Revised Build Back Better Bill
03 November 2021After months of negotiations, the White House announced a framework for President Biden’s Build Back Better agenda, a $1.75 trillion package of social infrastructure measures paid for by tax increases. The measures are in addition to those previously approved by the Senate in the transportation-related $1 trillion bipartisan infrastructure bill. In reaching the framework, both moderate and progressive Senate and House Democrats have been forced to compromise on certain priorities.
The announced framework includes the following spending measures:
- Extension of the childcare tax credit for one year (through 2022)
- Extension of the refundable earned income tax credit and other investments in affordable housing
- Universal and free preschool for three and four-year olds and additional childcare funding
- Expanded home care for older Americans and people with disabilities
- Expanded healthcare coverage, Medicare hearing benefits and lower healthcare premiums for certain Americans
- Clean energy tax credits and certain climate change provisions
- Expanded access to affordable high-quality education beyond high school
- Provisions for immigration system reforms
Key provisions excluded from the announced framework include paid family leave and Medicare coverage for dental and vision benefits. The framework also does not include key climate change measures that would reward electricity plants that use clean energy instead of fossil fuels, nor does it include provisions that would allow Medicare to negotiate lower prices for prescription drugs.
To pay for the social spending measures, the agreement includes the following tax increases:
- A 15% corporate minimum tax on companies reporting over $1 billion in financial statement profits
- A 1% surtax on corporate stock buybacks
- A 15% country-by-country minimum tax on foreign profits of U.S. corporations, which would bring the U.S. in line with the recent global agreement announced by the OECD
- A 5% surtax on individual incomes over $10 million, an additional 3% surtax on incomes over $25 million and expansion of the 3.8% Net Investment Income Tax
- Increased IRS funding to support additional enforcement resources focused on pursuing unpaid taxes of wealthy taxpayers (those with incomes of at least $400,000 per year)
A version of H.R. 5376 (the Build Back Better Act), released on October 28, 2021 by the House Budget Committee, eliminates many of the previously proposed tax increases that would have impacted individuals.
The tax proposals eliminated in the rewrite include:
- Increase in the top marginal individual income tax rate;
- Increase in the capital gains rate for certain high income individuals;
- Limitation on the deduction of qualified business income for certain high income individuals;
- Modification of the rules for carried interests;
- Taxation of certain transfers between a deemed owner and an irrevocable grantor trust;
- Termination of the temporary increase in the estate tax basic exclusion amount;
- Inclusion of assets held in an intentionally defective grantor trust in the gross estate of the deceased deemed owner;
- Valuation rules that would have eliminated valuation discounts for certain transfers of nonbusiness assets; and
- Modifications of rules relating to retirement plans including:
- Imposition of contribution limits for individual retirement plans of high-income taxpayers with large account balances;
- Increase in minimum required distributions for high-income taxpayers with large retirement account balances;
- Provisions that would have prohibited “back door” Roth IRAs; and,
- Prohibition of IRA investments that were conditioned on the account holder qualifying as an accredited investor or investments in entities in which the owner has a substantial interest.
Other provisions remained, some unchanged and some modified as discussed below.
Section 1202 – Qualified Small Business Stock (clarification)
Taxpayers are currently eligible for 75% and 100% exclusions for sales of qualified small business stock (QSBS). In an unexpected move, the proposed legislation would eliminate the 75% and 100% exclusions for sales of QSBS acquired after February 17, 2009, and sold after September 13, 2021, unless the sale was made pursuant to a written binding contract already in place and not materially modified thereafter. The proposed provision would apply to taxpayers whose adjusted gross income equals or exceeds $400,000 and to trusts and estates.
Under the current 50% exclusion rules, the remaining 50% QSBS gain is taxed at 28%. The excluded QSBS gain is considered an alternative minimum tax (AMT) preference item, which, when considered along with the net investment income tax on the taxable half of the gain, results in an effective rate of 16.88% for QSBS acquired after February 17, 2009, and sold after September 13, 2021. In addition, high-income taxpayers may also be subject to the surcharge discussed below.
The rewrite of the Build Back Better Act confirms that this proposed provision applies to sales and exchanges after September 13, 2021, correcting an error in the earlier draft, which created ambiguity regarding whether this provision would apply to sales or exchanges of qualified small business stock on or after September 13, 2021.
Net Investment Income Tax (no change)
Under the current rules, net investment income does not include income derived in the ordinary course of a trade or business or income attributable to the disposition of property earned outside of a passive activity. The rewrite made no change to the proposed legislation that would eliminate those carveouts and others, while broadening the type of income subject to net investment income tax (NIIT). NIIT applies to the greater of “specified net income” or net investment income for high income individuals, estates and trusts. “Specified net income” includes net investment income even if derived in the ordinary course of a trade or business and other gross income and net gains attributable to the disposition of property, even if earned outside of a passive activity or the trade or business of trading financial instruments or commodities. Certain foreign income is includible in the definition of net investment income.
The proposed provision would apply to taxpayers whose modified adjusted gross income exceeds $500,000 for married individuals filing jointly and surviving spouses, $250,000 for married individuals filing separately, $12,500 for estates and trusts and $400,000 for all other tax filers. The proposal would be effective for taxable years beginning after December 31, 2021.
Essentially, this change would subject all earnings from pass-through businesses to either the 3.8% self-employment Medicare tax or the 3.8% NIIT, regardless of whether the income is from a passive or nonpassive activity.
Given the potential rate increases, if there continues to be any limitation on the deductibility of state and local taxes for individuals, any available deductions to offset federal taxable income increase in value. Taxpayers should consider the cost/benefit of using pass-through entities and the available elective entity-level state tax regimes to address the impact of the SALT cap.
Excess Business Loss Limitation (no change)
Under a temporary provision, excess business losses (EBLs) of non-corporate taxpayers in excess of $500,000 for joint filers ($250,000 for all other taxpayers) are disallowed and treated as net operating losses in the following year; however, the provision is set to expire on December 31, 2026. The rewrite made no change to the initial proposal that would make the temporary provision permanent and modify how a disallowed EBL is treated. Instead of treating the disallowed loss as a net operating loss in the following year, the EBL would be treated as a deduction attributable to a taxpayer’s trades or businesses when computing the EBL in the subsequent year. The proposal would be effective for taxable years beginning after December 31, 2020.
Surcharge on High-Income Individuals, Estates and Trusts (modification)
There is currently no surcharge imposed on high-income individuals. The original Build Back Better Act proposal would have imposed a 3% surcharge on modified adjusted gross income in excess of $2,500,000 for married individuals filing separately, $100,000 for estates and trusts and $5,000,000 for all other individuals.
The rewrite of the Build Back Better Act would impose a 5% surcharge on modified adjusted gross income that exceeds $5 million for married individuals filing separately, $200,000 for estates and trusts and $10 million for all other individuals. An additional 3% surcharge would be imposed on modified adjusted gross income in excess of $12.5 million for married individuals filing separately, $500,000 for estates and trusts and $25 million for all other individuals. The proposal would be effective for taxable years beginning after December 31, 2021.
Wholly charitable trusts are excluded. Additional guidance on how the surcharge would apply to particular types of trusts may be required. Although not specifically excluded, it would seem that grantor trusts (as generally disregarded for federal income tax purposes) and charitable remainder trusts (which are tax exempt) would not be subject to the surcharge, but it would be helpful to have this clarified in the legislation. Also, as charitable deductions are not specified as a deduction that is allowed in determining the estate or trust’s adjusted gross income, the surcharge would appear to apply to income even if the trust contributed all of that income to a charity. This would affect any nongrantor trust making a charitable contribution but could particularly affect nongrantor charitable lead trusts.
Extension of expensing of research and experimental costs under Section 174
The bill retains a provision that would extend the expensing of research and experimental costs under Section 174 for expenses paid or incurred in tax years beginning before 2026. Section 174 expensing currently is scheduled to expire for tax years beginning after 2021.
Taxpayers with research and experimental expenses would continue to have the options of deducting in the tax year paid or incurred, capitalizing and amortizing generally over five years under Section 174, capitalizing under Section 263(a) and amortizing over the useful life under Section 167, or capitalizing and amortizing over 10 years under Section 59(e).
DETAILS OF PROPOSED CORPORATE MINIMUM TAX AND BILLIONAIRES TAX RELEASED
Senate Democrats have released details of two tax proposals – a minimum tax on large corporations and a tax on billionaires – that, if enacted, would be used to help pay for spending for social infrastructure under the Build Back Better Plan.
The proposed “corporate profits minimum tax” would impose a 15% minimum tax on companies that report over $1 billion in financial statement profits. Foreign tax credits and business credits such as R&D, clean energy and housing tax credits would continue to apply, as would loss carryforwards in certain cases. The minimum tax would be creditable against regular tax paid in future years.
The proposed billionaires tax would apply to individual taxpayers with more than $100 million in annual income or more than $1 billion in assets for three consecutive years. Under this proposal:
- Tradable assets (stocks, etc.) would be marked to market annually, with tax paid on any unrealized gains. Unrealized losses would be deductible and could be carried back three years in certain circumstances.
- Nontradable assets (such as real estate) would be subject to an additional tax in the form of a deferred interest charge (deferral recapture amount) when sold, which would be calculated on the realized gain over the holding period of the asset.
- Transition rules would apply in the first year to treat $1 billion of tradable stock as nontradable and would allow the tax on first year mark to market gains to be spread over five years.
Other specific rules would apply. The proposed taxes reportedly would raise hundreds of billions of dollars and are being embraced by many in the Democratic party as ways to close loopholes and ensure large corporations and the wealthiest individuals pay their fair share of federal tax.
If enacted, the billionaire tax would apply to taxable years beginning after December 31, 2021 and the corporate profits minimum tax would apply to taxable years beginning after December 31, 2022.
For more information reach out to Pat Capella.