*Editor’s Note: This blog has been updated as of October 20, 2021.

On Monday, September 13, 2021 the House Ways and Means Committee released proposed tax changes that will be included in the “Build Back Better” Act. There are several potential changes on the horizon, including raised tax rates for individuals and corporations. Here’s what you need to know about the $3.5 trillion proposed package.

Changes potentially coming for businesses

Tax Rate- The current flat 21% corporate tax rate could change to a graduated rate, as follows:

The graduated rate would phaseout for businesses making more than $10 million.

GILTI and FDII- The bill proposes reducing the Section 250 deduction with respect to foreign derived intangible income (FDII) and global low taxed intangible income (GILTI). Combined with the proposed 26.5% corporate rate, this would result in a 16.5625% GILTI rate and a 20.7% FDII rate. GILTI would be applied on a country-by-country basis.

S corps- S corps that elected S corp status prior to May 13, 1996 can convert to a partnership tax-free anytime within the two years following passage of the act.

Interest deduction limitation- The bill would limit the interest deduction of certain domestic corporations that are members in an international financial reporting group to an allowable percentage of 100% of net interest expense. The interest limitation would apply only to domestic corporations for which the average excess interest expense over interest includible over a three-year period exceeds $12 million.

Carried interest and capital gains- The holding period required for gain attributable to an applicable partnership interest to qualify for long-term capital gain treatment would be extended from three to five years. The Act would retain the three-year holding period for real property trades or businesses and taxpayers with an adjusted gross income (AGI) less than $400,000.

Our thoughts: “There has been a lot of interest in the changes to carried interest as well. The legislation further erodes the favorable tax treatment afforded to carried interest holders by extending the current 3 year holding period needed to qualify for capital gain treatment to 5 years for those with incomes over $400,000.”

Section 1202 stock-The special 75% and 100% exclusion rates for gains realized from certain qualified small business stock would not apply to taxpayers with AGI over $400,000.

Our thoughts: “There’s been a lot of interest when it comes to what’s changing on the QSBS front. Those with AGIs over $400,000 will want to take advantage of the special 75% and 100% exclusion of capital gains before the law changes.”

BEAT- The BEAT, or Base-Erosion and Anti-Abuse Tax would face various changes under the act, including:

• BEAT rate in Section 59A(B)(1)(A) would be 10% for tax years beginning after December 31, 2021, and before January 1, 2024
• BEAT rate would be 12.5% for tax years beginning after December 31, 2023 and before January 1, 2026
• BEAT rate would be 15% in any tax year beginning after December 31, 2025
• The BEAT amount would be determined factoring in tax credits.

Changes potentially coming for individuals

Tax Rates- The top marginal individual income tax rate would be increased to 39.6%, applicable to married individuals filing jointly with taxable income over $450,000, to heads of household 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.

Qualified business income deduction- The maximum allowable QBI deduction would be set at $500,000 for joint returns, $400,000 for individual returns, $250,000 for married individuals filing separate returns and $10,000 for trusts/estates.

Capital Gains- The capital gains tax rate would increase from 20% to 25%. The bill also proposes a transition rule which would provide that the current 20% rate would still apply to gains and losses for the portion of the tax year prior to September 13, 2021 as well as for transactions under binding contract that haven’t been completed yet.

Our thoughts: “We still have a long way to go in terms of negotiation, but there are still opportunities for businesses and individuals to plan. If you are considering a major sale or transaction, do it sooner rather than later as capital gains are likely to increase.”

High income surcharge- Taxpayers with modified adjusted gross income (MAGI) in excess of $5 million (or $2.5 million for married individuals filing separately) would be subject to a 3% high-income surcharge.

Trusts- Trusts will go to the highest tax rate at $13,450 in 2022. Trusts that have S corp or other profitable business ownership interests will be subject to 3.8% at $13,450, unless income is pushed out to beneficiaries.

IRA contributions- Those with individual retirement accounts (IRA) would be prohibited from making further contributions for a tax year if the value of their IRA and defined contribution retirement accounts exceeds $10 million as of the close of the last tax year. This limitation would apply to single taxpayers with taxable income over $400,000, married filing jointly with taxable income over $450,000 and heads of household with taxable income above $425,000. Also, the backdoor Roth IRA contributions loophole would be eliminated for high-earners.

Net investment income tax (NIIT)- The NIIT would be expanded to include net investment income from the ordinary course of a trade/business for those with greater than $400,000 (single) or $500,000 (joint and trusts/estates)

Limitation on excess business losses- The bill proposes permanently disallowing noncorporate taxpayers from claiming excess business losses.

RMDs- Individuals with combined traditional IRA, Roth IRA and defined contribution retirement account balances exceeding $10 million at the end of a tax year would be required to take a required minimum distribution (RMD) for the following year. The RMD would typically be 50% of the amount that exceeds the $10 million limit.

Roth IRA conversions- Individuals with IRAs and employer sponsored plans for single taxpayers with taxable income over $400,000 would not be allowed Roth Conversions. The same applies to married taxpayers filing jointly with taxable income over $450,000 and heads of household with taxable income over $425,000.

Changes to gift and estate planning- The $11.7 million per person lifetime exemption drops to $5,850,000 as of January 1, 2022 (no change in flat 40% tax rate). Pending enactment, grantor trust benefits would be eliminated, as well as discounts on gifts (except for sales of active trades or businesses).

“While nothing is certain at this point, it is pretty clear things are going to get more expensive from a gift and estate tax perspective,” comments Dave Desmarais, Partner in our Private Client Services Group. “Absent any new legislation, the increased gift/estate tax exemption was due to expire 12/31/25 so it was already a smart idea to meet with your team of advisors to address your gift/estate planning needs before the end of the year.”

Questions on these potential changes? Contact us. We will keep you posted if/when legislation becomes final.