CARES Act Passed Into Law

Tax Provision Draft Offers Starting Point for Final Details

Washington Policy Analyst Ed Mills outlines key components of the initial reconciliation package draft.

Tax details are beginning to emerge as House Democrats are crafting their reconciliation package. Included in the initial draft is a list of $2.9 trillion in tax provisions to pay for the targeted $3.5 trillion in spending.

Key details include the introduction of a progressive corporate tax rate from 18% to 26.5%, an increase in the top individual tax rate to 39.6% ($400,000 income threshold), a 3% surcharge for individuals with annual income above $5 million, an increase in investment taxes to 25% (effective rate of 28.8% with Affordable Care Act surcharge), a number of changes to high-balance IRAs/restrictions on Roth IRA conversions, lower estate tax exclusions, increased IRS enforcement, changes to international taxes, among other provisions.

Substantive changes are promised for state and local tax (SALT) relief, but are still under negotiation. The final details of these provisions are likely to change significantly. These details further narrow the potential outcomes, while the potential impact of individual provisions continues to pose risk, the overall list of tax provisions are lower than initially proposed by President Biden. Overall, the process to a final bill remains on track, but a looming budget showdown at the end of September and the debt limit present complicating procedural factors in the weeks ahead.

Note that the inclusion or the exclusion of a tax provision in this draft is only instructive of where negotiations are currently. There will be a number of changes to this bill before any final consideration.

Corporate tax modifications

Graduated corporate tax with higher top rate

  • 18% rate for income up to $400,000; 21% rate for income $400,000 to $5 million; 26.5% rate for income $5 million and above.
  • Graduated taxation phased out for income above $10 million with surtax lesser of 3% of excess or $287,000.
  • Personal service corporations not eligible for graduated rates and pay 26.5% on all income.

International tax adjustments

  • Foreign Derived Intangible Income (FDII) effective rate raised to 20.7% (from 13.125%). The Biden administration proposed repealing FDII.
  • Global Intangible Low Tax Income (GILTI) effective rate raised to 16.5625% and calculated country by country, up from 10.5% globally. Original Biden proposal targeted rate of 21% to26.25%.
  • Base Erosion and Anti-Abuse Tax (BEAT) raised from 10% to 12.5%, rising to 15% after 2025. Biden’s proposal initially repealed BEAT for newly developed minimum tax framework.

Limitation on REIT income test under Section 856

  • Rents from prison facilities not treated as qualified income for REIT income test purposes.

Individual tax modifications

Higher top marginal income tax rate

  • Top income tax rate raised to 39.6% from 37% on income over $400,000 for individuals, $450,000 for couples.

Higher capital gains rate

  • Top capital gains rate raised to 25% from 20%; 28.8% applying net investment income tax (NIIT)
  • Higher rate effective as of September 13, 2021, but with blended rate. Transactions made prior to this date would fall under previous rates, and transactions after this date would fall under new rate. Gains realized from transactions entered into prior to this date will apply existing rates. Only transactions started and realized after September 13, 2021, would have higher rate applied. This will require transitional regulation from the IRS to fully operationalize.
  • Income levels for new rate appear to apply to existing IRS rules, and not to incomes above $1 million as initially introduced under Biden plans.

New surtax on income over $5 million

  • A 3% surtax is applied to modified adjusted gross income above $5 million, applying to trusts and estates.

Limited qualified business income deduction (199A)

  • Maximum 199A deduction set at $400k for individual and $500k for joint returns.

Elimination of excess business loss deduction

  • Excess business loss deductions for non-corporate taxpayers are eliminated. Losses eliminated are allowed to be carried forward to next taxable year.

Phase out of higher estate and gift tax exemption

  • The higher exemption of $11.7 million due to phase out after 2025 is reverted to $5.85 million, indexed for inflation.

Increase in estate tax valuation limitation for family farms or businesses

  • Allowable reduction for real property raised from $750,000 to $11,700,000.

Retirement plan modifications

Elimination of Roth conversions

  • Roth conversions for traditional IRAs and employer-sponsored plans are eliminated for individual incomes over $400,000 (joint filers over $450,000).
  • Applies to distributions, transfers and contributions made after 2031.

Prohibition of after-tax contribution/conversion

  • Employee after-tax contributions in qualified plans are prohibited.
  • Prohibits after-tax IRA contribution converted to Roth regardless of income level, effective 2022.

Restricted IRA/defined benefit plan contributions

  • IRA/defined contribution accounts with balances above $10 million held by individuals with taxable income above $400,000 are restricted from further contributions.

Minimum required distributions for accounts

  • Minimum distributions required the following taxable year if aggregate IRA, Roth IRA and defined contribution balances exceed $10 million for account holders with income $400,000+.
  • Distribution is 50% of amount in excess of $10 million.
  • Additional rules for accounts exceeding $20 million.

Prohibition of IRA asset investment in entities with owner interest

  • Prevents IRA investment in entities (corporations, partnerships, trusts, or estates) in which individual has 50% or greater interest.
  • Adjusted to 10% for investments that are not tradable on a securities market.
  • Two-year transition period for IRAs holding such investments.

Miscellaneous

  • Acceleration of executive compensation deduction limitations – effective date of $1 million deduction limit for compensation paid to firm officers moved up to 2022 from 2026.
  • Tightened rules on digital assets/cryptocurrencies.
  • Increased tobacco and nicotine product taxes.

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