There’s been a lot of talk about higher taxes but now we’re starting to see some action: In mid-September 2021, an actual tax proposal was adopted by the Ways & Means Committee and is making its way through the House of Representatives. This is just a proposal and has a long way to go before becoming law (will need to be reconciled with Senate proposals that are significantly different). Still, it’s good to know what is being debated, especially since some of the changes would apply retroactively.

As expected, the House proposal focuses on high-income taxpayers and it attempts to raise revenue mostly through incremental increases in many areas rather than big tax hikes in a few. People with high income and/or extensive wealth will be affected in multiple ways but not as much as initially expected.

5 KEY THINGS TO NOTE 

1. Taxable income of $400,000 single ($450k married filing jointly) seems to be holding firm as the line above which tax increases will be focused.
2. Halving of the estate tax exclusion and fewer tax breaks for trusts and estates.
3. New restrictions on IRAs and Roth IRAs for high-income savers/investors.
4. Limiting of various tax breaks for business owners and/or shareholders.
5. Retroactive application: Certain increases would apply starting mid-September 2021, which is a bit unusual for tax changes (usually do not apply retroactively).

Below is closer look at the different types of tax increases in the House proposal:

INDIVIDUAL TAX RATES

• Top tax bracket would rise back up to 39.6% as of Jan. 1, 2022 and kick in at these levels:
       Single: $400,000
       Married filing jointly: $450,000
       Head of household: $425,000
       Trusts and estates: $12,500
• Top capital gains rate would rise to 25% (from 20% currently) as of Sept. 14, 2021  (transactions contracted before the 14^th would get 20% top rate). Note that the 25% cap gains rate would kick in at the top income tax bracket shown above.
• NEW 3% surtax on high-income taxpayers and trusts starting in 2022. This is 3% of the amount over $5 million in adjusted gross income (AGI) for married filing jointly and singles ($2.5 million for married filing separately). The surcharge also applies to any income over $100k for trusts and estates.
• Limits on the 20% qualified business income deduction starting in 2022. Up to $500k can be deducted by married business owners filing jointly; up to $400k for single filers; and $10,000 for trusts.
• Starting in 2022, the 3.8% Net Investment Income (NII) surcharge would also apply to ordinary business income for taxpayers with more than $400k in taxable income (single), $500k (married filing jointly) and trusts.

ESTATE TAXES/TRUSTS

• Federal estate tax exclusion would be halved to around $6 million per person starting in 2022; current exclusion is $11.7 million.
• The main estate planning benefits of grantor trusts would be gone: the assets in grantor trusts would be included in the estate of the grantor; sales between the grantor and the trust would be treated as third-party transactions and subject to taxes.
• No discounting of non-business assets for transfer tax purposes. When a stake in a business entity is transferred by gift or at death, the value of assets not used in an active trade or business cannot be discounted.

UNEXPECTED ELEMENTS

• Limits on the tax break that startup founders and early employees receive when they sell shares after holding for at least five years (Section 1202 on qualified small business stock (QSBS). Currently, up to $10 million on the sale of shares can be excluded from tax. The proposal would reduce that by 50% for trusts and estates and for taxpayers with modified adjusted gross income of $400k and above. Effective date would be Sept. 14, 2021, unless there is a binding contract to sell before that date.
• Rules on wash sales (selling to lock in a loss and buying something substantially similar within 30 days) would apply to commodities, currencies, and digital assets beginning in 2022.
• Numerous restrictions on retirement accounts:

— Closing of the back-door Roth conversion loophole for rollovers. Starting in 2022, after-tax contributions made to retirement plans and IRAs would not be eligible for rolling over into Roth IRAs. 

— Prohibiting high-income taxpayers from converting IRAs and other tax-deferred retirement accounts into tax-free Roth IRAs starting in 2032 (that is not a typo — more than a decade from now). The limitation applies when taxable income exceeds $450k (married filing jointly) $425k (head of household) and $400k (single and married, filing separately.)

— Disallowing traditional IRA contributions starting in 2022 for higher-income taxpayers with millions in retirement accounts. This applies to taxable income over $450k for married filing jointly ($425k for head of household, and $400k for single and married filing separately) AND ONLY IF the prior year-end value of all IRAs (traditional and Roth) plus any defined contribution plans (including 401(k)s and other employer plans) exceeds $10 million.

— Requiring much bigger Required Minimum Distributions (RMDs) from very large retirement accounts starting in 2022. This only applies to higher-income taxpayers as described above. The RMD would be 50% of the excess over $10 million. But if the combined account balances exceed $20 million, the first tier RMD is the lesser of 100% of the amount required to bring that total down to $20 million or the total of all Roth IRA accounts PLUS the 50% amount described earlier, taken from any account.

— One more big IRA change: IRAs would lose IRA status if they hold investments that have minimum requirements for investors based on income, assets, education, or specific license or credential. For us and our clients, this generally means investments available only to accredited investors and qualified purchasers. While this rule is effective starting in 2022, there’s a two-year transition allowance for IRAs currently holding such investments.

WHAT ELSE COULD HAPPEN

We might still see the following in the US Senate bill, which has not yet been released:

• Increased deduction for state and local income taxes
• Even higher corporate tax rates (House proposal raises corporate rate to 25% from 21% currently)
• Even higher capital gain tax rate
• Loss of the stepped-up basis at death
• Increased estate and gift tax rates

My colleagues and I are keeping a very close watch on tax policy and will be providing updates, analysis and potential strategies regarding new developments.