On November 15, 2021, President Biden signed the $1T infrastructure bill to upgrade roads, bridges, transit, broadband, and more. While many tax practitioners have focused on what’s in the bill, including cryptocurrency reporting, the expiration of Employee Retention Credit (ERC), and pension flexibility in funding obligations, most of the bill’s tax provisions do not significantly impact taxpayers.
The more interesting and valuable analysis is examining which provisions didn’t make the final bill. The excised provisions can be instructive to your 2021 year-end tax planning strategy.
a. Capital Gain Tax Rate
Despite months-long discussion and debate on raising the capital gains rate to 39.6 % (plus the 3.8 % surtax; potential 43.4 % for taxpayers with Adjusted Gross Income(AGI) on over $1M or the compromise of 25% (28.8 % including the surtax), there was no change to the capital gains rate.
Tax Planning Opportunity:
There is no rush to sell a business or elect out of installment gains with rates remaining the same. Also, the idea of deferring realized capital losses until 2022 to offset future capital gains is not a concern as of now.
b. Individual Tax Rates
Various legislative proposals recommended increasing tax rates to 39.6 % starting after 12/31/2021. In the end, tax rates for most individual taxpayers will remain the same as 2020 rates.
The proposed Build Back Better Act (BBB) includes a significant increase to the SALT (State & Local Tax) deduction from $10K to $80K starting after December 31, 2021, along with potential surcharges. Most taxpayers should pay close attention to the SALT deduction increase as this could impact their tax returns.
Tax Planning Opportunity:
With individual income tax rates remaining the same for now, plans to accelerate deductions in 2021 and defer income to the following year continue to be a best practice. Further, if in a lower 2021 tax bracket due to impact from the pandemic, it may be possible to convert IRA to a ROTH IRA and sell securities at a potential 0% capital gain rate.
c. Estate and Gift Exemption
The unified credit exemption equivalent amount of $11.7M remains intact. The initial House bill proposed to reduce the exemption to approximately $5M -$6M beginning in 2022. Similarly, the final bill did not include a controversial proposal that would have impacted taxpayers’ unrealized gains of appreciated estates/businesses passed on to their heirs utilizing the stepped-up basis for estate assets. The final bill also left various valuation discounts and sales into various trusts in place.
Tax Planning Opportunity:
There is much less urgency to gift assets by year-end with the estate and gift exemption intact and no change to valuation discounts. However, some congressional observers believe it’s only a matter of time until these changes become law.
d. Corporate tax rates
Initial bill language boosted the corporate rate to 28% for tax years beginning in 2021. Subsequent proposals increased corporate tax rates based on income ranging from 18% to 26.5 % and a 3% surtax on taxable income above $10M. However, the corporate tax rate did not increase and still resides at 21%.
Tax Planning Opportunity:
Converting to a more favorable taxable entity is now less of a concern. As a result, the potential to accelerate deductions such as placing fixed assets into service, maximizing contributions to pre-tax retirement and health savings accounts, and the opportunity to sell a passive investment can “free up” passive losses.
Build Back Better Legislation
Congress is still debating President Biden’s Build Back Better Act (BBB), including significant tax changes. Keep an eye on the following provisions in the impending legislative action:
- Changes to Net Investment income tax (NIIT surtax of 3.8%)
- Potential to apply to a new group of taxpayers based on income levels
- Surtax, which only applied to “passive” taxpayers of an LLC or an S Corporations (flow-through entities) could now apply to “active” flow through trade or businesses
- Changes to Estate Tax Exemption
- Potential Reduction to a lower level
- Estate Step-Up Basis
- State and Local Tax Deduction from $10K to $80K
- Back Door Roth IRAs and potential RMDs for significantly high retirement accounts
- Changes to Corporate Tax
- If rates increase, consider entity conversion
- Changes to International Tax
- GILTI, FTC categories, and carryover rules
- FDII Deduction, Base Erose and Anti Abuse (BEAT tax),
- IRC Section 958(b)(4) downward attribution provisions for CFCs, Section 245A deduction for eligible foreign sourced dividends
Now is a good time to talk to your Daszkal Bolton tax professional to ensure you stay up to date on the legislative changes and take advantage of year-end tax planning opportunities.
