So, I told you earlier that President Biden (and the Democratic Party) are considering a slew of new taxes to ensure that the Infrastructure Bills don’t accrue those bandied about $ 3.5 trillion expenditures.

Well, a few weeks ago, the House and Ways Committee (the committee with jurisdiction over taxes) released an 881 page proposed bill.  Obviously, there are more than a few simple changes in the tax law.  Given that, it’s time to consider what they may be to ensure that we can effect proper planning.

Of course, this is simply a bill- NOT a law.  Which means things can change- items can become more or less onerous, items can be deleted- or, the bill can simply be defeated.  But, still, forewarned is forearmed.  I did the same when TheDonald had proposed the 2017 Tax Cut and Jobs Act.  [This was the first of several blogs describing the proposed bill; a good number of the proposed provisions were incorporated.]

First, before we even get to tax changes, let’s talk about one big improvement.  The IRS is going to get a ton more money- some $ 80KKK over years to enforce the tax laws, provide customer service- and audit all those folks and businesses that have been playing 3-Card-Monte with their income.

That’s going to make all these tax changes much more likely to garner the desired revenue.  So, let’s start with the proposed changes in tax brackets and tax rates.

Obviously, we all heard that the maximum rate is going to increase to 39.6%.  (That’s actually not quite accurate- unless we don’t want to consider the additional social security and Medicare taxes that can accrue.)  But, since most of us don’t manage to earn $ 400K of taxable income (individuals; $ 425K for heads of household and $ 450K for married folks [$225K for married filing separately]), we really won’t be affected by that change. Oh, but some of us may be trustees for trusts and estates that accrue $ 12,500 in taxable income- a value at which those entities will be shelling out 39.6% in income taxes.

There also will changes in the income that is subject to 32% and 35% tax rates.  If those are your marginal rates, then it behooves you to find ways to accelerate as much income to this year’s taxes as possible.  That way when the new rate cuts in on 1 January 2022, you will be less affected. (Then, for those of us who are principals in pass-through entities, there also will be greater limitations on QBI [Qualified Business Income], that 20% deduction for pass-through income.)   

Not to mention that there is that 3% surcharge for high-income (the Democratic party calls these folks “ultra-high earners”) and the 3.8% Net Investment Income Tax surcharge. That means those making more than $ 400K (single taxpayers) will find their tax rates to be 46.4%.  (Don’t forget- there’s still state (and local) taxes that will be charged against your income.)

The Capital Gains Rate will also be increased.

This change will pose a real problem for planning.  Because the change in rates will already be in force.  For any capital gains earned on or after 14 September 2021, the rates increase from 20% to 25%.   And this higher rate is also imposed on Qualified Dividends that are issued on or after that date.   (Folks who don’t earn a lot of money – $ 40,000 or less won’t feel that capital gains tax increase, since their tax rate on capital gains is zero.  Folks who earn $ 441,500 or more are subject to the increased tax rates.)

Surcharge Applied to High Income Individuals, Trusts and Estates

Now, I am pretty sure this won’t affect most of us.  Unless, of course, you have earned $ 5KK ($2.5KK for those married filing separately).  And, if that describes your situation, then you will be subject to a 3% surtax.  For those who manage trusts and estates, the cutoff for the surcharge begins at $ 100K of taxable income.

Please note that this surtax is on ALL income- whether it’s ordinary income (like W2 wages), capital gains, and the like.  Oh, another key fact.  No itemized deductions (including donations to charity) can be used to lower your income below the thresholds.  (Trusts that transfer income to beneficiaries will receive a credit to reduce its income as the beneficiaries are assessed and pay that 3% surtax. Note that state law sets these rules.  Many states afford the trustee (fiduciary) to treat capital gains as income to be distributed to beneficiaries; as such escape the surtax.)

Now, here’s a key fact.  If the gains from the sale a building, another asset, or even a business exceeds that threshold, it, too, shall be subject to that 3% surtax.   That means more of us are likely to be affected (but not a great number of us… fortunately).

Don’t go thinking you can make this sale an installment sale, to be paid over a few years.  Because you had to have started this process at least two years prior to liquidation to escape the surtax.  The same applies if one is considering transferring interests to a CRT (Charitable Remainder Trust), where income is spread over several years to lower the tax bite.

Net Investment Income Tax (NIIT) Grows to Cover More Taxpayers

The NIIT of 3.8% will cover those single taxpayers who earn $ 400K of taxable income ($ 500K for married filers).   This becomes effective on 1 January 2022.   Prior to that date, this tax (the NIIT) only applied to passive investment income (that means interest, dividends, and capital gains).  Again, that won’t affect many of us.

But, trustees-actually just to the estates and trusts under their control- will see that this NIIT applies to incomes of $ 13,050 or more.  That is unless the income is disbursed to beneficiaries- who may then be subject to such surcharges. (S corporations that have elected to be an Electing Small Business Trust (ESBT) will be subject to said taxes, whether or not such income is distributed to principals.)

IRA/Pensions

Certain folks (Mitt Romney and Peter Thiel come immediately to mind) found ways to circumvent the intent of IRA accounts (both Roth and traditional IRA) and other retirement plan accounts.  To deal with such issues, limitations on contributions will be imposed upon those folks who have retirement funds in excess of $ 10 KK in value- if their income exceeds $ 400K ($450K for married folks).

Minimum distributions will also be 50% of the amount of the prior year aggregate value of retirement funds that exceed $ 10 KK.  (The rules get more onerous for those with $ 20 KK in combined retirement accounts.)

Oh, backdoor Roth conversions (indirect funding of Roth IRA) are blocked for those high earners. Which means you should immediately consider a backdoor Roth conversion, if these limitations apply to you.  That option will no longer exist the second the December 2021 calendar page drops to the floor.

Another provision will make a lot of self-directed IRA’s (SDIRA) less lucrative. These SDIRA can no longer invest in any property or entity for which the owner is a 10% owner- or if the IRA holder is an officer of the business subject to the investment.   (This is an IRA requirement- not a prohibited transaction.  That means a violation would be taxed as if the IRA was liquidated!)  For those IRA’s that already hold such investments, there will be two years to remove this holding from the IRA.

 

Businesses

C Corporations will see a tax rate change.  (Some of it’s good, some of it’s going to cost.)

What many don’t realize is that the Tax Cut and Jobs Act (TCJA) screwed many smaller C Corporations.  Up until that change, those firms that eked out small profits ($50K or less profit) only paid a 15% corporate income tax.  Once the TCJA came into effect, all corporations had to shell out 21% income taxes to the feds.  Big companies (assuming they actually paid taxes) saw a big decrease in tax rates; the smaller firms got saddled with a bigger tax bite.

This proposed bill will lower the taxes on even more smaller businesses, effective CY 2022.  Instead of a $ 50K income threshold, the new cutoff for lower rates will be $ 400K- and that will allow the firm to “enjoy” an 18% tax rate.  Over that threshold, the tax rate jumps to 21%, until net income exceeds $ 5KK.  That sets up a 26.5% business tax rate.   And, once corporate income exceeds $ 10KK, there is no graduated rate- all income is taxed at 26.5%.

We’re guessing these new rates effective for CY 2022 will create an avalanche of conversions from S corporations to C corporations- because the 3.8% Medicare tax imposed on pass-through income will be obviated if the firm is no longer a pass-through entity.  Not to mention that there will be new limitations on the QBI (Section 199A deduction)- individuals earning $ 400K or more will see the QBI squashed ($ 500K for marrieds).  There also is a QBI limitation for those trusts and estates earning more than $ 10K in taxable income.

Along those same lines, some S Corporations may elect to convert to partnerships.  This provision only applies to those entities that were S Corps prior to 13 May 1996.  They will have two years from the date of passage to make that conversion. [This means there is a taxable sale of all assets of the S Corporation.]  S Corps that become partnerships are still pass-through entities (and don’t have the rules on reasonable compensation), which means QBI still applies.  (These entities will also be those that earn less than $ 400K in income, which subject the principals to those tax surcharges mentioned above.)

Qualified Small Business Stock (QSBS)

The exclusion of gains (which is 100% now) for the sale of Section 1202 QSBS will be limited for high earners. Those with more than $ 400K will find the gain exclusion has been halved to 50%, unless that deal was inked before my daughter’s birthday (13 September 2021).

R&D Credit

The TCJA screwed around with our R&D (research and development) cost recovery.   Instead of being allowed to write off (fully depreciate) these expenses in 1 year, the TCJA required a 5 year amortization program.  Which would only lead to lessened involvement with R&D.

While this act doesn’t repeal that terrible provision, it does delay its implementation for 4 years until 2026.

GILTI (Global Intangile Low-Tax Income)

The TCJA made (more than) a few errors, requiring expense allocation of certain domestic expenses for US Multinationals.  That allocation meant they could be construed as foreign taxable income. These are now repealed.

On the other hand, the TCJA imposed a minimum 10.5% tax attributable to intangible assets (i.e., income >10% from tangible assets)-  and if these weren’t booked abroad (called FDII- Foreign-Derived Intangible Income deduction), up to a 13.125% would be assessed.   Now those two rates are 16.5% (minimum tax) and 20.7% (FDII).

Cryptocurrency

Despite the heavy lobbying, those who deal with Bitcoin, DOGEcoin, and the like will need to comply with wash sale rules comes 2022.  Up until the end of the year, you can sell your cryptocurrency and immediately buy back in to harvest losses.  (Moreover, it will still be passive income.)

Along these lines- and not really related to taxes- those firms that deal with cryptocurrencies are going to have to do way more reporting.  The government’s goal is to make all those hackers that lock up city, state, or business computers for ransom paid in cryptocurrency unable to cash in on their ill-gotten gains.