Legal Alerts

House Democrats Propose Detailed Federal Tax Changes, Mostly Increases

Washington, D.C. (September 15, 2021) - Late in the night on Sunday, September 12, 2021, Democrats on the House Ways & Means Committee leaked changes spanning much of federal tax law. On September 13, Ways & Means officially released a summary of the proposed changes and 645 pages of draft legislative text.

Above prescribed levels of income, most corporations, other businesses, and individuals would pay tax at higher rates on all income including capital gains. For example:

  • The top rate on corporate income would increase to 26.5%.
  • The top marginal rate on individuals would increase to 39.6%.
  • The top rate on capital gains of noncorporate taxpayers (including individuals) would increase to 25%.

Next Steps & Timing

These proposals initially will be considered by the House Ways & Means Committee. The Committee plans to review the proposals this week (starting Monday, September 13). This alert summarizes and highlights the proposals in deliberately sparse detail.

Caveats

Although increased tax rates and other tax changes have been rumored at least since President Biden was inaugurated, these proposals represent the first specifics toward possible legislation. Numerous additional steps toward actually enacting new tax legislation remain. Republicans continue seeking to derail tax increases, and various factions among Democrats do not necessarily agree about all the changes that have been proposed. Nevertheless, clients should start planning to anticipate changes, including effective dates.

Technical and other details of various proposals could change as the legislating process continues. In our experience, however, effective dates once proposed tend not to change unless the underlying substantive proposals significantly change.

In order to highlight these proposals soon after they surfaced, this alert does not attempt to cover every provision of the 645-page bill, nor do we analyze in detail the proposals it does summarize. However, members of Lewis Brisbois’ Tax Practice are pleased to entertain questions about any components of the proposals.

Corporate Income Tax Rates and Associated Rules

Rates

Currently, corporations are subject to federal income tax at a flat 21% of their taxable income. The bill would substitute graduated rates depending on the amount of a corporation’s taxable income:

  • 18% of income that does not exceed $400,000;
  • 21% of income that exceeds $400,000 but does not exceed $5 million; and
  • 26.5% of income that exceeds $5 million.
  • Taxable income exceeding $10 million would be subject to an additional 3% tax capped at $287,000.

Qualified personal service corporations would not be taxable at these graduated rates; all their taxable income instead would be taxed at 26.5 percent.

Effective Date: Taxable years beginning after December 31, 2021.

Individual Income Tax Rates and Associated Rules

Marginal Rates

Marginal income tax rates would increase for individuals the Bill considers “high income.” A top rate of 39.6% (increased from the current 37%) would apply to:

  • Married individuals filing joint returns and surviving spouses who earn income over $450,000.
  • Heads of households earning over $425,000. 
  • Unmarried individuals other than surviving spouses and heads of households earning over $400,000.
  • Married individuals filing separate returns earning over $225,000.
  • Estates and trust having over $13,450 of taxable income.

These threshold amounts would be indexed for inflation starting in 2023.

Effective Date: Taxable years beginning after December 31, 2021 (i.e., for most taxpayers, starting with tax year 2022).

Surcharge on High Incomes

Noncorporate taxpayers (individuals, trusts, and estates) would be subject to an additional tax equal to 3% of the modified adjusted gross income that exceeds:

  • $2.5 million in the case of a married individual filing a separate return;
  • $100,000 in the case of a trust or estate; and
  • $5 million for all other taxpayers.

Modified adjusted gross income means adjusted gross income reduced by any deduction allowed for investment interest (Internal Revenue Code (IRC) Section 163(d)).

Effective Date: Taxable years beginning after December 31, 2021.

Capital Gains

The maximum stated rate on capital gains of noncorporate taxpayers would increase from 20% to 25%.

Effective Date: Generally, the 25% rate will apply to capital gains realized in taxable years beginning after September 13, 2021. However, gains realized after that date under a written binding contract entered into on or before September 13, 2021 qualify to be taxed at the previous 20% capital gain rate. Capital gains realized before September 13, 2021 will be taxed at the current maximum rate of 20%. Consequently, many taxpayers will have to deal with blended capital gains rates depending on when in 2021 a gain is realized.

The maximum rate of 25% on capital gains will be re-aligned with the new top 39.6% marginal rate. The maximum zero rate on capital gains will apply up to: (1) $77,200 for a joint return or surviving spouse, (2) $51,700 for a head of household, (3) an amount equal to ½ the amount in effect for the taxable year for any other individual other than an estate or trust, and (4) $2,600 for an estate or trust. Remaining unchanged are the income levels at which the current 15% rate applies to capital gains.

Partial Exclusion of Gain from Selling Small Business Stock

Taxpayers having $400,000 or more of adjusted gross income no longer will be able to exclude from taxable income under IRC Section 1202 either 75% or 100% of gain from selling “qualified small business stock.” Additionally, trusts and estates no longer will qualify for the 75% or 100% exclusion regardless of income. The 50% exclusion will remain available for all taxpayers.

Effective Date: September 13, 2021 for all sales and exchanges other than those under a written binding contract entered into on or before September 12, 2021.

Net Investment Income Tax

The federal surtax of 3.8% on net investment income under IRC Section 1411 would remain and reach a broader range of income. Above specified levels of income, the tax now could be imposed on income derived in the ordinary course of an “active” trade or business unless the same income is subject to social security taxes (FICA or self-employment tax). The surtax’s expanded reach would apply to taxpayers whose modified adjusted gross income exceeds:

  • $400,000 for single filers;
  • $500,000 for joint filers and surviving spouses:;
  • $250,000 for married filing separately; and
  • $400,000 for any other case.

The bill clarifies that wages subject to FICA are not subject to the 3.8% surtax.

Effective Date: Taxable years beginning after December 31, 2021.

Qualified Business Income Deduction

The deduction for “qualified business income” or “QBI” under IRC Section 199A would be capped at prescribed amounts depending on a taxpayer’s filing status:

  • $500,000 for a joint return or surviving spouse;
  • $400,000 for a single return;
  • $250,000 for married individual filing a separate return; and
  • $10,000 for an estate or trust.

Effective Date: Taxable years beginning after December 31, 2021.

Estate Tax Changes

Exemption Amount

The amount (by value of assets) excluded from federal estate and gift tax (technically the “unified credit”) would revert to its level in 2010 of $5 million per individual, indexed for inflation.

Effective Date: Decedents dying and gifts made after December 31, 2021. For 2022, the Staff of the Joint Committee on Taxation estimates that the exclusion amount will approximate $6.02 million (determined by adjusting the base amount of $5 million for cumulative inflation starting when the base amount first was indexed for inflation).

Valuation of Family Farms and Family Businesses

Under IRC Section 2032A, the estate tax valuation of qualified real property used in a family farm or family business can be reduced by $750,000 ($1.19 million indexed for inflation in 2021). The bill would increase the allowable reduction to $11.7 million indexed for inflation after 2021.

Effective Date: Estates of decedents dying after December 31, 2021.

Grantor Trusts

The bill addresses in two ways uses of grantor trusts in estate planning considered in some quarters to be abusive. First, it includes grantor trusts in a decedent’s taxable estate when the decedent is the trust’s deemed owner and makes conforming changes involving gifts of interests in grantor trusts. Second, the amendments disallow losses on sales and exchanges between a grantor trust and its deemed owner.

Effective Date: Trusts created on or after the date of enactment and contributions to preexisting trusts on or after the date of enactment.

Valuation Discounts

For estate and gift tax purposes, the bill disallows the use of valuation discounts in valuing certain transfers of nonbusiness assets.

Effective date: Transfers after the date of enactment.

Partnership Taxation

Partnership Interests Held in Connection with the Performance of Services (Carried Interests)

In general, the bill broadens the reach of rules under IRC Section 1061 designed to prevent converting compensatory-flavored income taxable as ordinary income to capital gains taxable at lower rates.

The bill extends from three to five years the holding period required for long-term capital gain treatment (other than for real property trades or businesses and taxpayers having adjusted gross incomes under than $400,000). It also adds rules for measuring the three or five-year holding period (whichever applies).

The bill also modifies the rules applicable to sales or exchange transactions and expands the Treasury's regulatory authority to prevent avoidance of the purposes of the rules.

Effective Date: Taxable years beginning after December 31, 2021.

Qualified Conservation Contributions

The bill denies charitable deductions for contributions of conservation easements by partnerships and other passthrough entities if the amount of the contribution (and therefore the deduction) exceeds 2.5x the sum of each partner's adjusted basis in the partnership relating to the donated property.

Effective date: Generally, contributions made after December 23, 2016 (December 31, 2018, for contributions of easements related to preserving certified historic structures).

S Corporations Reorganizing as Partnerships

The bill allows eligible S corporations to reorganize as partnerships without triggering tax. An eligible S corporation is any corporation that was an S corporation on May 13, 1996.

The S corporation must completely liquidate and transfer substantially all its assets to a domestic partnership during the two-year period beginning on December 31, 2021.

Limitations on Losses and Deductions

Losses Generally

The bill expands circumstances under which losses from worthless securities and worthless partnership interests must be characterized as capital losses rather than ordinary losses under IRC Section 165.

Effective date: Taxable years beginning after December 31, 2021.

The bill defers loss on a taxable liquidation of a corporate subsidiary until the property received in liquidation is sold to a third party.

Effective date: Applicable to liquidations after the date of enactment.

Excess Business Losses of Noncorporate Taxpayers

The bill permanently disallows excess business losses (net business deductions exceeding business income) of noncorporate taxpayers for taxable years beginning after December 31, 2020. Under current law, this limitation, in IRC Section 461(l) will sunset after 2025.

Disallowed losses would continue to carry forward indefinitely. However, instead of being carried forward as net operating losses (NOLs), the disallowed amounts would continue to be treated as business deductions again subject to Section 461(l) until allowed.

Deductions of Employee Remuneration

The bill accelerates expansion of limitations on deducting excessive employee remuneration (IRC Section 162(m)). Under the American Rescue Plan Act of 2021, the limitation would cover a company's eight most highly compensated officers other than the principal executive and principal financial officers beginning in tax years after December 31, 2026. This expansion instead would apply for taxable years beginning after December 31, 2021.

International Taxation

The bill amends numerous rules subjecting domestic and foreign corporations to U.S. income tax. The thrust of many of the details is to increase the “minimum tax” the Biden Administration believes multinational corporations should have to pay. Among these amendments, the bill:

  • Limits interest deductions of certain domestic corporations that are members of an international financial reporting group.
  • Modifies deductions for foreign derived intangible income (FDII) and global intangible low-tax income (GILTI) and the rules under which GILTI is includable in taxable income. 
  • Modifies foreign tax credit limitations.
  • Narrows the categories of foreign base company sales income and foreign base company services income currently taxable to a domestic corporation under Subpart F of the IRC.
  • Broadens the scope of multinational corporations subject to the base erosion and anti-abuse tax (BEAT), an additional tax with respect to a corporation’s payments to foreign affiliates.

Retirement Plans

The bill amends and modifies rules relating to retirement plans. In general, these changes would reduce for “high income” individuals the benefits of deferring income through IRAs and other retirement plans. Among these amendments, the bill:

  • Prohibits upper-income taxpayers from further contributing to a Roth or traditional IRA if the total value of an individual's IRA and defined contribution retirement accounts exceeds $10 million, adjusted for inflation. 
  • Increases required minimum distributions (RMDs) for taxpayers whose retirement account balances exceed the $10 million (adjusted for inflation) limit.
  • Eliminates "back-door" Roth IRA conversions by upper-income individuals.
  • Prohibits investments in IRAs conditioned upon account holder’s status (determined under various benchmarks) and investments of IRA assets in non-public entities in which an owner has more than a 10% interest. 
  • Doubles from three years to six years the statute of limitations within which the IRS may challenge substantial valuation-related misreporting and prohibited transactions.

For more information on this bill, contact the authors of this alert. Visit our Tax Practice page for more alerts in this area.

Authors:

Michael J. Grace, Partner

Alexander Smith, Law Clerk

Additional Contributors:

John J. Heber, Partner

Sara Jane Holland, Partner

Related Practices


Related Attorneys

Find an Attorney

Each of the firm's offices include partners, associates and a professional staff dedicated to meeting the challenge of providing the firm's clients with extraordinary service.