Tax Laws: Proposed Changes

October 20, 2021 | David Givler, CFP®, Director of Financial Planning, Financial Advisor

The House Ways and Means committee recently published a number of proposed tax increases to pay for the potential $3.5 million infrastructure bill. We summarized the key components relevant to individuals, businesses and estate planning. Please note this is an initial proposal and revisions are possible before finalized.

Individuals

The highest marginal tax rate increases from 37% to 39.6%. On top of that, the income threshold for the highest tax bracket reduces from $628,000 to $509,000 for joint filers.

The highest capital gains tax rate would increase from 20% to 25% and adding on the net investment income tax (NIIT) of 3.8%, results in a total capital gains tax rate of 28.8%. This applies to individuals and married couples earning annual income over $400,000 and $450,000, respectively. The changes to the capital gains rate could pass as a retroactive measure, which would limit the planning around these transactions.

The proposal includes a newly created 3% surtax on individuals whose modified adjusted gross income (MAGI) exceeds $5 million.

Additional language eliminates backdoor Roth conversions for single filers with income in excess of $400,000 and $450,000 for those married filing jointly.

Businesses

One of the biggest changes for pass-through entities such as limited partners, LLCs, and S corporation shareholders is the taxation of their proportionate share of business income. Currently, the 3.8% investment income tax is only applicable to active income such as salaries, but these changes impose the 3.8% tax on all income both passive and active.  

The proposal caps the qualified business income deduction (QBI), which is available to certain qualified trades and businesses, at $500,000 for joint filers, $400,000 for single filers and $10,000 for trust/estate returns. Right now, there is no limitation on the deduction amount.

We currently have a flat 21% corporate income tax rate. The new tax laws would create the following tax brackets and income thresholds:

  • 18%: $0 to $399,999
  • 21%: $400,000 to $5,000,000
  • 26.5%: Greater than $5,000,000

If possible, business owners impacted by these changes should consider deferring some losses or business expenses until 2022 while accelerating income in 2021. 

Estate

The individual estate and gift exemption amount would decrease from $11.7 million to approximately $6.0 million starting January 1, 2022.

The proposal outlines significant changes to grantor trusts created after 2021. These trusts would be includable in the gross estate and subject to estate tax. Additionally, contributions to grantor trusts from January 1, 2022 onward causes a proportional amount of the trust to be included in the estate. 

Irrevocable life insurance trusts (ILIT) require special planning because annual insurance premiums are sometimes classified contributions to a grantor trust. This could ultimately undermine and defeat the purpose of the trust itself.

What is not included? 

To avoid any confusion we have identified a number of items publicly discussed, but not included in the proposal:

  • No changes to repeal the current cap on state and local deductions (SALT) of $10,000
  • There is no deemed sale at death and no elimination of the basis step-up at death
  • No increase in estate tax rates or estate tax rate surcharges for billionaires
  • There is no mention of a “Federal” rule against perpetuities to eliminate dynasty trust planning
  • Non-grantor trusts are not mentioned and there are no added limitations on grantor retained annuity trust (GRATs)

At this time, it is impossible to predict what proposals ultimately pass into law. With that in mind, we are monitoring negotiations out of Washington D.C. and as always, recommend individuals and families work with their professional team to review their financial plan once there is more clarity on the changes.

For more information on these proposed changes, take a look at this article: Now that tax change is more real, what should you do?

*Informational piece, please read Important Disclosures