On September 13th, The House and Ways Committee released tax proposals that will be part of the Build America Back Better Act, which may be effective as of January 1, 2022. Although there is uncertainty about which proposals will be passed, it is important to consider necessary actions in preparation for enactment. Here we discuss some highlights of anticipated tax provisions.
Increase in Individual Income Tax Rates
The top marginal individual income tax rate would increase from 37% to 39.6% for
- Unmarried Individuals with over $400,000 in taxable income
- Head of Households with over $425,000 in taxable income
- Married Individuals filing separately with over $225,000 in taxable income
- Married Individuals filing jointly with over $450,000 in taxable income
The increase would be effective for tax years after December 31, 2021.
Increase in Capital Gains Tax Rate
Under the previous proposal, the capital gains tax rate nearly doubled from 20% to 39.6% for high-income individuals with an AGI of more than $1 million. The latest House Ways and Means proposal would only increase long-term capital gain from 20% to 25%.
The 25% increase applies to transactions completed after September 13, 2021. The transition rules allow gains arising from a binding contract entered into before September 13, 2021 to be recognized prior to this date and taxed at 20%.
Qualified Small Business Stock
Section 1202 deduction of the Internal Revenue code allows non-corporate taxpayers to exclude 75% or 100% of the gain realized from the sale or exchange of qualified small business stock. Under the proposal taxpayers with an adjusted gross income equal to or exceeding $400,0000 would be limited to 50% exclusion. This change would be effective as of September 13, 2021.
The proposal extends the long-term capital gain holding period for gain attributed to an applicable partner interest from three to five years. The holding period would remain three years for income attributable to real property trade or business and for taxpayers with an adjusted gross income of less than $400,000.
Under the new proposal, the wash sale rule would be applied to cryptocurrency. A wash sale occurs when a stock or a security is sold at a loss and then replaced with a substantially identical stock or security within 30 days. The wash sale rule prevents taxpayers from claiming tax losses while retaining an interest in the loss asset. For example, if an investor buys Company A stock at $1,000 and then sells the stock at a lower price $800, they would have a $200 loss. However, if the investor buys Company A stock for $800 within a 30-day window, the $200 loss would be disallowed. The same rule would apply to cryptocurrency beginning in 2022.
Application of Net Investment Income to Trade or Business
Starting in the 2022 tax year, the 3.8% net investment income would be expanded to apply to pass-through net investment income from the ordinary course of trade or business for the following taxpayers:
- Unmarried individuals with over $400,000 in taxable income
- Married individuals filing separately with over $250,000 in taxable income
- Married individuals filing jointly with over $500,000 in taxable income
Surcharge on High-Income Individuals
A new surcharge would be applied to high-income individuals, estates, and trusts, effective January 1, 2022. The surcharge is equal to 3% of modified gross income in excess of:
- 5,000,000 for married individuals filing jointly
- 2,500,000 for married individuals filing separately
- $100,000 for trusts and estates
Estate and Gift Tax Exclusion Amount
The current federal estate and gift tax exclusion of $11,700,000 per individual applies to tax years up to 2025. The new proposal would reduce the exclusion amount to $6,700,000 beginning on January 1, 2022.
Limitation on Deduction of Qualified Business Income
The proposal limits section 199A Internal Revenue Code Qualified Business Income Deduction (QBI). Under section 199A, a taxpayer is allowed a 20% qualified business income deduction flowing from a pass-through entity until the tax year 2025. The proposal caps the QBI deduction for tax years after December 31, 2021 at:
- $500,000 for married individuals filing jointly
- $250,000 for married individuals filing separately
- $400,000 for all other taxpayers
- $10,000 for a trust or estate.
Limitation on Excess Business Losses of Non-Corporate Taxpayers
The Tax Cuts and Jobs Act of 2017 amended section 461 to limit the ability of non-corporate taxpayers to deduct business losses in excess of their business income against non-business income. It disallowed losses in excess of $250,000 for individuals and $500,000 for married filing joint taxpayers, in taxable years beginning after December 31, 2017, and ending before January 1, 2026. Any business loss beyond the limits laid out above was carried over as an NOL. Under the new proposal, section 461 would be amended to disallow excess business losses for non-corporate taxpayers permanently. This proposed change would be effective in tax years after December 31, 2021.
Corporate Tax Rate Increase
The corporate flat tax rate of 21% would be replaced with a three-step graduated rate structure:
- 18% tax rate on taxable income up to $400,000
- 21% tax rate on taxable income of $400,000 to $5,000,000
- 26.5% tax rate on taxable income over $5,000,000
The graduated income tax rate would phase out for corporations with over 10 million in taxable income.
Provisions not included in latest proposals:
- Limitations on Like-Kind Exchanges
- Elimination of Step-up Basis
Additional revisions are expected as the administration continues to work on the tax and budget proposals. However, taxpayers can take steps to take advantage of current tax provisions in light of the anticipated changes.
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