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Tax Proposals Update: How May They Affect You and Your Business?

September 24, 2021

KSM

On Sept. 15, 2021, the U.S. House Ways and Means Committee approved a $3.5 trillion spending package that includes numerous tax provisions. The Committee’s approval of the proposed spending package is the latest development in potential tax law changes which have been top of mind for many taxpayers and advisors since the Biden administration released the General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals (Green Book) in May 2021.

The Committee’s approval of the proposed legislation is an important milestone. However, it is just the most recent step in a long process whereby the tax provisions within the legislation will continue to be modified as the process progresses. It is difficult to predict at this time the extent to which these tax proposals will become law, but the Committee’s proposal is worthy of consideration as taxpayers and their advisors begin to consider year-end planning.

Key Highlights and Takeaways

  • Increasing the corporate tax rate by replacing the flat 21% corporate income tax with a graduated rate structure; 18% tax on first $400,000 of income, 21% on income up to $5 million, and a rate of 26.5% on income in excess of $5 million. The graduated structure would phase out for corporations making more than $10 million and this proposal would become effective for tax years ending after Dec. 31, 2021.
    • The Biden administration’s proposal called for a flat 28% corporate tax rate.
  • Increase the long-term capital gains rate from 20% to 25%. This change would apply to taxable years ending after the date this proposal was introduced; however, a transition rule applies to gains and losses recognized in the portion of such taxable year prior to the date of introduction. Additionally, gains recognized after the introduction date will be subject to the lower 20% rate if the transaction is pursuant to a written binding contract that was entered into prior to the introduction date.
    • Planning Point: Consider the timing of capital gain transactions but proceed with caution whenever accelerating the recognition of income.
    • The Biden administration’s proposal called for capital gains to be taxed at ordinary rates to the extent a taxpayer’s income exceeded $1 million.
  • An increase in the top individual tax rate from 37% to 39.6% for tax years ending after Dec. 31, 2021.
  • Expansion of the net investment income tax (NIIT) to cover net investment income from non-passive activities for taxpayers with greater than $400,000 (single) or $500,000 (joint), as well as for trusts and estates. Thus, all earnings from pass-through businesses would be subject to either the 3.8% self-employment Medicare tax or the 3.8% NIIT for taxpayers over the taxable income thresholds. This proposal would be effective for tax years ending after Dec. 31, 2021.
  • An additional 3% tax will be imposed on a taxpayer’s modified adjusted gross income in excess of $5,000,000 (or in excess of $2,500,000 for married filing separate returns). This will apply to tax years beginning after Dec. 31, 2021.
  • Limit the qualified business income deduction under Section 199A (QBI deduction) to $500,000 for joint returns, $400,000 for single taxpayers, $250,000 for married filing single, and $10,000 for trusts and estates. This proposal would be effective for tax years ending after Dec. 31, 2021.
  • The proposal contains three significant changes that would impact estate planning:
    • Eliminate the increased estate and gift tax exemption that was enacted as part of the Tax Cuts and Jobs Act (TCJA). This would reduce the existing exemption of $11.7 million to $5 million adjusted for inflation effective as of Jan. 1, 2022.
      • Planning Point: Taxpayers that can utilize the higher exemption should consider doing so prior to year-end.
    • Proposed changes would create closer harmony between income tax rules and estate and gift tax rules related to grantor trusts making it harder to shield appreciation of trust property from estate tax. The new provision will pull grantor trusts into the grantor’s taxable estate and will require gain recognition on sales between grantor trusts and their grantor. This provision will apply only to future trusts and future transfers.
    • Current law allows securities to be valued at fair market value (FMV) which includes consideration for a lack of marketability and/or a lack of control. The proposal would eliminate these valuation discounts when taxpayers transfer nonbusiness assets. This provision will apply to transfers after the date of enactment.
      • Planning Point: Taxpayers with family limited partnerships or other structures designed to take advantage of valuation discounts should consider making additional gifts of such structures as soon as possible.
  • The proposed legislation also includes many changes that could affect those whose organization structures include foreign entities. Potential changes may impact: 163(j), Global Intangible Low-Tax Income (GILTI), Foreign-Derived Intangible Income (FDII) deduction, and more.

What’s Next?

Democrats are attempting to pass the legislation through budget reconciliation rather than the traditional law-making process. Reconciliation requires a simple majority vote in the Senate rather than the 60 votes normally required. The next step in the reconciliation process is for the House Budget Committee to combine the proposed legislation with various other proposals approved by other committees into a single bill. The bill is then taken to the House where additional amendments can be proposed and voted on. The House has a stated goal of Sept. 27 for a vote on this legislation.

Once the bill is approved by the House, it will go to the Senate where it will follow a similar process. Because the Senate has an amendment process like the House, the bill passed by the Senate will likely be different than the bill passed by the House. The House and the Senate will have to work together to agree on identical legislative text. The bill will not go to President Biden for signature until an identical bill has passed both the House and Senate.

While taxpayers should consider the current proposals and potential impacts, it is important to understand the details of these tax provisions are likely to change, potentially significantly, from now until signed into law (assuming a bill does get signed into law). Over the coming weeks and months, there are many key issues that still need to be worked out.

A primary challenge will be the balance of various political interests and opinions within the Democrat party. Moderate and conservative Democrats may not support the $3.5 trillion bill. For example, Senator Joe Manchin of West Virginia has publicly stated that he will not support any bill with a cost of more than $1.5 trillion. Meanwhile, more progressive Democrats in the House consider the current proposal to be a compromise. Additionally, the White House has publicly noted that the current proposal is more modest than its proposal and has supported even more significant changes.

In addition to the “big picture” discussions and balancing of political interests, there are numerous key issues that are receiving significant attention. For example, many Democrats are unsatisfied with a bill that would not adjust or repeal the state and local tax (SALT) deduction cap. The SALT deduction was capped at $10,000 as a part of the TCJA. This cap had a disproportionate impact on Democratic states.

We’re Here To Help

Over the coming weeks the push and pull of these various forces will shape the tax legislation. As we learned with the TCJA, these changes can be significant, and the ultimate bill could look substantially different. We will continue to monitor this draft legislation and others as they work their way through the system in the next few months. Please reach out to your KSM advisor with questions on how these changes may impact your tax situation or complete this form.

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