On September 13, 2021, the House Ways & Means Committee of the U.S. House of Representatives released the draft text of its proposed budget reconciliation bill (the “Build Back Better Act [First Draft]”), and on September 15, 2021 it approved various sections of the proposal. The Committee released an updated draft on October 28, 2021 (the “Build Back Better Act [Second Draft]). The Second Draft omitted many sections from the First Draft kept the rest with relatively little alteration. The Committee released a further draft on November 3, 2021 (the “Build Back Better Act [Third Draft]”) which returned certain sections from the First Draft. On November 5, 2021, the changes detailed below were approved by the Senate and are going to be voted on in the House of Representatives. This document reflects the potential tax implications for the Third Draft.
It is important for clients to note that as of the date of this article, these proposals are not the law, and are subject to ongoing negotiations. The proposed provisions could change considerably and there is no guarantee that any of the provisions will become law. Nevertheless, this article is to alert clients of the potential changes to individual taxpayers and the resulting consequences of such changes if they are approved. We encourage our clients to be proactive and plan in advance of possible impending changes.
Potential Tax Impact to Individual Taxpayer: Effective – January 1, 2021
- Increase to Allowable State and Local Tax Deduction (§137601): Currently, up to $10,000 may be deducted for state and local taxes. If passed, the new limitation would be $72,500 ($36,250 married filed separately). This would be effective through 2031.
Potential Tax Impact to Individual Taxpayer: Effective – January 1, 2022
- Net Investment Income Tax Expanded (§138201): Under current law, a 3.8% tax is imposed on Net Investment Income (NII) on certain individuals, estates, or trusts if a trade or business is a passive activity for the taxpayer (i.e., the taxpayer does not materially participate in the trade or business). In other words, the 3.8% tax does not apply to income from a trade or business conducted as a sole proprietor, partnership, or S Corporation, if the taxpayer materially participates in the trade or business. Under the proposal, the 3.8% tax would be imposed on the NII of high-income individuals (taxpayers with greater than $400,000 in modified adjusted gross income (single filer) or $500,000 (joint filer)) regardless of whether the trade or business is a passive activity for the taxpayer so long as the income isn’t already subject to the Federal Insurance Contribution Act (FICA) or Self-Employment Tax.
Additionally, the current tax is 3.8% of the lesser of NII or the excess of modified Adjusted Gross Income (AGI) over a set dollar amount. For trusts and estates, the current tax is 3.8% of the less of undistributed net income, or the excess of AGI over a set dollar amount. The drafted legislation also proposes to expand the definition of the NII subject to the tax by stating the 3.8% tax would apply to the greater of specified net income or NII. For trusts and estates, the 3.8% would apply to the lesser of (1) the greater the undistributed specified net income or undistributed NII; or (2) the excess AGI over the set dollar amount.
- High Income Surcharge Tax (§138203): This proposal would impose a surtax equal to 5% of a taxpayer’s modified adjusted gross income in excess of $10,000,000 ($20,000,000 if married, filing separately) and an additional 3% of a taxpayer’s modified adjusted gross income in excess of $25,000,000. For this purpose, the modified adjusted gross income would be defined as the adjusted gross income reduced by any allowed deductions.
- Rollover and Conversion Limits; Eliminate Back Door Roth IRAs (§138311): This proposal would prohibit after-tax IRA or employer plan contributions from being converted to Roth accounts for all taxpayers irrespective of income level.
- IRA Non-Compliance Statute of Limitations Extended (§138312): This legislation would extend the statute of limitations for IRA noncompliance related to valuation related misreporting and prohibited transactions from 3 years to 6 years. This would apply to taxes to which the current 3-year period ends after December 31, 2021.
- IRA Owners Treated as Disqualified Persons (§138313): The legislation proposes to further clarify that IRA owners (including individuals who inherit an IRA as beneficiary aft the IRAs owner’s death) are always disqualified persons for the purpose of applying the prohibited transaction rules.
- Holding DISC or FSC In IRA (§138503): An IRA holding an interest in a Domestic International Sales Corporation (DISC) or Foreign Sales Corporation (FSC) that receives commission or payment from any entity, stock, or interest owned by the individual for whose benefit the IRA is established, is a prohibited transaction.
Potential Tax Impact to Individual Taxpayer: Effective – Enactment Date (January 1, 2022)
- Deductions for Attorneys Representing in Contingency Fee Cases (§138518): If passed, expenses made that would be repaid contingent on recovery or settlement would be included as Section 162 (ordinary business expenses) deductions.
Potential Tax Impact to Individual Taxpayer: Effective – January 1, 2029
- Contribution Cap on Individual Retirement Plans of High-Income Taxpayers (§138301): The proposed legislation would prohibit new contributions to a Roth or traditional Individual Retirement Accounts (IRAs) if the total value of all of the taxpayer’s IRAs exceeds $10 million at the end of the prior tax year. However, rollover contributions shall not be treated as new contributions. This provision would only apply to individuals whose adjusted taxable income exceeds $400,000 (single filer) or $450,000 (joint filer).
- Increased Required Minimum Distributions for Excess Balances (§138302): This legislation would impose new required minimum distributions for taxpayers whose adjusted taxable income exceeds $400,000 (single filer) or $450,000 (joint filer) and whose combined IRAs (Roth, traditional, and defined contribution plan) exceed $10 million at the end of year. These individuals, regardless of their age, would be required to take a minimum distribution in the following year of an amount equal to 50% of the amount by which the aggregate accounts exceed $10 million. For taxpayers whose aggregate account balances exceed $20 million, the taxpayer will be required to draw the lesser of: (1) the amount needed to bring the aggregate balance down to $20 million; or (2) the aggregate balances in all Roth IRAs and designated Roth accounts.
Potential Tax Impact to Individual Taxpayer: Effective – January 1, 2032
- Rollover and Conversion Limits; Eliminate Back Door Roth IRAs (§138311): This proposed legislation would eliminate the “backdoor” conversions of traditional IRAs or employer plan accounts to Roth IRAs for a taxpayer whose adjusted taxable income exceeds $400,000.
NOTE: This article does not list all of the legislation being proposed in the Build Back Better Act. It is merely a list of the provisions we believe to be most relevant to a majority of our clients. Please contact your tax attorney to discuss the potential legislation and how it may or may not affect your planning needs. Although it is impossible to know which provisions will pass, possible tax-planning strategies may still be available to those who would like to act in advance of the impending change.
Please contact The Burton Law Firm at 916.822.8700 or email@example.com for more info.