,000 for single filers. This also affects trusts with income in excess of $100,000.  This can be consequential for trusts that are beneficiaries of IRAs.  Capital gains can make this tax apply.

Reduces the Estate Exemption

Currently the exemption for estate (death) taxes is $11,500,000 per individual. The proposal reduces the exemption to its 2010 level of $5,850,000 indexed for inflation.

Changes to Retirement Plan Rules

For individuals with IRA, Roth IRA and defined contribution plans (401K) balances in excess of $10 million, the proposal imposes limitations on contributions and increased required minimum distributions.

 

Elimination of the “back door” Roth IRA strategy

The proposal eliminates Roth conversions for both IRAs and employer sponsored plans for single filers with income over $400,000 and joint filers with income over $450,000. This section also prohibits any after tax IRA contributions from being converted to a Roth regardless of income level. It also bans any after tax contributions in qualified plans. The provision goes into effect for tax years beginning after December 31, 2021.

Increase in Corporate Tax Rate

President Trump’s 2017 tax bill reduced the corporate tax rate to a flat 21%. The House’s proposal replaces the flat tax with a graduated rate structure: 18% on the first $400,000 of  income; 21% up to $5 million; 26.5% on any income above $5 million. 

Limitation on Exclusion of Gain from Qualified Small Business Stock

Currently section 1202(a) provides special 75% and 100% exclusion rates for gains from certain qualified small business stock. The proposal eliminates the exclusion for taxpayers with AGI equal or exceeding $400,000.

Wash Sale Rules

Includes commodities, currencies, and digital assets in the wash sale rule, a rule previously only applicable to stocks and other securities.

 

While some of these proposals are scaled back from the president’s original priorities like the capital gains rates, other proposals, the elimination of the “back door” Roth strategy and changes to grantor trusts can have a serious impact on individuals retirement/estate planning.   With a razor thin majority in the Senate, the proposal kicks off what is likely to be contentious negotiations to arrive at a final bill.

1. https://www.wsj.com/articles/democrats-release-details-of-tax-increase-11631539532
2. House Committee on Ways and means Subtitle I-Responsibly Funding Our Priorities, Section by Section