House Ways & Means Committee tax proposals’ impact on individuals
On September 13, the House Ways & Means Committee released its first draft of the proposed tax changes to be incorporated into the Build Back Better Act budget reconciliation bill to fund President Biden’s $3.5 trillion spending priorities.
While the draft — referred to as “Subtitle I – Responsibly Funding Our Priorities” — provides some insight on where negotiations currently stand, this is only the first step in creating the final legislation that will eventually be voted upon by Congress and sent to President Biden for signature. Given the current political environment, the final tax law changes will likely look very different than this draft text.
Below is a summary of key individual tax revenue provisions included in the draft:
Top ordinary tax rate
- Increase the top marginal income tax rate from 37% to 39.6%
- Imposed on taxable income over $450,000 married filing jointly (MFJ), $400,000 single and $225,000 married filing single (MFS)
Top capital gains tax rate
- Increase the top capital gains rate from 20% to 25%
- Generally effective for gains recognized after September 13, 2021, unless pursuant to a written binding contract in effect on September 13, 2021
New surcharge tax
- Impose a 3% surcharge on individuals with modified adjusted gross income greater than $5 million MFJ and single, and $2.5 million MFS
Net investment income tax (NIIT)
Currently, the 3.8% NIIT does not generally apply to income from an active trade or business or income attributable to the disposition of property in an active trade or business.
- This provision would impose NIIT on all flow-through business income that is not already subject to NIIT, FICA or self-employment income tax
- Applicable regardless of whether the individual is active or passive in the entity
- Perhaps most significantly, under this provision, NIIT would now be imposed on active S corporation K-1 income
- However, the exception for rental real estate activities would still apply
- Applicable to taxpayers with taxable income over $500,000 MFJ, $400,00 single and $250,000 MFS
Sec. 199A
- Limit the Sec. 199A qualified business income deduction (20% of pass-through income) to a maximum of $500,000 MFJ, $400,000 single and $250,000 MFS
Excess business loss (EBL) limitation
- Make the EBL limitation permanent, limiting the ability to deduct net business losses to an annual maximum of $500,00 MFJ, $400,000 single and $250,000 MFS, adjusted for inflation
- Rather than the disallowed EBL being treated as a net operating loss carryover to the following year, this provision would instead treat the excess as a business loss in the following, where it would again be subject to the EBL limitation
Sec. 163(j)
- Modify the business interest deduction limitation rules so that they are applied at the pass-through owner level (S corporation shareholder and partner) rather than at the entity level
- Modify the carryover of disallowed business interest expense in excess of the limitation so that it can be carried forward a maximum of five tax years, with carryovers being utilized on a first-in, first-out basis
Carried interests
Partnership interests issued for services currently require a holding period of three years (rather than the normal one-plus year holding period) in order to obtain favorable long-term capital gain treatment of capital gains attributable to such interests (e.g., from the sale of either the partnership interest or the partnership’s sale of partnership assets)
- This provision would extend the application of the carried interest rules to include any asset eligible for long-term capital gain treatment — including business and real estate assets taxed under the Sec. 1231 rules
- This would eliminate a substantial exception that previously existed for the real estate industry
- Applicable regardless of taxpayer’s income level
- This provision would also extend the holding period required for a service partner holding a carried interest to qualify for long-term capital gain treatment from three years to five years
- This extended holding period would not be applicable to interests in real property trades or businesses
- Applicable to taxpayers with AGI of $400,000 or more
Qualified Small Business Stock
- Eliminate the ability to exclude 75% or 100% of gains realized from certain qualified small business stock (QSBS) sold after September 13, 2021, unless the sale was made pursuant to a written binding contract prior to September 13, 2021
- Applicable to taxpayers with adjusted gross income of $400,000 or more
- The 50% exclusion under Sec. 1202 would remain available for all taxpayers, with the 50% remaining QSBS gain taxed at 28%
Personal casualty losses
- Eliminate the temporary limitation that currently applies on the deduction of personal casualty losses
- Given the overwhelming natural disasters that have occurred and are likely to continue to occur (e.g., hurricanes, flooding, fires, excessive temperatures, cicadas, etc.), the elimination of the limitation on casualty losses is a very pro-taxpayer provision
Worthless partnership interests
- If a partner’s interest in a partnership becomes worthless during the taxable year, the resulting loss would be treated as a loss from the sale or exchange of the interest in the partnership, effectively eliminating the partner’s ability to claim an ordinary loss on the worthless interest, rather than a capital loss
Additional comments
- The proposed legislation does not include a repeal of the $10,000 limit on the state and local tax deduction for individual taxpayers
What’s next?
Some of these changes were expected, while others come as a surprise. Unless noted, the changes would be effective for tax years beginning after December 31, 2021, allowing taxpayers minimal time to implement planning opportunities to minimize their impact.
Wipfli will continue to monitor progress with respect to the Build Back Better Act and issue guidance as further details are provided on provisions that could impact businesses and their owners. But don’t wait until these proposals have become law to start thinking about how they will impact you, your business and your future deals. If you have questions or would like additional information, please contact us.
Sign up to receive additional tax-related information in your inbox, or continue reading on:
Author(s)
