The House Ways and Means Committee released initial legislative language containing changes to many areas of tax law on Monday, September 13th. The resolution is over 800 pages and is intended to cover the American Families Plan, which President Biden revealed last April. Negotiations within the Democratic party will almost certainly lead to changes in any potential final bill.
Let’s break down some of the highlights in terms of the good and the bad.
The Good (Relatively Speaking)
- The bill extends, enhances, and/or increases the Child Tax Credit, Child & Dependent Care Credit, and Credit for Caregiver Expenses.
- It could have been worse?
- Tax rate increases from 21% to 26.5%.
- There are various changes to international tax rules and the deductibility of interest expense.
- Business profits from S-corporations would be subject to a 3.8% surtax for taxpayers with Modified AGI greater than $500K ($400K for single filers).
- The Section 199A (20% deduction) deduction would be limited to a maximum deduction of $500K ($400K for single filers).
- The marriage penalty comes back for those in the highest tax brackets.
- Many of the current brackets and rates remain the same; however, the 35% tax bracket now stops at $450K (used to be $628K).
- The top tax rate increases from 37% to 39.6%.
- The top capital gains tax rate increases from 20% to 25% on income above $450K ($400K for single filers). The effective date for this provision is 9/13/2021.
- A 3% surtax would be assessed on all Modified AGI above $5M.
- The bill would eliminate the special 75% and 100% exclusion rates for capital gains realized from the sale of certain, qualified small business (C corporation) stock for taxpayers with AGI greater than $400K. The 50% exclusion would still apply.
IRA and Roth IRA Planning:
- Roth IRA conversions for taxpayers in the highest ordinary income tax bracket would be prohibited starting 1/1/2032.
- Roth IRA conversions of after-tax funds in qualified retirement accounts would be prohibited for all taxpayers starting 1/1/2022. This effectively eliminates the ability to do backdoor Roth IRA contributions after 2021.
- The bill prohibits traditional IRA and Roth IRA contributions if taxable income exceeds $450K AND the total value of qualified retirement accounts is greater than $10M. This limitation does not apply to contributions to employer plans.
- The bill imposes significant RMDs on large retirement account balances if taxable income is greater than $450K AND the combined value of all qualified retirement plans is greater than $10M.
- The bill generally prohibits new investments into private market investments. It appears existing holdings/commitments would be grandfathered under the old rules.
The Potential Impact of the Income Tax Changes to Your Family:
The above example is intended for discussion purposes only. SWA is not a professional tax services firm. Please consult your tax professional for tax advice.
- Maximum estate tax rate remains at 40%.
- No proposed changes to the GST tax or dynasty trusts.
- Gift tax exemption remains unified with estate tax exemption.
- No changes to the annual gift tax exclusion.
- No capital gains tax when a gift is made or on the death of a taxpayer.
- No change to the basis step-up rules.
- New rules would become effective as of 1/1/2022.
- There is no Wealth Tax.
- In general, existing trusts would be grandfathered into the existing rules.
The estate tax exemption would drop from $11.7M/person to $5.85M/person in 2022.
Discounts would no longer be applied when determining the valuation of non-business assets (e.g., marketable securities inside an operating business).
Many benefits of defective grantor trusts would be eliminated for new grantor trusts moving forward:
- Transfers would be treated as sales – gains would be recognized and losses would not.
- The ability to swap assets would be eliminated.
Existing defective grantor trusts would be grandfathered under the old rules; however, if contributions are made to the existing trust, then a portion of the existing trust would be subject to the new rules (i.e., portion of trust would be subject to estate tax in the future).
New Code Section 2901 would significantly impact estate taxation of grantor trusts. Some examples are as follows:
- GRATS – Assets passed in trust or to the beneficiaries would now be valued for estate tax purposes at their fair market value at that time rather than when the original gift was made. In addition, annuity payments back to the grantor during the GRAT term could result in deemed capital gains to the grantor.
- ILITs – Future gifts (contributions) to the ILIT to pay premiums could result in a portion of the death benefit being subject to estate tax.
- SLATs – It will be extremely difficult to create a SLAT for the benefit of a spouse without subjecting the full value of the assets of the SLAT to estate tax when the grantor dies.
Please contact Strategies Wealth Advisors with any questions or concerns you may have on the potential impact of this bill on you, your family, and your business. Please also consult with your CPA and estate tax planning attorney. We believe in working as a team, with you and your other advisors, to make sure you are best positioned to navigate these potential changes.