The House passed the $1.75 trillion Build Back Better Act on November 19, 2021, and the legislation is now under Senate consideration. Known as H.R. 5376, the legislation is the second prong of President Biden’s social and economic policy program. Although some of the most significant tax rate increases were taken out, the bill still includes provisions for higher taxes on corporations and high-wealth individuals, with the general effective date of 2022.
In the Senate, the bill must go through the reconciliation process to pass without being subject to a filibuster, and the bill managers are now negotiating the process with the Senate parliamentarian. The Senate Democrats want a vote by Christmas, but the path to passage is uncertain at this point.
Below is a summary of the major House-passed tax provisions of the bill. Note that these provisions could change by Senate amendment.
The Senate Finance Committee released its version of the tax provisions in the Build Back Better plan that proposes some changes from the House version. However, the changes will be subject to further negotiations with the House. One change is that the Senate version omits the SALT deduction increase but leaves a placeholder to put in a compromise proposal. The Senate also would make changes to the corporate minimum tax for pension income and would be more generous with
Corporate Tax Provisions
Corporate Minimum Tax
- 15% minimum tax on adjusted financial statement income for corporations with three-year average annual financial statement income in excess of $1 billion. Corporations under common control are aggregated.
- A corporation’s minimum tax would be the amount by which tentative minimum tax exceeds the corporation’s regular tax for the year.
- The tentative minimum tax is determined by applying a 15% tax rate to the adjusted financial statement income of the corporation, after taking into account AMT foreign tax credit and financial statement net operating losses. General business credits also can offset the tax.
- Effective for taxable years beginning after December 31, 2022.
Excise Tax on Corporate Stock Repurchases
- 1% excise tax on a publicly-traded US corporation for the value of stock that is repurchased during the tax year.
- The amount of repurchases subject to tax is reduced by the value of any new issuance to the public and stock issued to the employees.
- The subsidiary that performs buyback for its parent or a U.S. subsidiary of a foreign corporation that buys back its parent’s stock is subject to excise tax.
- Applies to repurchases of stock after December 31, 2021.
- The Excise Tax does not apply:
- if the total value of stock repurchased during tax year does not exceed $1 million.
- to tax-free reorganizations
- if the repurchased stock or its value is contributed to an employer-sponsored retirement plan, employee stock ownership plan or similar plan.
- if repurchase is by a dealer in securities in the ordinary course of business
- to repurchases by a RIC or REIT
- to the extent the repurchase is treated as a dividend
Worthless Securities, Losses in Taxable Liquidations
- Losses on securities are treated as realized on the day the event establishing worthlessness occurs.
- Partnership indebtedness is treated the same as corporate indebtedness.
- Abandoned securities are treated as worthless at the time of abandonment.
- Changes rules for taxable liquidations of corporate subsidiaries—losses are deferred until the property received in the liquidation is sold to a third party.
Aggregation Rules for Deduction Limit on Executive Compensation
- Changes the aggregation rules for deduction limit to apply to a parent-subsidiary controlled group.
- Compensation paid by different entities within an aggregated group is combined when determining whether deduction limitation is exceeded.
- Clarifies that the deduction limit applies to performance-based compensation, commissions and post-termination payments, whether or not paid directly by the publicly held corporation.
Reduced Small Business Stock Exclusion
- Higher Sec. 1202 exclusion of gain on small business stock of 75% and 100% would not apply to taxpayers with AGIs of $400,000 or above.
- Regular 50% exclusion would continue to apply to all taxpayers.
- Applies to all sales or exchanges of small business stock after September 13, 2021, subject to a binding contract exception. Note: This provision is retroactive.
Expansion of Wash Sale Rules to Digital Assets
Expands the types of assets subject to the wash sale rules to include commodities, foreign currencies and digital assets (including contracts or options to acquire or sell these assets).
The wash sales rules prevent taxpayers from claiming tax losses while retaining an interest in the loss asset.
Expansion of Constructive Sales Rules to Digital Assets
Expands the definition of “appreciated financial position” in the constructive sale rules to include positions with respect to “digital assets.”
Constructive sale rules treat the adoption of certain offsetting positions to previously owned positions as sales of the previously owned position.
The rules prevent taxpayers from locking in investment gains without realizing a taxable gain.
Rules Relating to Common Control
Clarifies that a taxpayer engaged in any activity in connection with a trade or business or any for-profit activity is subject to the Sec. 52 aggregation rules. Under the rules, taxpayers may be required to aggregate as a parent-subsidiary controlled group, a brother-sister controlled group, or a combined group of corporations.
Termination of Employer Credit for Paid Family and Medical Leave
Accelerates the termination of the employer credit for paid family and medical leave so it does not apply to wages paid after December 31, 2023.
The bill also includes four weeks of federally funded family and medical leave, so it appears this provision is related to that benefit.
Backup Withholding for Third-Party Network Payments
The American Rescue Plan Act of 2021 decreased the reporting threshold for Form 1099-K, Payment Card and Third-Party Network Transactions, from $20,000 in aggregate payments and 200 transactions to $600 in aggregate payments, with no minimum transaction requirement, effective 2022.
The bill provides a 2022 transition year reinstating the 200-transaction requirement before backup withholding is imposed on payees who fail to provide TIN.
Expensing of Research and Experimentation Costs
- Extends the expensing of research and experimental costs under Sec. 174 for expenses paid or incurred in tax years beginning before 2026. Expensing allows a current deduction.
- Expensing currently is scheduled to expire after 2021.
- Five-year amortization will not be required until 2026.
Passthrough Businesses
Excess Loss Limitation Made Permanent
- Permanently disallows excess business losses for noncorporate taxpayers, which are calculated as net business deductions in excess of business income.
- The provision limits the amount of trade or business deductions that can offset nonbusiness income to an amount indexed each year for inflation. For 2021, the limitation amount is $262,000 for singles and $524,000 for joint returns.
- Unused losses are no longer NOLS but are carried forward as excess business losses to be applied to limits in future years.
- Limits are effective in 2021 and continue permanently.
3.8% Net Investment Income Tax on Active Passthrough Income
- Extends the 3.8% net investment income tax to income from active passthrough businesses for taxpayers with incomes above $400,000 for singles and $500,000 for joint filers. Currently, the tax does not apply to active business interests.
- The NIIT would not be assessed on income on which FICA already is imposed.
- This means that any partnership and LLC income that is not treated as self-employment income will be subject to the tax. It also has the effect of removing the S Corporation payroll advantage which S Corporation shareholders can minimize payroll taxes by income as profit.
Increase in Payroll Tax Offset of Research Credit for Small Businesses
Doubles the current $250,000 limitation allowing small businesses to apply the research credit against their $500,000 in payroll taxes.
Individual Tax Provisions
High-Income Surcharge on Individuals, Estates and Trusts
- Imposes a 5% surcharge on modified adjusted gross income (MAGI) above $10 million.
- Imposes a 3% surtax on modified AGI above $25 million.
- “Modified adjusted gross income” means adjusted gross income reduced by any deduction allowed for investment interest.
- For trusts and estates, the 5% tax would be imposed on MAGI of more than $200,000 and an additional 3% on MAGI over $500,000.
Tax Benefits And Incentives
SALT Deduction Cap Raised
Increases the state and local tax deduction from $10,000 to $80,000 through 2030 and reduces it to $10,000 in 2031.
Employer’s Childcare Credit
- Increases the credit for employers providing childcare assistance to employees from 25% to 50%.
- Increases the dollar limitation from $150,000 to $500,000.
Electric-Vehicle Tax Credits and Other Green Energy Incentives
- $4,000 credit amount
- Higher credit for domestic components
- Credit phases out based on MAGI
- A price limitation applies.
The bill also includes extensions of many green energy incentives, such as energy and production credits.
Higher Child Tax Credit
- Extension and modification of child tax credit and advance payment for 2022-2025. Note that married taxpayers with up to $400,000 in income can claim a portion of the credit.
- Permanent advance payments for lower-income families.
- Credit is reduced after 2025.
Above-the-line Deduction for Employee Uniforms
- Allows a $250 deduction for employee uniforms or work clothing.
- Uniforms or work clothing must be required as a condition of employment and not be suitable for everyday wear.
Extension of Period of Limitation for Certain Legally Married Couples
Allows lawfully married same-sex couples to file claims for credits and refunds related to a change in marital status back to their year of marriage or civil union, which in some cases is as early as 2004. Previously, couples could only amend returns in light of the Supreme Court ruling in U.S. v. Windsor, back to 2010.
Payroll Credit for Compensation of Local News Journalists
- Allows an employment tax credit for calendar quarter wages up to $12,500 paid to local news journalists by a local news organization or broadcasting station.
- Credit for each calendar quarter may not exceed the total amount of employment taxes paid. Excess is treated as overpayment and allowed as a refund.
- The credit amount is equal to 50% of wages for each of the first 4 calendar quarters and 30% of wages for each calendar quarter thereafter.
- Credit ends after 2025.
Deduction for Union Dues
Allows a $250 above-the-line deduction for dues paid to a labor organization.
Expenses in Contingency Fee Cases
Modifies current law expensing rules to allow plaintiffs’ attorneys to deduct out-of-pocket litigation costs in the year they are incurred, rather than waiting until the conclusion of the litigation.
Retirement Plans
- IRA Contributions Prohibits IRA contributions when balances in all IRAs and defined contribution plans exceed $10 million, for single filers with taxable income over $400,000 and married taxpayers with taxable income over $450,000. The provision would take effect after 2028.
- Reporting on Defined Benefit Plans. New annual reporting requirement for employer-defined contribution plans on aggregate account balances of at least $2.5 million.
Required Minimum Distributions
- Requires higher minimum distributions when retirement accounts exceed $10 million in the prior year.
- Minimum distribution is 50% of the amount by which the individual’s prior year aggregate traditional IRA, Roth IRA and defined contribution account balance exceeds the $10 million limit.
- An additional amount is required to be distributed to bring accounts down to $20 million.
- The provision would take effect in 2029.
Roth Conversions Restricted
- Prohibits all employee after-tax contributions in qualified plans and after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers and contributions made after 2021.
- Eliminates Roth conversions for both IRAs and employer-sponsored plans for single taxpayers with taxable incomes over $400,000 and married taxpayers filing jointly with taxable incomes over $450,000. This provision applies to distributions, transfers and contributions made in taxable years beginning after December 31, 2031.
Note: This provision was included because of a threefold increase in the number of taxpayers with aggregate IRA account balances of more than $5 million since 2011, according to the bill managers.
Statute of Limitations on IRA noncompliance
Expands statute of limitations for IRA noncompliance related to valuation-related misreporting and prohibited transactions from 3 to 6 years. This provision gives the IRS more time to challenge IRA transactions.
IRA Owners Treated as Disqualified Persons under Prohibited Transactions Rules
Clarifies that, for purposes of applying the IRA prohibited transaction rules, the IRA owner (including an individual who inherits an IRA as beneficiary) is always a disqualified person.
Increased Funding For IRS
- Appropriates $79 billion in funds for the IRS for taxpayer services, enforcement, operations support and business systems modernization.
- Appropriated funds, which would be available to the IRS until September 30, 2031, could not be used to increase taxes on any taxpayer with taxable income below $400,000.
- Provides $15,000,000 of funds for IRS to report to Congress on the cost of developing and running a free direct efile tax return system.
International Tax Provisions
- Limits the deduction of interest by domestic corporations that are members of an international financial reporting group.
- Increases the effective GILTI minimum tax rate from 10.5% to 15% and calculates GILTI minimum tax on a per-country basis.
- Reduces foreign-derived intangible income (FDII) deduction resulting in an effective 15.8% FDII rate instead of the current 13.1% rate.
- Repeals election for 1-month deferral in the determination of taxable year of some foreign corporations.
- Modifies the foreign tax credit limitation, requiring the making of foreign tax credit determinations on a country-by-country basis.
- Modifies foreign tax credit rules applicable to dual capacity taxpayers.
- The base-erosion and anti-abuse tax (BEAT) rate would be increased to 10% in 2022, 12.5% in 2023, 15% in 2024 and 18% after 2024.
- Adjustments to Earnings and Profits of Controlled Foreign Corporations.
- Dividends from Controlled Foreign Corporations to United States Shareholders Treated as Extraordinary Dividends.
NOTE: With the OECD members’ approval of a 15% global minimum tax, these changes would move the U.S. toward that requirement.
What Was Taken Out Of The Build Back Better Plan?
A number of tax increases were taken out of the Build Back Better plan before it was passed by the full House of Representatives. Here is a list of provisions removed from the bill over anticipated objections from conservative Senate Democrats.
- 26.5% top corporate tax rate.
- 39.6% top individual tax rate.
- 25% long-term capital gains and qualified dividend tax rate for higher-income taxpayers.
- Extended 5-year carried interest holding period for applicable partnership interests.
- Cap on the 20% Section 199A deduction for pass-through income of high wealth taxpayers, those with incomes of $400,000 single filers and $500,000 for joint filers.
- Lower estate and gift tax exemption of $6,020,000 per person beginning in 2022.
- End of the stepped-up basis for inherited assets.
- Bank account reporting.
- Taxing grantor trusts.
- Requiring automatic retirement savings accounts.
Conclusion
You can expect some changes in any Senate-passed version. Frazier & Deeter will be monitoring the legislative process carefully and will update its readers on future developments.