The $3.5 trillion infrastructure bill, the second prong of President Biden’s social and economic policy program, has cleared the House tax writing committee and now is the subject of intense negotiations to move it forward. The negotiations are not with Republicans but within the Democrats’ own party. Senators Joe Manchin, D-W.Va, and Kyrsten Sinema, D-Az. have balked at the size of the spending program and some of the tax increases that would pay for it.
The bill, which will be considered under the reconciliation process, does not have any Republican support and the Democrats need every vote in the Senate to get it passed. Manchin has indicated he is open to a $1.9 to $2.2 trillion plan with more modest tax increases while it has been reported that Sinema has said privately that she will not accept any corporate or individual tax rate increases.
Given the realities of this situation, it is unlikely that the final bill will include all tax changes proposed in the original plan. Some tax provisions have already been toned down. Instead, we may see more modest tax increases along the lines that Manchin has floated in his plan. Here’s a rundown of the major outlines of the latest tax proposals that may make it into the final bill, some reflecting Manchin’s position.
Corporate Tax Increases
- Increase the top corporate income tax rate from 21% to 26.5% for corporate income above $5 million. A graduated rate would start at 18% on the first $400,000 of income and would be 21% on income up to $5 million. Above $5 million, the rate would be 26.5%. The graduated rate would phase out for corporations with more than $10 million in income. Manchin wants to raise it to 25%.
Small Business Stock Exclusion
- The 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. The regular 50% exclusion would continue to apply to all taxpayers.
- Increase the GILTI minimum tax from 10.5% to 16.5% and calculate the GILTI minimum tax on a per-country basis.
- Reduce the foreign-derived intangible income (FDII) deduction resulting in a 20.7% FDII rate instead of the current 13.1% rate.
- The base-erosion and anti-abuse tax (BEAT) rate would be increased to 10% in 2022, 12.5% in 2024 and 15% in 2026.
- Limit the deduction of interest by domestic corporations which are members of an international financial reporting group.
With the OECD members’ approval of a 15% global minimum tax, these tax changes would move the U.S. toward that requirement.
Passthrough Business Interests
- Carried Interests. Extend the holding period for “applicable partnership interests” (carried interests) to get capital gains treatment from 3 to 5 years. The 3-year holding period would continue to apply to real estate businesses and taxpayers with AGIs of less than $400,000. The bill includes language to extend this rule to all capital assets with some exceptions, but it is unclear if that provision will remain in the legislation.
- Excess Loss Limitation. Permanently disallow excess business losses for noncorporate taxpayers, which are calculated as net business deductions in excess of business income.
- QBI Deduction. Cap the maximum qualified business income deduction at $400,000 for single filers and $500,000 for joint filers.
- NII. Extend the 3.8% net investment income tax to income from active businesses for taxpayers with income above $400,000 for singles and $500,000 for joint filers.
Individual Tax Increases
- Capital Gains Rate. Increase the top capital gains rate to 25% for single filers with $400,000 in income and joint filers with $450,000 in income, with a September 13, 2021, effective date. Senator Manchin is on board with this change.
- Individual Tax Rate. Increase the top individual tax rate from 37% to 39.6% and apply it to those with incomes above $400,000 for single filers and $450,000 for joint filers. Senator Manchin has indicated he is in favor of this change.
- High-Income Surcharge. Impose a 3% surcharge on modified AGI above $5 million.
Estate and Gift Taxes
- Reduce the estate tax exemption to $6,020,000 per person beginning in 2022. Note that the provision to end the step-up in basis for inherited assets was dropped from the bill.
Bank Account Reporting
- Require financial institutions to report information on account flows so that earnings from investments and business activity are subject to reporting in the same way wages are. The threshold amount is now set at $600. Speaker Pelosi indicated this type of provision will be in the final bill, but the amount could be negotiated.
- IRA Contributions. Prohibit 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.
- Required Minimum Distributions. Require higher minimum distributions when retirement accounts exceed $10 million in the prior year, with an additional amount required to be distributed to bring accounts down to $20 million.
- Roth conversions. Eliminate Roth conversions for IRAs and employer plans for single taxpayers with taxable income over $400,000 and married taxpayers with taxable income over $450,000.
Speaker Pelosi has expressed optimism that a compromise will be reached within her own party soon, but it will not be a $3.5 trillion package. Expect that it will be reduced substantially to get the centrist Senators to sign on. Pelosi said the savings will come not from cutting programs but instead from limiting their duration. With a lower cost bill, the pressure to raise taxes is reduced, so these proposed tax increases may be further reduced as negotiations continue.
The goal is to complete both the infrastructure and the reconciliation bills this Fall. The fate of both bills, however, is uncertain at this point but that could change rapidly. Frazier & Deeter tax professionals are watching developments carefully and can answer your questions.