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Higher Income Individuals Beware

Article Highlights:

The House Ways and Means Committee has released an extensive list of proposed tax changes that impact individual, retirement, international and corporate tax law. We have been selective and have only included a portion of the proposed changes. A full list of proposed changes is available from the PDF file titled Responsibility Funding Our Priorities.

As you read through the article, you will quickly realize that the provisions are aimed at higher-income taxpayers. The full list available from the link above includes numerous provisions not included in this article and are primarily related to corporate foreign transactions.

Increase in Corporate Tax Rate

This provision replaces the flat corporate income tax with a graduated rate structure. The rate structure provides for a rate of 18 percent on the first $400,000 of income, 21 percent on income up to $5 million, and a rate of 26.5% on income thereafter. The benefit of the graduated rate phases out for corporations making more than $10,000,000. Personal services corporations are not eligible for graduated rates. The domestic dividends received deduction is adjusted to hold constant the tax on domestic corporate-to-corporate dividends.

Increase in Top Marginal Individual Income Tax Rate

The provision increases the top marginal individual income tax rate to 39.6%. This marginal rate applies to married individuals filing jointly with taxable income over $450,000, to heads of households with taxable income over $425,000, to unmarried individuals with taxable income over $400,000, to married individuals filing separate returns with taxable income over $225,000, and to estates and trusts with taxable income over $12,500. The amendments made by this section apply to taxable years beginning after December 31, 2021

Increase in Capital Gains Rate for Certain High-Income Individuals

The provision increases the capital gains rate to 25%. The amendments made by this section apply to taxable years ending after the date of introduction of this Act. A transition rule provides that the preexisting statutory rate of 20% continues to apply to gains and losses for the portion of the taxable year prior to the date of introduction. Gains recognized later in the same taxable year that arise from transactions entered into before the date of introduction according to a written binding contract are treated as occurring before the date of introduction.

Deduction for Certain Employee Trade or Business Expenses

The provision allows up to $250 in dues to a labor organization to be claimed as an above-the-line deduction. The provision is effective for taxable years beginning after December 31, 2021.

Application of Net Investment Income Tax to Trade or Business Income

This provision expands the net investment income tax to cover net investment income derived in the ordinary course of a trade or business for taxpayers with greater than $400,000 in taxable income (single filer) or $500,000 (joint filer) as for trusts and estates. The provision clarifies that this tax is not assessed on wages on which FICA is already imposed. Effective for taxable years beginning after December 31, 2021.

Limitation Qualified Business Income Deduction

The provision amends IRC Sec 199A pass-through deduction by setting the maximum allowable deduction at $500,000 in the case of a joint return, $400,000 for an individual return, $250,000 for a married individual filing a separate return and $10,000 for a trust or estate. (Effective for taxable years beginning after December 31, 2021).

Limitations on Excess Business Losses of Noncorporate Taxpayers

This provision permanently disallows excess business losses (i.e., net business deductions more than business income) for non-corporate taxpayers. The provision allows taxpayers whose losses are disallowed to carry those losses forward to the next succeeding taxable year. Effective for taxable years beginning after December 31, 2021.

Surcharge on High-Income Individuals, Trusts, and Estates

This provision imposes a tax equal to 3% of a taxpayer’s modified adjusted gross income of more than $5,000,000 ($2,500,000 for married individuals filing separately). Effective for taxable years beginning after December 31, 2021.

Termination of Temporary Increase in Unified Credit

This provision terminates the temporary increase in the unified credit against estate and gift taxes, which for 2021 is $11,700,000, reverting the credit to its 2010 level of $5,000,000 per individual, indexed for inflation.

Estate Tax Valuation for Real Property Used in Farming

This provision would increase the special valuation reduction available for qualified real property used in a family farm or family business. This reduction allows decedents who own real property used in a farm or business to value the property for estate tax purposes based on its actual use rather than fair market value. This provision increases the allowable reduction from $750,000 to $11,700,000.

Certain Tax Rules Applicable to Grantor Trusts

This provision adds IRC Sec 2901, which pulls grantor trusts into a decedent’s taxable estate when the decedent is the deemed owner of the trusts. Before this provision, taxpayers were able to use grantor trusts to push assets out of their estate while closely controlling the trust.

The provision also adds a new section 1062, which treats sales between grantor trusts and their deemed owner as equivalent to sales between the owner and a third party. The amendments made by this section apply only to future trusts and future transfers.

Valuation Rules for Certain Transfers of Nonbusiness Assets

This provision clarifies that when a taxpayer transfers nonbusiness assets, those assets should not be afforded a valuation discount for transfer tax purposes. Exceptions are provided for assets used in hedging transactions or as working capital of a business. A look-through rule provides that when a passive asset consists of a 10-percent interest in some other entity, the rule is applied by treating the holder as holding its ratable share of the assets of that other entity directly. The amendments made by this section apply to transfers after the date of the enactment of this Act.

Contribution Limits for Individual Retirement Plans

Under current law, taxpayers may contribute to IRAs irrespective of how much they already have saved in such accounts. To avoid subsidizing retirement savings once account balances reach very high levels, the legislation creates new rules for taxpayers with large IRA and defined contribution retirement account balances.