House Ways and Means Committee Addresses Reconciliation Bill Tax Increases

On September 13, 2021, Richard Neal (D-MA), chairman of the House Ways & Means Committee, released far-reaching tax proposals included in the $3.3 trillion reconciliation legislation under active consideration by Congress. This is one step in a multi-step process that will need to be completed before any legislation becomes law, and it is likely that many substantive changes will be made during that process. Most of the provisions are currently intended to be effective after December 31, 2021, with the principal exception of capital gains rate increases (described below). However, the effective date with respect to any tax law change remains uncertain until finalized.

Of special note is that these proposals do not address changes to the existing $10,000 cap on the deductibility of state and local taxes or an elimination of the step-up in basis at death. Both are likely to be the subject of further debate and discussion.

The following is a summary of the highlights of the Ways & Means Committee tax proposals:

Tax Increases for High-Income Individuals

• Beginning in 2022, the top marginal income tax rate would increase from 37% to 39.6% for married individuals filing joint returns with taxable income over $450,000; single taxpayers with taxable income over $400,000; and married individuals filing separate returns with over $225,000. This increase would also apply to trusts and estates with taxable income over $12,500.
• A surcharge tax equal to 3% of a taxpayer’s modified adjusted gross income (AGI) in excess of $5 million (or $2.5 million for a married individual filing separately) would be imposed.
• The net investment income tax would be extended to cover net investment income derived in the ordinary course of a trade or business for individuals with taxable income of greater than $400,000 or $500,000 for individuals filing a joint return, as well as for trusts and estates.
• The deduction for qualified business income would be amended by setting a cap on allowable deductions at $500,000 for individuals filing a joint return, $250,000 for a married individual filing a separate return, and $10,000 for a trust or estate.
• The bill would increase the long-term capital gains rate from 20% to 25%, effective for tax years ending after September 13, 2021. However, a transition rule provides that the preexisting statutory rate of 20% would continue to apply for the portion of the taxable year beginning prior to that date. Gains recognized later in the same taxable year that arise from transactions entered into before September 13, 2021 pursuant to a written binding contract (and which is not modified thereafter in any material respect) would be treated as occurring prior to September 13, 2021.
• The bill would permanently disallow “excess business losses” (i.e., net business deductions in excess of business income) for non-corporate taxpayers. The provision would allow taxpayers whose losses are disallowed to carry those losses forward to the next succeeding taxable year.

Estate and Gift Tax Provisions

• Reduction in Estate and Gift Tax Exclusion
  • The bill would reduce the federal estate and gift tax exclusion to its 2010 level of $5 million per individual, indexed for inflation, effective for decedents dying and gifts made after December 31, 2021.
• Certain Tax Rules Applicable to Grantor Trusts
  • The bill takes aim at grantor trusts and would essentially shut them down as a planning vehicle.
    • Assets held in a grantor trust would be includible in the grantor’s estate.
    • Distributions from grantor trusts (other than to the grantor or the grantor’s spouse) would be treated as gifts made by the grantor.
    • If a grantor trust ceases to be treated as such during the grantor’s life, the grantor would be deemed to make a gift of the trust assets.
    • Sales between a grantor and their grantor trust would no longer be disregarded for income tax purposes.
    • These rules would apply to any trusts created on or after the date of enactment and to any portion of the trust attributable to contributions made on or after the date of enactment.
• Valuation Rules for Certain Transfers of Nonbusiness Assets
  • The bill attempts to clamp down on estate and gift tax valuation discounts applied to transfers of family-owned entities by disallowing discounts for nonbusiness assets held in an entity. A nonbusiness asset is any passive asset which is held for the production or collection of income but is not used in the active conduct of a trade or business. So, for example, forming a family limited partnership or limited liability company and funding it with marketable securities would no longer be a viable strategy for transferring marketable securities at a discounted value.
  • This provision would apply to transfers after the date of enactment.

General Business Provisions

• Corporate Tax Rate
  • The bill would change the corporate income tax rate to 18% on the first $400,000 of income, 21% on income up to $5 million, and 26.5% on income above $5 million, phasing out the graduated tax rates for corporations with income above $10 million.
• IRC Sec. 1061 (Partnership Interests Held in Connection with the Performance of Services)
  • The bill would extend the three-year holding period required to qualify for long-term capital gains in connection with carry interests to five years, except for real property trades or businesses, and taxpayers with less than $400,000 of AGI. The bill would also extend the application of IRC Sec. 1061 to all assets eligible for long-term capital gain rates, not just specified assets currently listed in IRC Sec. 1061(c)(3). The bill would also provide that the holding period referenced above has to be satisfied with respect to both the holding period in the partnership as well as the partnership’s holding period in substantially all of its assets, and by applying similar rules in the case of tiered partnerships.
• IRC Sec. 1202 (Qualified Small Business Stock)
  • The 75% and 100% exclusion rates for gains realized from the sale of certain qualified small business stock would not apply to taxpayers with AGI of $400,000 or more. This change would also potentially have the effect of some of the gains on the disposition of qualified small business stock becoming subject to the Alternative Minimum Tax. This change would be applicable to sales and exchanges after September 13, 2021, subject to a binding contract exception.
• Cryptocurrencies
  • The bill would extend IRC Sec. 1259 constructive sales rules and IRC Sec. 1091 wash sale rules to digital assets, such as cryptocurrencies. (IRC Sec. 1091 would also be extended to commodities and currencies).
• Temporary Rule for Converting Certain S Corporations to Partnerships on a Tax-Free Basis
  • The bill would permit any corporation that was an S corporation on May 13, 1996, to convert or reorganize as a partnership on a tax-free basis, during the two-year period beginning on December 31, 2021.

Modification of Rules Related to Retirement Plans

• Contribution Limit for Individual Retirement Plans of High-Income Taxpayers with Large Account Balances
  • The bill would prohibit 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 exceeded $10 million as of the end of the prior taxable year. This 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).
• Increase in Minimum Required Distributions for High-Income Taxpayers with Large Retirement Account Balances
  • For taxpayers with taxable income in excess of the limits noted above whose 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 (generally in the amount of 50% of the amount by which the individual’s prior year combined account balances exceed $10 million).
    In addition, to the extent that the combined account balances exceed $20 million, that excess would be required to be distributed from Roth IRAs and Roth designated accounts in defined contribution plans (generally limited to the aggregate balance thereof).
• Tax Treatment of Rollovers to Roth IRAs and Accounts
  • In order to close the so-called “back-door” Roth IRA strategies, the bill would eliminate Roth conversions for both IRAs and employer-sponsored plans for taxpayers with taxable income exceeding the limits noted above. This provision would apply to distributions, transfers, and contributions made in taxable years beginning after December 31, 2021. Additionally, this provision would prohibit 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.
• Prohibition of IRA Investments Conditioned on Account Holder’s Status
  • The bill would prohibit 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; e.g.; investments offered to accredited investors. IRAs holding such investments would lose their IRA status. There is a two-year transition period for IRAs already holding these investments.
• Prohibition of Investment of IRA Assets in Entities in Which the Owner Has a Substantial Interest
  • To prevent self-dealing, the bill would adjust the 50% ownership threshold to 10% for investments that are not tradable on an established securities market, regardless of whether the IRA owner has a direct or indirect interest. The bill would also prevent investing in an entity in which the IRA owner is an officer. The bill also modifies the requirement to be an IRA rather than the prohibited transaction rules; i.e., in order to be an IRA, it must meet this requirement. There is a two-year transition period for IRAs already holding these investments.
• IRA Owners Treated as Disqualified Persons for Purposes of Prohibited Transactions Rules
  • The bill would clarify that, for purposes of applying the prohibited transaction rules with respect to an IRA, the IRA owner is always a disqualified person.

International Tax Provisions

• Interest Expense Limitations
  • The bill includes a new limitation on interest deductibility for domestic corporations that are members of an international financial reporting group. The proposal is similar to one proposed in the Tax Cuts and Jobs Act of 2017, and is intended to limit the interest expense of a multinational group’s U.S. operations to its proportionate share of the group’s overall interest expense. The U.S. share of the group’s interest would generally be determined by comparing a domestic corporation’s earnings before interest, taxes, depreciation, depletion and amortization (EBIDTA) to the worldwide group’s EBIDTA.
  • The bill would modify the existing IRC Sec. 163(j) limitation to apply at the partner, rather than partnership, level. Additionally, a newly proposed IRC Sec. 163(o) would limit the carryover period for amounts disallowed under IRC Sec. 163(n) or 163(j) to five years. For these purposes, interest would be allowed as a deduction on a first-in, first-out basis.
• Rate Changes
  • The bill would lower the IRC Sec. 250 deduction percentage for GILTI from 50% to 37.5%. When combined with the proposed corporate tax rate of 26.5%, the resulting effective rate on GILTI would be 18.5625%. Similarly, the IRC Sec. 250 deduction percentage for foreign-derived intangible income (FDII) would decrease from 37.5% to 21.875%, yielding an effective FDII rate of 20.7%. The rate changes would generally apply to tax years beginning after December 31, 2021, with special transition rules for fiscal year taxpayers.
• GILTI
  • The bill would require a U.S. shareholder to compute its GILTI inclusion on a country-by-country basis by aggregating the items (e.g., net controlled foreign corporation (CFC) tested income, qualified business asset investment (QBAI), etc.) of taxable units within a single foreign country and computing a separate GILTI amount for each country. The GILTI proposal differs in key aspects from the approach proposed by the Biden Administration. Unlike the Biden Administration proposal to repeal the QBAI exemption, the proposal would allow a QBAI return of 5% generally and 10% in U.S. territories.
• Foreign Tax Credit Limitation
  • The bill would determine a U.S. shareholder’s foreign tax credit (FTC) limitation for all baskets on a country-by-country basis. This would prevent excess FTCs from high-tax jurisdictions from being credited against income from low-tax jurisdictions.
• Covered Asset Dispositions
  • The bill would extend the principles of IRC Sec. 338(h)(16) to transactions treated as an asset disposition for U.S. tax purposes but as a stock disposition (or disregarded) for foreign tax purposes. Consequently, the source and character of any item resulting from a covered asset disposition would be determined for FTC purposes as if the seller had sold or exchanged stock (determined without regard to IRC Sec. 1248). This could result in a loss of FTCs because the source of the gain would be considered U.S.
• Dividends from Foreign Corporations
  • The bill would limit the IRC Sec. 245A deduction to dividends received from CFCs, whereas current law allows the deduction for dividends received from “specified 10%-owned foreign corporations.” The proposal would apply to distributions made after enactment. U.S. shareholders of a foreign corporation could jointly elect, however, to treat a foreign corporation as a CFC, potentially allowing dividends from otherwise non-CFCs to be eligible for the IRC Sec. 245A deduction. Such an election would subject the U.S. shareholders to GILTI and subpart F inclusions from the foreign corporation.
• BEAT
  • The bill would significantly modify IRC Sec. 59A while retaining its general framework. Specifically, the proposal would increase the BEAT rate from 10% to 12.5% for tax years beginning after December 31, 2023, and before January 1, 2026; for tax years beginning after December 31, 2025, the rate would increase from 12.5% to 15%. Additionally, the base erosion percentage threshold would be eliminated prospectively for any tax year beginning after December 31, 2023.
• Reinstate Prohibition on Downward Attribution
  • The bill would reinstate IRC Sec. 958(b)(4) to prohibit downward attribution from a foreign corporation, retroactive to December 31, 2017, and would add new IRC Sec. 951B to more narrowly allow downward attribution only to foreign controlled U.S. corporations.

With regard to the modifications related to the restoration of former IRC Sec. 958(b)(4) and the enactment of new IRC Sec. 951B, the proposal would apply to (A) the last taxable year of foreign corporations beginning before January 1, 2018, and each subsequent taxable year of such foreign corporations and (B) taxable years of U.S. persons in which or with which such taxable years of foreign corporations end.

Funding the Internal Revenue Service and Improving Taxpayer Compliance

• Increases to IRS Funding
  • The bill appropriates nearly $80 billion to the IRS over the next ten years. The funding is to be used to strengthen tax enforcement activities and increase voluntary compliance, expand audits and other enforcement activities, and modernize the agency’s information technology. The bill would also designate approximately $400 million over the next ten years for the Treasury Inspector General for Tax Administration, and would allocate $157 million to the United States Tax Court.
• Back-up Withholding on Third Party Network Transactions
  • The bill would expand the definition of “reportable payment” subject to withholding to include payments in settlement of third party network transactions where the aggregate payment during the calendar year is $600 or more. The proposal provides a transitional rule for 2022.
• Limits on Deductions for Qualified Conservation Contributions Made by a Partnership
  • The bill provides the latest attempt to curb abusive syndicated conservation easements. With limited exceptions for family partnerships and contributions outside of a three-year holding period, the proposal provides for full disallowance of any deduction claimed for a conservation contribution if the contribution exceeds 2½ times the partner’s relevant basis in the partnership. The proposal would also add the disallowance of a conservation contribution deduction as a gross valuation misstatement subject to a 40% penalty, and would remove both the availability of a reasonable cause defense and the requirement for IRS managerial approval of the penalty before assessment.

These provisions would generally apply to contributions made after December 31, 2016.

• Modification of Procedural Requirements Relating to Assessment of Penalties
• • The bill addresses the highly litigated issue of IRS managerial approval for penalty assessment by revenue agents, and would replace the requirement with quarterly certifications of compliance by appropriate supervisors of employees, effective beginning after the date of enactment.

EisnerAmper will continue to keep you informed on this important tax legislation as developments warrant.

Contributors to this article include Harold Adrion, Peter Alwardt, Stanley Barsky, Miri Forster, Karen Goldberg.