On September 15, the House Ways and Means Committee voted to approve the tax provisions to be included in the Build Back Better Act. Our experts outline the key tax provisions to watch.
By Plante Moran
Editor’s note: This alert was first published on September 13 when the text of the tax portion of the Build Back Better Act was initially released by the House Ways and Means Committee, prior to its markup. That markup was completed by the Committee on September 15, and this alert has been updated to reflect that.
On September 15, the House Ways and Means Committee approved the tax provisions of the Build Back Better Act (BBBA), the legislation intended to implement President Biden’s social and education reforms. There are still many steps in the process to become law, but this is a major first step to begin understanding which tax proposals Congress will use to balance revenue and spending priorities as well as the specifics of how those tax proposals will apply.
How did we get here?
Earlier this year, the Biden administration announced plans to pursue two major pieces of legislation. One package would provide significant infrastructure spending, and the second package would involve new social and education spending programs. The Infrastructure Investment and Jobs Act has since passed the Senate and is still pending in the House. For the infrastructure legislation to be passed on a bipartisan basis, compromises made by both parties in the Senate resulted in no major tax changes being included.
The social and education spending plan is now tentatively named the Build Back Better Act and includes major tax changes. The House Ways and Means Committee spent four days marking up its portions of the proposed legislation which, in addition to the major tax proposals, also covers infrastructure financing and community development, green energy, the social safety net, state and local government support, and Medicare drug pricing.
What’s in the proposed legislation?
Here are some of the key tax provisions:
Individual income tax
- Increase in the top marginal individual income tax rate — The top marginal individual income tax rate would increase to 39.6%, the same top marginal rate that existed before the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA). This rate would apply to the taxable income of (1) married couples filing jointly which exceeds $450,000, (2) single filers which exceeds $400,000, (3) married individuals filing separately which exceeds $250,000, and (4) trusts and estates with taxable income over $12,500. An additional surtax of 3% would be applied to modified adjusted gross income exceeding $5,000,000 ($2,500,000 for married taxpayers filing separately). This proposal would be effective for tax years beginning after Dec. 31, 2021.
- Increase in the maximum long-term capital gains rate — The maximum capital gains rate would increase to 25% from the current rate of 20%. The income level that this capital gains rate bracket applies to would be aligned with the new 39.6% rate bracket. These rates would also apply to qualified dividends. This increase is far lower than the Biden administration’s original proposal to increase the capital gains rate to as high as 39.6%. This proposal includes transition rules that will generally apply the increased rate to capital gains and dividends recognized after Sept. 13, 2021, but certain sales subject to a binding contract in effect on that date could still apply the previous rates.
- Net investment income tax application to active business income — Under current law, the net investment income tax applies an additional 3.8% tax to a taxpayer’s net investment income when adjusted gross income exceeds a certain threshold. Net investment income only includes income earned from a business if the taxpayer is passive with respect to that business, but not if a taxpayer is active. The proposal would subject active business income to the net investment income tax as well, but only when adjusted gross income exceeds (1) $500,000 for married couple filing jointly, (2) $250,000 for married couples filing separately, and (3) $400,000 for all other taxpayers. This rule would not apply if the business income was already subject to self-employment tax. When combined with the individual tax rate increases above, this could increase the tax rate applicable to active business income from the maximum marginal rate of 37% under current law to as high as 46.4% (39.6% maximum marginal rate + 3.8% net investment income tax + 3% high income surcharge). This proposal would be effective for tax years beginning after Dec. 31, 2021.
- Section 1202 modifications — Under current law, Section 1202 permits up to a 100% exclusion from the sale of certain C corporation stock. The proposal would cap the exclusion at 50% for taxpayers with adjusted gross income in excess of $400,000 and for all estates and trusts. For taxpayers with income below $400,000, the 75% and 100% exclusions would still be available. Even with a 50% exclusion, this provision could still provide an effective federal tax rate reduction of up to approximately 15%. The proposal is effective for sales occurring after Sept. 13, 2021, but certain sales subject to a binding contract in effect on that date could still apply the previous rules.
- Limitations on contributions to IRAs and increases in required minimum distributions (RMDs) for certain high-income taxpayers with large account balances — Under current law, taxpayers can make contributions to certain retirement accounts regardless of their income level. The bill would prohibit contributions when the total balance of the contributor’s IRAs and other retirement accounts exceeds $10 million (determined as of the close of the previous taxable year) and taxable income exceeds (1) $450,000 in the case of a married couple filing jointly or (2) $400,000 in the case of single or married taxpayers filing separately. Those same taxpayers would have to take a RMD equal to 50% of the value that exceeds $10 million, plus 100% of any amount exceeding $20 million. This provision is effective for tax years beginning after Dec. 31, 2021.
- Limitations on “back door” Roth IRA conversions — Under current law, while contributions to Roth IRAs may not be made by taxpayers with incomes exceeding certain thresholds, those taxpayers may effectively avoid the limitations by first making a nondeductible contribution to a traditional IRA and then converting it to a Roth IRA. The bill would prohibit this practice for taxpayers with taxable income exceeding (1) $450,000 in the case of married taxpayers filing jointly or (2) $400,000 in the case of single taxpayers and married taxpayers filing separately. The proposal would generally be effective for tax years beginning after Dec. 31, 2021, but certain rollover provisions wouldn’t be effective until tax years after Dec. 31, 2031.