House Ways and Means Committee Releases its Plan to Pay for the $3.5 Trillion Reconciliation Bill
House Ways and Means Committee Releases its Plan
to Pay for the $3.5 Trillion Reconciliation Bill
September 14, 2021
On September 13th the House Ways and Means Committee released a blueprint for the tax increases that businesses and higher earners intended to pay for the Democrats' $3.5 trillion reconciliation bill.
I’ve read the committee report and am copying the sections from it below that are most relevant to our clients, Newsletter subscribers and seminar attendees. I have many thoughts on this, but share a few of them:
- While this proposal reveals Congressional Democrats’ intentions and what it thinks it will be able to pass into final legislation, it is only a proposal at this point. Congress is pushing at breakneck speed to vote on a reconciliation bill by September 27, less than two weeks from now. It remains to be seen how much of this (or in what form) will make its way into a final bill.
- Just because certain things that had been proposed earlier are not in this blueprint (e.g., elimination of the step-up in basis rule at death or setting the capital gains rate at the ordinary income rate) doesn’t guarantee that they won’t be in the final legislation.
- There is a lot to digest here. I am interspersing my own initial reactions in “ALL CAPS” text throughout the proposal below – not in every section, but many.
What follows below is word-for-word from the committee proposal (other than my ALL CAPS insertions)…
Increase in Corporate Tax Rate.
This provision replaces the flat corporate income tax with a graduated rate structure. The rate structure provides for a rate of 18 percent on the first $400,000 of income; 21 percent on income up to $5 million, and a rate of 26.5% on income thereafter. The benefit of the graduated rate phases out for corporations making more than $10,000,000. Personal services corporations are not eligible for graduated rates.
AS “PERSONAL SERVICE CORPORATIONS,” C CORP DOCTORS WILL WANT TO ZERO OUT CORPORATE PROFIT TO AVOID A FLAT TAX OF 26.5%.
Increase in Top Marginal Individual Income Tax Rate.
The provision increases the top marginal individual income tax rate in section 1(j)(2) to 39.6%. This marginal rate applies to married individuals filing jointly with taxable income over $450,000, to heads of households with taxable income over $425,000, to unmarried individuals with taxable income over $400,000, to married individuals filing separate returns with taxable income over $225,000, and to estates and trusts with taxable income over $12,500. The amendments made by this section apply to taxable years beginning after December 31, 2021.
THIS IS A VERY LOW THRESHOLD FOR THE HIGHEST TAX RATE TO KICK IN. CURRENTLY, FOR MARRIEDS, THE 35% RATE STARTS AT $418,850 AND THE 37% RATE AT $628,300. NOTE ALSO THE REIMPOSITION OF THE “MARRIAGE PENALTY” WHERE THE 39.6% RATE WILL HIT MARRIED COUPLES AT ALMOST THE SAME INCOME LEVEL AS INDIVIDUALS.
Increase in Capital Gains Rate for Certain High Income Individuals
The provision increases the capital gains rate in section 1(h)(1)(D) to 25%. The amendments made by this section apply to taxable years ending after the date of introduction of this Act. A transition rule provides that the preexisting statutory rate of 20% continues to apply to gains and losses for the portion of the taxable year prior to the date of introduction. Gains recognized later in the same taxable year that arise from transactions entered into before the date of introduction pursuant to a written binding contract are treated as occurring prior to the date of introduction.
AT LEAST IT’S BETTER THAN A 39.6% CAPITAL GAINS RATE. THE RATE WOULD BE EFFECTIVE AS OF SEPT. 13, 2021. IF YOU ARE SELLING YOUR PRACTICE THIS YEAR AND YOU HAVE A SIGNED CONTRACT, YOU’VE LOCKED IN THE LOWER RATE. IF YOU’VE YET TO SIGN A CONTRACT FOR SALE, IT APPEARS THAT YOU WILL GET A PRO-RATED 20% RATE FOR THE PORTION OF THE YEAR PRIOR TO SEPT. 13.
Application of Net Investment Income Tax to Trade or Business Income of Certain High Income Individuals
This provision amends section 1411 to expand the net investment income tax to cover net investment income derived in the ordinary course of a trade or business for taxpayers with greater than $400,000 in taxable income (single filer) or $500,000 (joint filer), as well as for trusts and estates. The provision clarifies that this tax is not assessed on wages on which FICA is already imposed. The amendments made by this section apply to taxable years beginning after December 31, 2021.
THIS WOULD FINALLY END THE MEDICARE TAX SAVINGS STRATEGY USED BY SO MANY S CORPORATION OWNERS.
Surcharge on High Income Individuals, Trusts, and Estates
This provision adds section 1A, which imposes a tax equal to 3% of a taxpayer’s modified adjusted gross income in excess of $5,000,000 (or in excess of $2,500,000 for a married individual filing separately). For this purpose, modified adjusted gross income means adjusted gross income reduced by any deduction allowed for investment interest (as defined in section 163(d)). The amendments made by this section apply to taxable years beginning after December 31, 2021.
Termination of Temporary Increase in Unified Credit
This provision terminates the temporary increase in the unified credit against estate and gift taxes, reverting the credit to its 2010 level of $5,000,000 per individual, indexed for inflation.
THE CURRENT $11.7 MILLION CREDIT WOULD REVERT TO ABOUT $6 MILLION STARTING NEXT YEAR, SO SPOUSES COULD COMBINE THEIR CREDITS TO SHELTER $12 MILLION OF MARITAL ASSETS.
Certain Tax Rules Applicable to Grantor Trusts
This provision adds section 2901, which pulls grantor trusts into a decedent’s taxable estate when the decedent is the deemed owner of the trusts. Prior to this provision, taxpayers were able to use grantor trusts to push assets out of their estate while controlling the trust closely. The provision also adds a new section 1062, which treats sales between grantor trusts and their deemed owner as equivalent to sales between the owner and a third party. The amendments made by this section apply only to future trusts and future transfers.
WITH A GRANTOR TRUST THE WEALTHY INDIVIDUAL CONTRIBUTES ASSETS TO AN IRREVOCABLE TRUST GETTING THEM (AND FUTURE GROWTH ON THOSE ASSETS) OUT OF HIS OR HER ESTATE. THE GRANTOR RETAINS ENOUGH CONNECTION TO THE ASSETS, (E.G., PERSONALLY PAYS THE ANNUAL TAXES ON TRUST ASSETS) THAT THE TRANSFER IS ALSO NOT TREATED AS A TAXABLE GIFT TO THE GRANTOR’S CHILDREN OR OTHER BENEFICIARIES. THIS IS A KEY WAY THAT THE WEALTHY AVOID ESTATE TAX, AND THIS PROVISION WOULD END THE TECHNIQUE BY PULLING THESE TRUST ASSETS BACK INTO THE ESTATE.
Valuation Rules for Certain Transfers of Nonbusiness Assets
This provision amends section 2031 by clarifying that when a taxpayer transfers nonbusiness assets, those assets should not be afforded a valuation discount for transfer tax purposes. Nonbusiness assets are passive assets that are held for the production of income and not used in the active conduct of a trade or business. Exceptions are provided for assets used in hedging transactions or as working capital of a business. A look-through rule provides that when a passive asset consists of a 10-percent interest in some other entity, the rule is applied by treating the holder as holding its ratable share of the assets of that other entity directly. The amendments made by this section apply to transfers after the date of the enactment of this Act.
THIS WOULD RESTRICT THE USE OF FAMILY LIMITED PARTNERSHIPS STARTING AFTER THE DATE OF FINAL LEGISLATION. IF YOU ARE IN THE PROCESS OF SETTING THIS UP, HAVE YOUR ESTATE PLANNING ATTORNEY COMPLETE YOUR PARTNERSHIP AGREEMENT GIFTS TO YOUR HEIRS ASAP.
Contribution Limit for Individual Retirement Plans of High-Income Taxpayers with Large Account Balances.
Under current law, taxpayers may make contributions to IRAs irrespective of how much they already have saved in such accounts. To avoid subsidizing retirement savings once account balances reach very high levels, the legislation creates new rules for taxpayers with very large IRA and defined contribution retirement account balances.
Specifically, the legislation prohibits further contributions to a Roth or traditional IRA for a taxable year if the total value of an individual’s IRA and defined contribution retirement accounts generally exceed $10 million as of the end of the prior taxable year.
The limit on contributions would only apply to single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation).
The legislation also adds a new annual reporting requirement for employer defined contribution plans on aggregate account balances in excess of $2.5 million. The reporting would be to both the Internal Revenue Service and the plan participant whose balance is being reported.
The provisions of this section are effective tax years beginning after December 31, 2021.
CASH BALANCE DEFINED BENEFIT PLANS ARE EXCLUDED. ULTIMATELY THESE PLANS ARE CLOSED, AND THE BALANCES ROLLED TO IRAS. HOWEVER, THE PENALTIES DESCRIBED BELOW FOR “EXCESSIVE” IRAS ACCUMULATIONS ARE DAUNTING.
Increase in Minimum Required Distributions for High-Income Taxpayers with Large Retirement Account Balances.
If an individual’s combined traditional IRA, Roth IRA and defined contribution retirement account balances generally exceed $10 million at the end of a taxable year, a minimum distribution would be required for the following year. This minimum distribution is only required if the taxpayer’s taxable income is above the thresholds described in the section above (e.g., $450,000 for a joint return). The minimum distribution generally is 50 percent of the amount by which the individual’s prior year aggregate traditional IRA, Roth IRA and defined contribution account balance exceeds the $10 million limit.
A 50% RMD IS ENORMOUS AND PUNISHES SAVERS FOR COMPLYING WITH THE TAX LAWS AS THEY’VE TRADITIONALLY BEEN WRITTEN AND UNDERSTOOD.
In addition, to the extent that the combined balance amount in traditional IRAs, Roth IRAs and defined contribution plans exceeds $20 million, that excess is required to be distributed from Roth IRAs and Roth designated accounts in defined contribution plans up to the lesser of (1) the amount needed to bring the total balance in all accounts down to $20 million or (2) the aggregate balance in the Roth IRAs and designated Roth accounts in defined contribution plans. Once the individual distributes the amount of any excess required under this 100 percent distribution rule, then the individual is allowed to determine the accounts from which to distribute to satisfy the 50 percent distribution rule above.
This provision is effective tax years beginning after December 31, 2021.
A 100% RMD IS DOUBLY PUNITIVE. THANKS TO COMPOUNDING GROWTH, ACCOUNT VALUES OF THESE SIZES ARE POSSIBLE EVEN WITH NORMAL ANNUAL CONTRIBUTIONS, SO LONG AS THEY’VE BEEN MADE FOR ENOUGH YEARS AND ALLOWED TO GROW FOR ENOUGH YEARS. ALSO, THEY ARE TARGETING ROTH ACCOUNTS FOR THESE EXCESS DISTRIBUTIONS.
Tax Treatment of Rollovers to Roth IRAs and Accounts.
Under current law, contributions to Roth IRAs have income limitations. For example, the income range for single taxpayers for making contributions to Roth IRAs for 2021 is $125,000 to $140,000. Those single taxpayers with income above $140,000 generally are not permitted to make Roth IRA contributions.
However, in 2010, the similar income limitations for Roth IRA conversions were repealed, which allowed anyone to contribute to a Roth IRA through a conversion. irrespective of the still- in-force income limitations for Roth IRA contributions. As an example, if a person exceeds the income limitation for contributions to a Roth IRA, he or she can make a nondeductible contribution to a traditional IRA – and then shortly thereafter convert the nondeductible contribution from the traditional IRA to a Roth IRA.
In order to close these so-called “back-door” Roth IRA strategies, the bill eliminates Roth conversions for both IRAs and employer-sponsored plans for single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation). This provision applies to distributions, transfers, and contributions made in taxable years beginning after December 31, 2031.
NO MORE CONVERSIONS FROM A TRADITIONAL IRA TO A ROTH IRA STARTING IN 2032 (NOT 2022) IF YOUR INCOME IS OVER $400,000/$450,000. CONGRESS THINKS TOO MANY WEALTHY TAXPAYERS HAVE ROTH IRAS AND IT WANTS TO END THAT. BUT THE RULE DOESN’T KICK IN IMMEDIATELY. THE TREASURY NEEDS THE INCOME TAXES THAT WILL BE GENERATED BY ROTH CONVERSIONS OVER THE NEXT DECADE.
Furthermore, this section prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021.
WE COVERED THESE SO-CALLED “MEGA BACK DOOR ROTH IRAS” IS IN THE AUGUST 1ST NEWSLETTER AND EXPLAINED THAT, BECAUSE OF THE IRS’S NON-DISCRIMINATION TESTING, THEY TYPICALLY DON’T WORK WELL FOR MOST PRACTICE OWNERS TO BEGIN WITH.
THE SECOND PART OF THIS SENTENCE, HOWEVER, SEEMS TO PROHIBIT BACK-DOOR ROTH IRA CONTRIBUTIONS STARTING NEXT YEAR FOR EVERYONE, REGARDLESS OF INCOME LEVEL. IF YOU INTEND TO MAKE A BACK-DOOR CONTRIBUTION THIS YEAR AND HAVEN’T DONE SO, BE SURE IT’S COMPLETED BY YEAR-END.
Prohibition of IRA Investments Conditioned on Account Holder’s Status.
The bill prohibits an IRA from holding any security if the issuer of the security requires the IRA owner to have certain minimum level of assets or income, or have completed a minimum level of education or obtained a specific license or credential. For example, the legislation prohibits IRAs from holding investments which are offered to accredited investors because those investments are securities that have not been registered under federal securities laws. IRAs holding such investments would lose their IRA status. This section generally takes effect for tax years beginning after December 31, 2021, but there is a 2-year transition period for IRAs already holding these investments.
THIS IS WHAT WE’D CALL THE “ANTI-PETER THIEL RULE,” NAMED FOR THE TECH BILLIONAIRE WHO IS PURPORTED TO HAVE TAKEN A SMALL $2,000 INVESTMENT IN PAYPAL BACK IN THE LATE 1990’S AND TURNED IT INTO A $5 BILLION TAX-FREE ROTH IRA. SO NO MORE TAKING INVESTMENT RISKS IN START-UP VENTURES OR PRIVATE INVESTMENTS IN ROTH IRAS.
Statute of Limitations with Respect to IRA Noncompliance.
The bill expands the statute of limitations for IRA noncompliance related to valuation-related misreporting and prohibited transactions from 3 years to 6 years to help IRS pursue these violations that may have originated outside the current statute’s 3-year window. This provision applies to taxes to which the current 3-year period ends after December 31, 2021.
THE RULES CRACKING DOWN ON IRAS WILL BE SO LUCRATIVE TO THE FEDERAL GOVERNMENT THAT THE TRADITIONAL THREE-YEAR STATUTE OF LIMITATIONS WILL BE INCREASED TO SIX.
Funding of the Internal Revenue Service.
This provision appropriates $78,935,000,000 for necessary expenses for the IRS for strengthening tax enforcement activities and increasing voluntary compliance, and modernizing information technology to effectively support enforcement activities. No use of these funds is intended to increase taxes on any taxpayer with taxable income below $400,000. Further, $410,000,000 is appropriated for necessary expenses for the Treasury Inspector General for Tax Administration to provide oversight of the IRS. Finally, $157,000,000 is appropriated for the Tax Court for adjudicating tax disputes. These appropriated funds are to remain available until September 30, 2031.
Limitation on Deduction for Qualified Conservation Contributions Made by Pass-Through Entities.
To curb syndicated conservation easement tax shelters, this provision denies charitable deduction for contributions of conservation easements by partnerships and other pass-through entities if the amount of the contribution (and therefore the deduction) exceeds 2.5 times the sum of each partner’s adjusted basis in the partnership that relates to the donated property. This general disallowance rule does not apply to donations of property that meet the requirements of the 3- year holding period rule, and contributions by family partnerships. In addition, certain taxpayers whose deeds are found to have certain defects and are notified by the Commissioner have the opportunity to correct such defects within 90 days of the notice. This ability to cure does not apply in the case of reportable transactions and transactions for which deduction is disallowed under this section.
Various accuracy-related penalties apply, including gross valuation misstatement penalty, and adjustments are made to the statute of limitations on assessment and collection by the IRS, in case of any disallowance of a deduction by reason of this provision.
This section applies to contributions made after December 23, 2016 (the date of the relevant IRS Notice). In the case of contributions of easements related to the preservation of certified historic structures, this section applies to contributions made in taxable years beginning after December 31, 2018. The ability to cure defective deeds are permitted for returns filed after the date of the enactment and for returns filed on or before such date if the section 6501 period has not expired as of such date.
ABUSIVE CONSERVATION EASEMENT TAX SHELTERS HAVE LONG BEEN ON THE IRS’S RADAR. NOW THEY ARE TARGETING AGGRESSIVE ONES DATING BACK TO LATE 2016.
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