Federal Tax Update: Reconciliation Bill Proposals from the House Ways and Means Committee

Federal Tax Update: Reconciliation Bill Proposals from the House Ways and Means Committee

On September 13, 2021, House Ways and Means Committee Chairman Richard Neal (D-MA), released the tax portion of the "Build Back Better" reconciliation bill, outlining proposed tax increases and tax relief provisions drafted by House Democrats titled, "Responsibly Funding Our Priorities."

According to estimates by the Joint Committee on Taxation (JCT), the proposals are projected to raise federal revenues by more than $2 trillion over the next 10 years to help offset the cost of $3.5 trillion in spending through tax relief packages. The document includes 18 pages of changes to the current enacted tax law.

Below is a comprehensive summary of the potential changes we believe will have the largest effect on the current federal tax system.

Tax Relief Proposals:

• Extension of expanded child tax credit – The provision will extend expanded child tax credit benefits passed under the COVID-relief American Rescue Plan Act (ARPA) passed earlier this year. The ARPA increased the child tax credit on a temporary basis from $2,000 per child in 2020 to $3,600 for each child under 6. For children ages 6-16, the credit was increased from $2,000 to $3,000 and the ARPA made prior ineligible 17-year-olds eligible for the $3,000 credit. Through the ARPA, these are currently being delivered to eligible families on a monthly basis. These provisions were set to expire at the end of 2021 but will be continued through 2025 under the new proposal.
• Green energy tax credits - The legislation includes multiple "green energy" tax credits. These consist of expansion of several existing tax credits and new credits. New credits created include, but are not limited to, a credit for emerging technologies, a credit for qualifying commercial electric vehicles, and a credit for plug-in electric vehicles for individuals.
• Other proposed non-tax relief provisions - Non-tax relief measures include retirement savings incentives, expanded Medicare health benefits, proposals dealing with the Paid Family Leave Act, childcare assistance, universal Pre-K, and two free years of community college.  

Individual Tax Change Proposals:

• Increased top individual tax rate - The legislative proposals include increasing the top individual income tax rate from 37% to 39.6%, effective for tax years beginning after 12/31/2021.
• High net income surtax - In addition to an increase in the effective tax rate for high net worth individuals there will be a 3% surtax on individuals with modified adjusted gross income in excess of $5 million and $2.5 million for married filing separately.
• This income tax surplus would also apply to estates and trusts with modified adjusted gross income above $100,000.
• Increase in capital gain and dividend tax rate - An increase from 20% to 25% on the current top rate for capital gains and qualified dividend income. This varies from the Biden administration's proposed tax plan, which would tax the capital gains of high-income individuals at the same rate as ordinary income.
• Changes to net investment income tax (NIIT) - These proposals will expand the definition of net investment income tax (NIIT) to cover net investment income derived in the ordinary course of a trade or business for taxpayers with taxable income greater than $400,000 for single filers and $500,000 for joint filers. The tax imposed will be a 3.8% Medicare tax and will NOT be applied to wages on which FICA is already imposed. Currently, NIIT is only imposed on passive income such as interest, dividends, and capital gains.
  • Key point: If this proposal passes, then capital gains arising from the sale of a pass-through business would be subject to this additional 3.8% Medicare tax. Currently, this isn't the case.
  • The expanded definition of net investment income tax mentioned above under the "Individual Tax Change Proposal" section will apply to trusts and estates as well.
• IRA contribution limits and distribution mandates - There are provisions prohibiting high net worth individuals from contributing to their individual retirement accounts (IRAs) once their IRAs and defined contribution account balances reach $10 million. These would be effective beginning 12/31/21. Furthermore, the proposals would also mandate distributions once the value of assets in IRA, Roth IRA, and defined contribution accounts reach certain levels.

Trust & Estate Tax Change Proposals:

• Reduction in estate and gift tax exclusion - Acceleration of the scheduled expiration of 2017 Tax Reform Act (the 2017 Act) estate tax provision, which would reduce the federal estate and gift tax exclusion to the 2010 level of $5 million per individual.

Business Tax Change Proposals:

• Corporate income tax rate changes - The proposal replaces the flat corporate income tax rate with a graduated rate structure, increasing the top U.S. corporate tax rate from 21% to 26.5%, which is less than President Biden's proposed 28% rate increase. Companies would have an 18% rate on income up to $400,000, 21% on income up to $5 million, and 26.5% on any income above that. The benefits of the graduated rate would phase out for companies earning more than $10 million a year.
  • Key point: When the new proposed tax rate of 26.5% is coupled with the average blended state corporate tax rate, the effective U.S. corporate tax rate would be about 30.9%.
• Acceleration of the enactment date for new expanded limits on the deduction of executive compensation for publicly traded companies. Under the ARPA, this $1 million dollar limitation was expanded to include not just the CEO, CFO, and the three next highest paid employees, but the five next most highly compensated employees after that. The proposed regulations will push the enactment date of this law forward from years beginning after 12/31/26 to 2022.
• Higher limitation on Section 199A – qualified business income – deduction - Effective for tax years beginning after 12/31/2021, the Section 199A deduction for pass-through business income will be limited. The maximum allowed deduction for joint filers is set at $500,000 and $400,000 for individual filers.
• Excess business loss deduction limit would be permanent - The current limitation on excess business losses will be made permanent under the proposal. The current limit in place only allows up to $500,000 of business losses (indexed to inflation) to offset wage or other income in any year.
• Limitation on exclusion of gain from the sale of Qualified Small Business Stock – The proposals would deny the exclusion rates for gains realized from the sale certain Qualified Small Business Stock (QSBS) to taxpayers with AGI equal to or exceeding $400,000. This rule will be effective for sales and exchanges after September 13, 2021.

International Tax Change Proposals:

• Beginning after December 31, 2021, rate changes for both GILTI and FDII would be applied. The proposals would lower the IRC Section 250 deduction percentage for GILTI from 50% to 37.5% and for FIDII from 37.5% to 21.875%.
• S. shareholders would now be required to calculate its GILTI inclusion on a country-by-country basis. Resulting in tested losses in one country not being allowed to reduce GILTI inclusion attributable to tested income in another country. However, the proposal would allow tested losses to be carried forward to the next succeeding tax year to offset GILTI income, if any.
• The updated Foreign Tax Credit limitation calculation will now determine a U.S. shareholder's limit for all baskets on a country-by-country basis. The impact of this change will prevent U.S. shareholders from being able to utilize excess FTCs from high-tax jurisdictions by netting them against income from low-tax jurisdictions. Any excess FTCs, including excess GILTI FTCs would be able to be carried forward five years, with no carryback period. Current law allows no carryover for GILTI FTCs and a ten-year carryforward period with a one-year carryback period for non-GILTI FTCs.
• Updates being made to the definition of Subpart F income will result in foreign base company sales and services income currently taxed as Subpart F income to be taxed as GILTI tested income unless the transaction involves a U.S. resident, directly or by way of a branch pass-through.
• Updates to interest expense limitations, currently 163(j), will be calculated by limiting interest expense of a multinational groups U.S. operations to its proportionate share of the group's overall interest expense. Furthermore, the carryover period for amounts disallowed will be reduced to a five-year period and must be utilized on a first-in, first-out basis.

The House hopes to pass this new legislation using a process called budget reconciliation. Budget reconciliation was created by the Congressional Budget Act of 1974 and can be used to expedite certain tax, spending, and debt limit legislation. Instead of needing 60 votes, a reconciliation only requires a majority vote in the Senate to be passed. Furthermore, the Senate is not allowed to filibuster a reconciliation.

The budget reconciliation process can be arduous and tedious, and it is likely that not all the proposals summarized above will be included in the final proposed legislation and some additional proposals may be added. We will keep abreast of this proposed legislation as it evolves and will provide meaningful updates as they occur.

Article prepared by Susie Pancoast. For additional information contact us at info@herbein.com.