Regulatory and Industry News Alerts from Armanino

House Proposes Broad Tax Increases for Individuals and Businesses

by David Sordello
September 17, 2021

The latest piece of the reconciliation plan from the House Ways and Means Committee has been unveiled, providing a new 645-page bill to create new tax breaks for renewable energy, social safety net, infrastructure bonding and health care proposals. The unofficial, initial outline of the House tax plan includes roughly $2 trillion in tax increases. Below, we outline some high-level bullets for you to consider:

Key Highlights

Increase of Corporate Tax Rate to 26.5% This is the top end of a graduated rate structure starting at 18% on the first $400,000, 21% on the next $4.6M and a rate of 26.5% on income higher than $5M. Corporations with taxable income over $10M are taxed at a flat 26.5% for all income. Personal service corporations are also not eligible for the benefit of graduated rates.
Individual Income Tax Rate Raised From 37% to 39.6% This tax rate applies to more income of the taxpayer than the current tax rate. Currently, the 37% tax rate applies to income at $523,000 for individuals and $628,000 for married couples. Under the House plan, the tax rate will kick in at $400,000 and $450,000 respectively.
Estate Tax Changes Effective January 1, 2022, the proposed plan drops the lifetime exemption to the year 2010 level of $5M (indexed for inflation so it might be close to $6M). This change is four years ahead of schedule when the Trump tax cuts expire in 2026.
Estate/Gift Valuation Changes The proposed plan disallows valuation discounts for passive assets with partial ownership. The valuation changes do not apply to businesses or farms.
Grantor Trust Changes The proposed plan changes the tax rules for new grantor trusts. A sale of assets to a new grantor trust would be treated like a normal asset sale for income tax purposes. Also, the assets in new grantor trusts will be included in a decedent’s estate.
Individual Retirement Accounts (IRA) Reforms The legislation disallows new contributions to an IRA if a balance exceeds $10M. The legislation also requires distributions when account balances reach a certain level.
New 3% “Surtax” On Income Over $5M When added with other taxes (e.g., net investment income tax), this brings the top marginal individual federal rate to 46.4% for ordinary income and 31.8% for capital gains.
Expansion of the 3.8% Net Investment Income Tax This tax would apply to virtually all income not subject to employment or self-employment tax for individual taxpayers with income greater than $400,000 (single) or $500,000 (joint).
Increase in Capital Gains Tax Rate from 20% to 25% for Those Making Over $400,000 With the current 3.8% net investment income tax, the capital gains tax rate will be 28.8%. Effective for sales after September 12, 2021, with exceptions for binding contracts. Also applies to qualified dividends. Unrecaptured Section 1250 gain apparently stays at 25%.

Additional Updates

Modifications to FDII, GILTI, FTC, BEAT & Other International Tax Regimes The chairman is proposing to raise taxes on multinationals but keep the proposals somewhat in line with the OECD negotiations, of which a global tax deal has not been finalized. Some changes to §163 are related to international financial reporting groups. The GILTI rate would be increased to a theoretical minimum of 16.5625% before considering QBAI and taxable income limitations, up from previous law minimum of 10.5%. The FDII rate would be increased to a theoretical minimum of 20.7% from the previous minimum of 13.125% (assuming the corporation is being taxed at the top corporate rate of 26.5%).
Limitation on Certain Special Rules for Section 1202 Gains (QSBS) QSBS is complex. Contact your tax advisor for additional information on how the proposed changes could impact your specific situation.
Research and Experimental (R&E) Delays the effective date for amortization of R&E expenditures starting taxable years beginning after December 31, 2021, to taxable years beginning after December 31, 2025.
Holding Period for Carried Interest The increase in the capital gains tax rate lowers the spread between ordinary income and capital gains, thereby closing some of the carried interest spread. The legislation further proposes that the holding period to qualify for carried interest increase from its current three-year period to a five-year period. Real estate businesses retain a three-year holding period.
Cuts the Small Business Deduction Currently, business owners who pay the individual income tax, including REITs and publicly traded partnerships, receive a 20% deduction for their qualified business income. This deduction is ended for business owners with more than $500,000 in a joint return and $400,000 for a single taxpayer.<

Context: A small business owner with $500,000 of income will see their income tax rate increase, the amount of income subject to that tax rate increase, be subject to the 3.8% net investment income tax, and lose a 20% deduction. This business owner could be looking at a 46-48% income tax rate before considering payroll taxes and state/local taxes.
Tobacco Tax Increase Expands tax to vaping products.
Income Deduction Limitations for Employees with Compensation Over $1M of Income Expands the number of covered employees under §162(m) for tax years beginning after December 31, 2021.
IRS Enforcement Allows for $80B of funding for IRS audits of high-income taxpayers. The Congressional Budget Office says this could yield $200B of revenue over 10 years.
Advanced Refunding of Municipal Bonds The legislation reinstates the tax exemption on interest from state and local government refunding bonds.
Build American Bonds 2.0 The legislation proposes to reinstate a version of Build America Bonds, which allows qualified infrastructure bonds to receive an applicable percentage of interest to finance infrastructure projects.

Other Proposed Changes

There are additional, pharma-specific industry changes outlined in the legislation, including a provision for the U.S. government to negotiate the price of drugs for Medicare for 25 drugs in 2025, and 50 drugs thereafter. There are also some Medicare implications.

Notably, hot topics such as Section 1031 changes, the loss of step-up in basis at death and changes to the $10,000 state and local tax (SALT) cap were left out of the proposal.

Overall, this is only an overview of what could pass. The tax proposals may change before the bill is finalized, and the above is preliminary and subject to change. If you’d like to discuss any of the above proposed changes, don’t hesitate to reach out to your local Armanino tax expert.

This communication is provided as an educational service by Armanino LLP for clients and friends of the firm. This communication is an overview only, and it should not be construed as legal or tax advice or advice to take any specific action. Individuals or organizations should consult with their tax/legal advisors before making any tax/legal-related decisions.

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