The House Ways and Means Committee released their first draft of proposed tax changes on September 14, 2021, as part of their efforts to fund the Biden administration’s Build Back Better Program. The significant changes still need to undergo rigorous negotiations in the House and Senate before being sent to the president for his signature.
Though a fair amount of uncertainty remains as to the eventual law’s specifics, key insights emerged that can help you proactively prepare for possible tax law changes now rather than waiting for the final bill.
A Note on Process
House and Senate tax proposals fall under a fiscal year 2022 budget resolution that provides reconciliation instructions. The original package of spending and tax relief provisions added up to roughly $3.5 trillion, offset in part by corporate and individual tax increases.
Democrats are looking to use budget reconciliation as a way of enacting this legislation with a simple majority, as Republicans are reluctant to sign off on a spending bill of this size. This would require a “Yes” vote from every Senate Democrat; however, within the Democratic Party there are differing opinions on the final scope and size of the spending package.
Overview of Individual Tax Proposals
The following sections cover high-level proposals for individuals and planning considerations.
It’s more important than ever to consult and collaborate with your advisors to ensure proper planning and execution of goals and objectives.
Sec. 138150. Limitation on Certain Special Rules for Section 1202 Gains.
Taxpayers with an adjusted gross income exceeding $400,000 would no longer be able to take advantage of the special 75% and 100% exclusion ratios from certain qualified small business stock (QSBS) sales. Instead, they’ll revert to a 50% exclusion ratio.
If passed, this provision would apply to sales made after September 13, 2021.
Individuals need careful income and investment planning to diversify concentrated QSBS holdings and use the higher exclusion ratios.
For example, individuals may maintain their special exclusion ratios if they sell tranches of QSBS and combine that with other income that keeps adjusted gross income (AGI) under $400,000.
Sec. 138153 Wash Sales.
If this provision passes, the same wash sale rules which apply to stocks and other securities would also apply to commodities, currencies, and digital assets.
For the remainder of 2021, holders of volatile assets, such as cryptocurrency, that are currently in a loss position may consider selling their position to realize the loss for tax purposes without needing to wait to repurchase the same asset.
Sec. 138201. Increase in Top Marginal Individual Income Tax Rate.
The top marginal rate for taxable income above $400,000 for single filers or $450,000 for joint filers would rise to 39.6%.
If possible, you may want to consider pulling income into 2021 or pushing deductions into 2022.
Sec. 138202. Increase in Capital Gains Rate for Certain High Income Individuals.
Capital gains rates for high income individuals are proposed to increase from 20% to 25% at the top rate, effective September 14, 2021, so this proposal would impact any gains from that point on.
Given the retroactive nature of this proposal it may be difficult to avoid this higher tax rate where income exceeds $400,000. One strategy to consider would be using charitable donations to reduce taxable income below the threshold of higher taxed gains.
Sec. 138207. Termination of Temporary Increase in Unified Credit.
This would eliminate the provision in the tax law passed in 2017, commonly referred to as the Tax Cuts and Jobs Act (TCJA), that temporarily raised the estate tax exemption to $11.2 million.
While plans exist to reverse that in 2025, this provision reverts the exclusion to the 2010 level of $5 million per individual—indexed for inflation, approximately $5.85 million.
While there doesn’t appear to be any claw back for gifted assets prior to December 31, 2021, any unused credit would expire.
Individuals and families would be wise to consult with an estate planning attorney to see how to take advantage of the current exemption before missing out.
Sec. 138209. Certain Tax Rules Applicable to Grantor Trusts.
Grantor trusts let individuals shift assets outside of their estate while still exerting some control over the trust. This provision would pull those assets back into the estate of the grantor, but apparently the provision does not apply to legacy trusts. However, future trusts or future transfers could create issues for the grantor.
Stay connected with your estate planning attorney; no one knows how this provision may affect years of planning, especially around life insurance trusts, qualified personal residence trusts, and charitable trusts.
Sec. 138311. Tax Treatment of Rollovers to Roth IRAs and Accounts.
This provision would close the back door on Roth conversions, preventing individuals from making after-tax contributions to qualified plans or after-tax individual retirement account (IRA) contributions, then convert them to a Roth IRA.
This provision would also eliminate Roth conversions for individuals with incomes above $400,000 for single filers and $450,000 for joint filers.
If you plan to use your nondeductible 2021 IRA or qualified plan contribution to convert to a Roth, be sure to do so in 2021. Don’t wait until next year.
Sec. 138312. Prohibition of IRA Investments Conditioned on Account Holder’s Status.
IRA owners would no longer be able to hold unregistered investments and securities according to federal securities legal requirements.
These securities require individuals to be accredited investors who are often illiquid in nature, which could prove challenging given the two-year transition period for IRAs already holding these investments.
Start looking at your retirement accounts now and work with your advisor to see what options exist to remove any prohibited investments out of your IRA.
It may be challenging to liquidate some unregistered investments. Reach out to sponsors of these investments to inquire about your options.
We’re Here to Help
To assess how you may be able to proactively prepare for potential changes to tax laws, contact your Moss Adams professional.