Making headlines over the past few months has been the Biden administration’s Infrastructure Plan. On September 15, 2021, the House Ways and Means Committee advanced part of the Build Back Better Act, which includes proposed tax changes expected to generate over $2 trillion in federal funds. In total, the House bill is expected to cost $3.5 trillion. In August, the Senate also passed its version of the infrastructure bill, which is limited to $1 trillion in federal spending. According to House Speaker Nancy Pelosi, Biden’s $4.5 trillion infrastructure plan is expected to pass by the end of September. Changes made to the legislation must get approved in both chambers of Congress before it can get signed into law. Biden will have 10 days to sign or veto the bill after Congressional approval.
How will taxpayers pay for the Infrastructure Plan?
Below is a list of specific corporate tax changes based on the latest proposals from the House Ways and Means Committee, some of which will be followed by a more detailed breakdown:
- Reestablish a graduated corporate tax structure, which will be capped at 26.5% for companies making more than $10 million;
- Appropriate nearly $79 billion in Internal Revenue Service (“IRS”) resources to increase tax enforcement, voluntary compliance, and improve the IRS’s information technology to support enforcement activities;
- Increase the requisite holding period for carried interest and capital gains from three years at the corporate level to five years;
- Limit Qualified Small Business Stock exemptions for taxpayers with adjusted gross income exceeding $400,000 from;
- Modifications to Foreign Tax Credit Limitations (see below for further detail);
- Raise corporate taxes on Controlled Foreign Corporations to 16.5625%, which currently range from 10.5% to 13.125%;
- Raise the Base Erosion and Anti-Abuse Tax from 10% up to 15% by 2025; and
- Reduce the Qualified Business Asset Investment Exemption from 10% to 5%.
Increased Corporate Tax Rate
Currently, the corporate income tax rate is a flat 21%. If the House Ways and Means Committee’s proposals are passed, the flat rate will return to a graduated rate structure like it was before President Trump’s Tax Cuts and Jobs Act. As a result, the graduated rate structure will begin with an 18% rate on the first $400,000 of income; 21% up to $5 million of income; and 26.5% on any additional income. The domestic dividends received deduction will be adjusted to hold constant the tax on domestic corporate-to-corporate dividends.
Modifications to Foreign Tax Credit Limitations
Section 904 of the Internal Revenue Code (“IRC”) will be amended to require foreign tax credit determinations on a country-by-country basis for purposes of sections 904, 907, and 960. More importantly, the proposed amendment would limit the carryforward of excess foreign tax credits to the succeeding five tax years while the carryback of such credits will be repealed. Under current law, taxpayers are able to carryforward excess foreign tax credits for 10 years and carryback such credits 1 year. Such amendments would apply on a go-forward basis beginning after December 31, 2021.
Modification of Rules for Partnership Interests Held in Connection with the Performance of Services
The proposed changes to IRC § 1061 would extend the requisite holding period from three to five years for gains attributable to applicable partnership interests to qualify for long-term capital gain treatment. The proposed amendment also extends IRC § 1061 to all assets eligible for long-term capital gain rates. As a result, this could greatly impact sales in the marketplace as a result of the additional two-year holding period. The proposed amendment would begin for tax years beginning after December 31, 2021.
Wash Sales and its Possible Application to Cryptocurrency
The proposed change to the wash sale rules includes commodities, currencies, and digital assets. The wash sale rule was previously only applicable to stock and other securities and is intended to prevent taxpayers from claiming tax losses while retaining an interest in the loss asset. The proposed amendment would begin for tax years beginning after December 31, 2021.
Tax Increase for High-Income Individuals:
Increase in Top Marginal Individual Income Tax Rate
A major change that will assuredly impact taxpayers across the country is the Biden Administration’s proposal to increase the top marginal individual income tax rate to 39.6% from 37%. For married individuals filing jointly, the marginal rate will apply to taxable income over $450,000, to married individuals filing separately with taxable income over $225,000. For heads of households, it will apply to taxable income exceeding $425,000, to unmarried individuals with taxable income over $400,000, and to estates and trusts with taxable income over $12,500. The proposed changes would take place beginning with tax years after December 31, 2021.
Increase in Capital Gains Rate for High-Income Individuals
The long-term capital gains rate will increase from 20% to 25% under the proposed amendment. An interesting aspect of the proposed change includes a transition rule that will permit the 20% current rate to apply to preexisting gains and losses for the portion of the tax year prior to the date of introduction. As a result, if gains are recognized at a later date in the same taxable year arising from transactions pursuant to a written binding contract will be treated as occurring prior to the date of the rate change.
Limitation on Qualified Business Income Deduction
The purpose of the QBI was to allow owners of businesses other than C-Corporations the ability to lower their effective tax rates to be more in line with the current 21% corporate rate. QBI was originally intended to reward small business owners for creating jobs within their communities. With the proposed amendment, the QBI deduction will be limited to those earning less than $500,000 as married individuals filing jointly, $400,000 for individual returns, and $250,000 for married individuals filing separate returns. The proposed amendments will apply to tax years beginning after December 31, 2021.
Limitation on Excess Business Losses of Noncorporate Taxpayers
Biden’s administration is proposing to permanently disallow excess business losses for non-corporate taxpayers. In other words, net business deductions in excess of business income would be permanently disallowed; however, the provision allows taxpayers whose losses are disallowed to carry those losses forward to the next succeeding tax year. Accordingly, this may encourage corporate structure formations; however, with a corporate structure comes double taxation – once at the corporate level and once at the shareholder level. This could result in additional taxes being paid at the federal level. The proposed amendments will apply to tax years beginning after December 31, 2021.
Termination of Increase in Unified Credit
The Committee’s proposal would terminate the increased unified credit against estate and gift taxes, which is currently set at $11.7 million per person for 2021. The proposal will revert the credit to $5,000,000 per individual, indexed for inflation. For reference, the unified tax credit is a certain amount of assets that each person is allowed to gift to other parties without having to pay gift, estate, or generation-skipping transfer taxes.
Tax Treatment of Rollovers to Roth IRAs and Accounts
With the proposed changes, Biden’s administration will eliminate Roth conversions for IRAs and employer-sponsored plans for married taxpayers filing jointly with taxable income over $450,000, individual taxpayers with taxable income over $400,000, and heads of households with taxable income over $425,000 indexed for inflation. Additionally, the proposed change would prohibit all employee after-tax contributions to qualified plans along with converting any after-tax IRA contributions to Roth IRAs regardless of income level.
Statute of Limitations with Respect to IRA Noncompliance
In an effort to increase IRS enforcement, the Committee’s proposed change would extend the IRS’s statute of limitations for IRA noncompliance related to valuation misstatements and prohibited transactions from 3 years to 6 years.
Funding the IRS and Increasing Enforcement:
As previously mentioned, the proposal will allocate approximately $79 million to the IRS in an effort to increase taxpayer compliance through strengthened IRS enforcement activities. According to the proposal, none of the funds are intended to increase taxes on any taxpayer with taxable income below $400,000. As a result, high-income taxpayers should expect increased rates of IRS examinations. Additionally, the proposal will repeal a requirement that any assessment of penalties be approved by a supervisor of the IRS employee making such determination. While this may increase processing times, there may be an increased risk of erroneously assessed penalties.
The Biden Administration’s proposed tax changes are sure to cause sweeping changes to corporate and individual taxpayers across the country. According to the Tax Foundation, the Ways and Means Committee’s tax proposal may eliminate over 300,000 full-time equivalent jobs across the country while simultaneously reducing after-tax income for the top 80% of taxpayers.
If you or someone you know needs assistance due to the increased IRS enforcement, contact The Wilson Firm today.