Tax Provisions in the House Budget Reconciliation Bill
The Budget Reconciliation Bill is still being drafted and its fate is still being determined in the halls of Congress; however, I wanted to bring to your attention the recent action taken on it in the House Ways and Means Committee. Once these provisions become finalized, I will update you immediately!
On September 15th, the House Ways and Means Committee passed the following new tax provisions to be included in the pending Budget Reconciliation Bill. Among them, are some significant taxes on pass-through entities and small business owners. The Ways and Means Committee’s provisions do not eliminate the step up in basis for assets going through an estate. Unfortunately, it is too early to assume that we won’t see this provision surface again as the reconciliation bill (recall this type of bill only requires a simple majority of votes in the Senate) is finalized in the House and potentially subject to modifications in the Senate. If the Senate and the House pass different versions of the reconciliation bill, then it is conceivable that even if this provision was not included in either version, it could still emerge during the conference committee where the differences between the versions are ironed out. Some think that, because this provision is one of the most controversial, it will be introduced at the last hour.
Under the Ways and Means provisions, by and large, few income taxes will rise for those with incomes less than $400,000. The Ways and Means provisions include no fix to the current limit of $10,000 for state and local income and property taxes (“SALT”) which many Democrats want included in the reconciliation bill. This limitation hurt the taxpayers in blue states such as California, Maryland, New York, New Jersey, and Connecticut where property, state and local taxes are high. Many Democrats from these states are saying they will not vote for the bill unless something is done to reverse this unpopular limitation. Rumors continue to abound that the fix included might only apply to taxpayers with income below the $400,000 limit, or the limitation will be eliminated but only for a 2 year period (though the limitation is set to expire at the end of 2025 in any event) or that the $10,000 limit will be increased by a somewhat modest amount, say up to $40,000.
Here's a brief breakdown prepared by me and the Small Business Legislative Council (SBLC) regarding the major provisions affecting individuals recently passed by the Ways and Means Committee:
- The new top marginal tax rate will be increased to 39.6% on taxable income over $400,000 for a single taxpayer, $450,000 for married individuals filing jointly and $13,000 for trusts and estates. This provision would be effective January 1, 2022.
- The capital gains and dividend tax rates would rise to 25% for those individuals, trusts and estates with taxable income at the top taxable rate. This provision is to be effective for sales occurring or dividends received on or after September 13, 2021.
- The 3.8% net investment income tax will be imposed on income not otherwise taxed as dividends, capital gains, or wages for persons with income greater than $400,000 for single taxpayers, $500,000 for married individuals filing jointly and all trusts and estates (no threshold). This provision is to be effective January 1, 2022.
- The maximum allowable deduction for the 199A deduction for pass through entities would be available only for single taxpayers making $400,000 or less, $500,000 or less for married individuals filing jointly and $10,000 or less for trusts and estates. This provision would be effective January 1, 2022. Even though the valuable 199A 20% deduction from income for pass-through entities was slated to expire as of January 1, 2026, the Ways and Means changes to the 199A deduction would mean that those pass-through entities that are more successful will lose this deduction come January 1, 2022. The original purpose of Section 199A was to try to give pass-through entities more tax rate parity with C corporations.
- A new 3% surcharge would be imposed on all income for either single or joint individuals having more than $5 million of income, or more than $2.5 million for married individuals filing separately or more than $100,000 of income for trusts and estates. This provision would be effective January 1, 2022.
- Effective January 1, 2022, the gift and estate tax exemption would be reduced to approximately $6 million per individual (i.e., this would repeal the 2017 increase in the deduction four years earlier than slated under existing law). While some consider it good news that the federal estate tax exemption in January 1, 2022 will only revert to the amount that was slated to be in force come January 1, 2026.
- Effective on or after the date of enactment, assets in a grantor trust would be taxed in the grantor’s estate and distributions from a grantor trust would be taxed as a gift unless already reported as such. This provision would apply to any new grantor trusts created after the effective date OR to additions made after the effective date to a previously existing trust.
- Effective after the date of enactment, current discounts used in valuing family limited partnerships, LLCs and other closely held interests on the transfer of nonbusiness assets (passive assets) would be eliminated.
- An $11.7 million estate tax valuation reduction at death for real estate used in a family farm or business which is included in the estate would be available effective January 1, 2022.
- For individuals with income of $400,000 or more, no additional contributions can be made if the value of all of the individual’s IRAs, defined contribution accounts, and 403(b) accounts is greater than $10 million, effective January 1, 2022.
- Effective January 1, 2022, two new Required Minimum Distribution rules are applicable to large IRAs (traditional and/or Roth) – for IRAs in excess of $10 million, 50% of the excess over $10 million must be distributed – for IRAs in excess of $20 million, 100% of the excess must be distributed. These IRAs are now referred to on the Hill as “mega-IRAs.”
- Taxpayers with more than $400,000 of income are not allowed to make conversions to Roth IRAs after December 31, 2031. This appears to be a revenue raiser in the bill in that it encourages conversions to Roths during the ten year budget window. No after-tax contributions to Roth IRAs (sometimes referred to as “back door” Roth conversions) will be allowed after December 31, 2021. No after-tax contributions will be allowed in qualified retirement plans after December 31, 2021.
- Starting January 1, 2022, IRAs will not be allowed to hold investments in an entity in which the owner has 50% or greater of a public security or, what will be much more likely, 10% or more of a nonmarketable security. An IRA can no longer invest in an entity in which the IRA owner is an officer. These types of investment must be divested by the IRA by December 31, 2023.
Moving forward, once the House passes its version of the reconciliation bill, then the Senate Finance will start marking up their tax provisions. If this happens, then it is expected that the House and the Senate will end up with bills that have different provisions. Then either the House will have to pass the Senate’s version of the bill or the two versions will go to the conference committee which will work out a compromise bill. The final bill will then go back to the House and the Senate (if changes are made from the Senate version) for final passage and then on to the President to be signed into law. Under this scenario, we could see different provisions emerge and the overall size of the final bill could end up far smaller than what may initially come out of the House. Senators Manchin (D-WV) and Sinema (D-AZ) are not in favor of a $3.5 trillion bill.