Potential tax law changes have been on taxpayers’ minds for some time now. Unfortunately, there has been a lot of talk and not much action. That changed on Saturday, as the House Committee on the Budget voted to pass the $3.5 trillion spending bill out of committee and onto the floor.
Almost two weeks ago, thirteen committees approved legislation to be included in a reconciliation package. As a reminder, reconciliation is a congressional tool that makes legislation easier to pass in the Senate, and more specifically, will make it easier for Democrats to try to pass their policies without Republican support or the threat of the Republican filibuster. A reconciliation bill only needs a simple majority in the Senate.
The following are highlights from the draft legislative text, with a primary focus on the tax policy proposed by the House Ways and Means Committee, the committee primarily responsible for funding President Biden’s economic and social agenda:
- Increase in the individual income tax rate. The proposal would increase the top marginal individual income tax rate from 37% to 39.6% for joint filers with taxable income over $450,000 and for individuals earning more than $400,000. President Biden’s proposal called for the same top tax rate, but for thresholds of $509,000 for joint filers and $452,000 for individuals.
- A new 3% surtax. The surtax would be imposed on individuals with adjusted gross income in excess of $5 million.
- Immediate impact on trusts. The higher tax rates would affect substantially all trusts that pay an income or capital gains tax. Similar to the current rules, trusts would pay tax into the highest tax bracket almost immediately (income in excess of $13,450). Many trusts would also be affected by the new 3% surtax.
- Increase in the capital gains rate. The proposal would increase the capital gains rate to 25% as of the effective date of the draft legislative text (September 13, 2021). Transactions supported by a written binding contract that were entered into prior to this date will be treated as if occurring prior to the effective date. President Biden’s proposal called for a much higher threshold ($1 million) than the House’s proposal ($400,000).
- Increase in the corporate income tax rate. The proposal would create a graduated rate structure, replacing the current flat corporate income tax. The new structure would provide for an 18% rate on the first $400,000 of income; 21% on income up to $5 million; and then 26.5% on income thereafter. The highest corporate tax rate under President Biden’s proposal was 28%.
- Carried interest. The proposal would increase the holding period on investments from three years to five years in order to qualify for preferential rates on carried interest. The proposal also defines when the holding period would commence, includes restrictions on entering and exiting funds, and transfers of interests. President Biden proposed an elimination of preferential tax rates on carried interests.
- Limitation on the Section 199A deduction. The proposal would limit the allowable deduction to $500,000 for joint filers and $400,000 for individuals. An estate or trust would be limited to $10,000.
- Reduction in estate and gift tax exemption. The current exemption is scheduled to decrease from $23.4 for joint filers and $11.7 million for individuals to roughly $6 million in 2025. The proposal would accelerate the lower exemption by four years.
- Elimination of valuation discounts. The proposal would repeal the use of valuation discounts for certain non-business assets. Discounts typically taken are lack of marketability (an interest owned within a partnership) and lack of control (limited partner vs. general partner). The repeal would mean that partnership interests would be valued (and taxed) as if owned outright by the owner.
As notable as what was included in the draft legislative text is what was not included:
- Partial repeal of deferred gains from Section 1031 exchanges. President Biden proposed a limit on gains eligible to be deferred through Section 1031 exchanges to $1 million for joint filers or $500,000 for individuals for each year for real property exchanges that are like kind.
- State and Local Tax (SALT) deduction. Democratic lawmakers in California, New Jersey and New York have consistently expressed their desire to have the SALT deduction reinstated, but this appears unlikely for two reasons: (1) many state legislatures have since enacted SALT cap workarounds, and (2) the reported disproportionate benefit of the SALT deduction to white households versus brown and black households. Back in April, the Institute on Taxation and Economic Policy reported that “72% of the benefit of [the] SALT repeal would go to white households“ and that the repeal of the SALT cap without other reforms [could] worsen economic disparities and exacerbate racial inequities [that are] baked into the federal tax system.”
- Annual taxation of appreciated investments. Tax under current law is imposed upon the sale of an appreciated asset at a price that is in excess of the asset’s underlying basis. Senate Finance Committee Chairman Ron Wyden’s “Mark-to-Market” proposal would impose taxes annually on the change in an asset’s value year-over-year.
- The elimination of the “step up in basis” for gains in excess of $2.5 million for joint filers and $1 million for individuals.
There is still a long way to go before any of these proposals become law. A vote on the $500 million infrastructure bill could come this week. And, there is a looming battle over increasing the nation’s $28 trillion debt ceiling. If you are to take anything away from this post, it should be: don’t panic, stay informed/engaged, and remain flexible. Stay tuned to CLAconnect.com and the Real Estate Industry Insights blog for future updates. Major thanks to CLA’s National Tax Office for their contributions!
- Carey M. Heyman, Principal, CLA
Compliments of CliftonLarsonAllen LLP – a member of the EACCNY.