Months of campaigning, proposals, hearings and negotiations have produced an infrastructure bill that needs to be paid for, and a reconciliation bill that is meant to pay for it. The final measures are becoming clearer, but the actual numbers are still subject to change. Depending on the details of the pay-fors in the reconciliation bill, the result could be a tax overhaul that dwarfs the Tax Reform Act of 1986.
“Whatever they settle for in the infrastructure bill will drive the tax provisions in the reconciliation bill,” said Ryan Losi, executive vice president at Glen Allen, Virginia-based accounting firm Piascik, in mid-October. “Until they settle that, we won’t have a bill that addresses tax.”
“In terms of headlines, it’s an increase in the marginal rates, both individual and corporate, and an increase in the capital gains rates. And the capital gains rate increase is proposed to be retroactive to Sept. 13, 2021 — for those wanting to sell in advance of the proposal, it might be too late,” said Tim Steffen, director of tax planning at Milwaukee-based financial planning firm Baird.
“Those are the big ones,” he continued. “The other areas to focus on are limitations on Roth conversions, which basically end the whole backdoor Roth conversion strategy. You would no longer be able to convert dollars that would not otherwise have been taxable, so if you have after-tax money in an IRA, when it comes out of the IRA and you don’t pay tax on it, you can’t convert those dollars to a Roth IRA anymore. And you would not be able to make after-tax contributions to an employer plan, so you could no longer create a megabackdoor Roth by loading up after-tax 401(k) dollars and then converting them to a Roth, which is how people have been getting very large balances in their Roths.”
The other broad category of change is in estate planning, Steffen indicated: “The current estate tax exemption is scheduled to be cut in half in 2026. The proposal would accelerate this to 2022. So it would fall from roughly $12 million to roughly $6 million, beginning next year. This means people who would have estate tax liability probably will want to take advantage of the high exemption this year in the form of gifts and other transfers. For a taxpayer who is married with, say, about $15 million, it’s tougher. Younger taxpayers want to be careful with moving too much out of their name — who knows how much they might need for the rest of their life?”
Waiting on the details
There have been so many proposals going in and coming out of the Ways and Means bill that it’s difficult to predict how it will end, according to Mike Tucker and Nick Spoltore of Surgent CPE. “Yes, there will be an increase in individual and corporate rates, but we don’t yet know the exact details,” said Tucker, a CPA and tax attorney. “There will be many other changes. The estate and gift tax changes will impact many in the upper middle class. If the proposed changes get enacted they will need estate planning advice. Altogether, the changes could be as revolutionary as the Tax Reform Act of 1986, which produced seismic changes.”
The proposal to max out the qualified business income deduction at $500,000 for married filing jointly, $400,000 for singles, and $10,000 for estates and trusts would be effective in 2022. The cap has a built-in marriage penalty tax, observed Spoltore, a tax attorney.
A 3% surtax applies to adjusted gross income above the $5 million threshold for individuals. The corporate rate is complex, with a three-tiered structure (18%, 21% and 26.5%) and an additional 3% on income exceeding $10 million until the lower brackets’ advantages are eliminated.
One of the biggest questions for advisors is choice of entity, according to Tucker. “If you’re doing business as an S corporation, should you continue as an S corporation? Every tax practitioner should have this in the back of their minds and raise it with their clients. That’s an incredibly important issue, and it’s vital that we get out in front of our clients and address that, once we know what all the changes are.”
Modifications were made to the Employee Retention Credit in March 2021, noted Jim Brandenburg, tax partner at Top 100 Firm Sikich. “These extended the credit through the end of the year, and made it easier to qualify for those who received Paycheck Protection Program loans, so long as they’re not based on the same wages. The benefit of this will disappear as one of the pay-fors in reconciliation.”
“Interest expense calculations would be pushed from an entity level to the individual shareholders in an S corporation and partners in a partnership,” he noted. ”And Section 1202 stock, for those with adjusted gross income over $400,000, would no longer qualify for the 100% exclusion of gain after five years.”
“An elimination or easing of the SALT cap was not included in the Ways and Means bill, but Chairman Neal has said that does not mean it won’t be addressed on the House floor,” Brandenburg added.
Looking further ahead
There are a variety of changes in the House bill that will have significant impact on estate and gift planning, according to Keith Grissom, co-practice group leader with the trust and estates department at law firm Greensfelder. The reduction of the lifetime exemption, which is currently scheduled to be reduced on Jan. 1, 2026, will be accelerated to Jan. 1, 2022, for instance. “And grantor trusts created on or after enactment will now be includable in the estate of the grantor,” he said. “So basically the use of grantor trusts as an estate planning tool will vanish.”
“Existing grantor trusts will be grandfathered; however, if contributions are made to the existing trust after enactment, a portion of the trust will be included in the grantor’s estate,” he explained. “In addition, it will be a taxable event if the grantor sells assets to a grantor post-enactment if it includes unrealized gain. Under current law it would not be a taxable event because the grantor is deemed to be the owner.”
As this issue went to press, there was still speculation as to whether the bill would pass both chambers of Congress.
“It’s so tight in the Senate,” said Losi. “I think the Senate will instruct the House committee on what they want, so by the time it comes out of Ways and Means it won’t materially change in the Senate.”
The goal is to have the legislative process complete before the Thanksgiving break, but things could move quickly once agreement is reached on the infrastructure bill, according to Losi. “It might be similar to 2017, where it was early November that they had a bill, and a little over a month later it was law. It probably won’t be signed until after Thanksgiving — it might come down to the wire and be late in the year before there’s a bill on the president’s desk.”
