It seems like most years we say that year-end planning is especially important. Part of the reason for that is that Congress tends to enact tax law changes every year. However, making planning difficult, Congress also tends to put off passing tax legislation until the end of the year. At the end of 2017 it was the Tax Cuts and Jobs Act. At the end of 2020 it was the Consolidated Appropriations Act. And now, at the end of 2021, it might be the Build Back Better Act — and then again, it might not.
The Build Back Better Act has the potential to impact broad areas of tax planning: individual income tax planning, corporate income tax planning, pass-through income tax planning, international tax planning, retirement planning and estate planning. As this is being written, Congress is working on paring back the act from a $3.5 trillion bill to something that might be as low as $1.5 trillion to come up with something that the Democrats can pass without Republican support under the budget reconciliation process in the Senate.
A lot of those cutbacks could be in the non-tax provisions. Those tax provisions that cost revenue, such as the expanded tax breaks for low- and middle-income taxpayers, could also face cutbacks. The tax provisions that raise revenue are less likely to face cutbacks, since they help pay for everything else. However, with an estimated $2 trillion raised from revenue provisions, if the total package is reduced to $1.5 trillion, even some of the less controversial revenue-raisers could be reduced or eliminated if they are no longer required for funding.
There are a few specific objections to some of the revenue-raisers. Some Democrats object to the extent to which corporate tax rates are proposed to be raised. Some Democrats object to the elimination of all tax breaks for fossil fuels.
It is very difficult at this point to know what is likely to emerge as the final product, assuming they can get to a final product. However, once we know what a final product looks like, it may be too late to do significant year-end tax planning in response. Most of the provisions in the legislation have effective dates tied to the enactment date, Jan. 1, 2022, or even later. A few proposals, such as the capital gains rate increases, have retroactive effective dates for which it may already be too late to do year-end planning in response.
At this point it seems that the Democrats will somehow work out a way to compromise on their differences. The failure to enact anything would seem to be much worse for both the moderate and the progressive Democrats than coming away with at least part of what they want, but they may try to hold out as long as possible to try to get as much as they can.
It is difficult to do tax planning in anticipation of what might happen in Washington, but it may well be too late for tax planning after the fact. Tax advisors will want to at least make sure that their clients are aware of the potential issues and possible actions that could be taken, whether or not those clients decide to take action.
In general, tax increases on individuals only affect those with more than $400,000 in income. A proposed increase in the top individual tax rate to 39.6% may survive, proposed to be effective beginning in 2022. There is also a proposed 3% surcharge on incomes in excess of $5 million. The surcharge may be more at risk. Taxpayers potentially impacted by the rate increases may want to reverse the usual year-end strategy by accelerating income and postponing deductions. Increases are also proposed in capital gain tax rates; however, with a proposed effective date of Sept. 13, 2021, it may already be too late to realize capital gains at lower rates in 2021.
Owners of pass-through businesses may be impacted by an expanded application of the 3.8% net investment income tax, a new cap on the 20% deduction for qualified business income, and a permanent disallowance of excess business losses in excess of certain caps. Further changes in the taxation of carried interests are also proposed, including extending the required holding period from three to five years and changing when the five-year period would commence.
Owners of pass-through businesses will want to discuss with their tax advisors year-end options in response to these possible changes. The Senate Finance Committee also has an additional set of proposals affecting many aspects of partnership taxation. It is still unclear at this point how many of these partnership proposals might be included in the final legislation.
Although some of the new proposals made by President Biden to tax estates, including the income taxation of the fair market value of assets at death, have not survived in the Build Back Better bill, the bill does include a rollback of the estate and gift tax exemption amount and significant curtailment of the benefits of grantor trusts and valuation discounts.
Some of these changes are proposed to be effective as of the date of enactment, whenever that might be. It is difficult to control the date of death, but it is probably a good idea to review the assumptions upon which an estate plan was based and perhaps consider lifetime gifts this year.
Among the proposals included in the Build Back Better plan are provisions that would limit contributions to Roth and traditional IRAs exceeding $10 million, put greater restrictions on the assets that can be held in an IRA, increase required minimum distributions for large IRA accounts, and place restrictions on Roth conversions. Taxpayers may want to look into a possible last opportunity to do a Roth conversion before the proposed changes come into effect.
Although the House Ways and Means Committee has proposed raising the top capital gains rate from 21% to 26.5%, it appears likely that this top rate might have to be lowered to 25% to achieve passage. A proposed 3% surcharge on income in excess of $10 million up to a maximum of $287,000 might also fall by the wayside. There are also proposed increases in the domestic dividends-received deduction. Changes in the taxation of corporations and pass-through entities always make it a good idea to review choice-of-entity decisions to make sure the current entity structure makes the most sense.
The Tax Cuts and Jobs Act made significant changes in the taxation of foreign activities of U.S. taxpayers. The Build Back Better Act proposes to rework almost everything included in the TCJA, including GILTI, FDII, BEAT and the foreign tax credits. Some of the provisions are designed to correct problems with the language of the TCJA.
Some of the provisions also appear to try to begin to accommodate international tax proposals being worked on by the OECD, although a corporate minimum tax has not been included at this point. Some of the changes are actually taxpayer-friendly, but the vast majority are scored to raise revenue. The proposed changes will likely bring into question the value of international corporate structures put in place in response to the Tax Cuts and Jobs Act.
Although dropped out of the bipartisan infrastructure bill, IRS funding has reemerged in the Build Back Better Act and is likely to survive if anything is enacted. Democrats are relying on increased IRS funding to provide additional enforcement revenue to help pay for some of the human infrastructure proposals in the legislation. All taxpayers should anticipate a significant reversal of a long-term decline in audit rates.
The tax provisions are not all revenue-raisers affecting high-income individuals and businesses. There are also many provisions focused on new and expanded tax breaks for green energy. The Biden proposal to eliminate tax breaks for fossil fuels does not appear likely to happen.
Individuals with incomes under $400,000 should generally be safe from most of the proposed tax increases and are likely to benefit from extensions of increases in the Child Tax Credit, the Child and Dependent Care Credit, and the Earned Income Tax Credit, and support for caregivers, job training, and expanded health coverage and tax benefits.
As has been seen with the advance Child Tax Credits that began in 2021, many tax breaks for lower and middle-
income taxpayers may also require some assistance from tax advisors to take maximum advantage of them.
Principal Federal Tax Analyst, Wolters Kluwer Tax & Accounting