U.S. House Approves Build Back Better Act and Sends it to the Senate

On November 19, 2021, the U.S. House of Representatives passed the “Build Back Better Act” (BBBA), which includes an estimated $1.7 trillion in spending and an estimated $1.5 trillion in tax increases over 10 years.

The Senate is expected to take up the BBBA in early December and will likely make significant changes to the legislation before a revised bill is be sent back to the House for approval.

This article provides brief summaries of the following individual tax provisions in the BBBA as approved by the House:

• A surcharge on high-income taxpayers
• Expansion of the Net Investment Income Tax
• An increase in the cap on the deduction for state and local taxes
• Increased funding for the Internal Revenue Service
• Permanent disallowance of excess business losses
• IRA contribution restrictions for certain taxpayers
• Additional required minimum distributions for certain taxpayers
• Restrictions on the use of Roth IRAs
• Reduction of the exclusion of gain from the sale of qualified small business stock
• Expansion of eligibility for the American Opportunity Tax Credit
• Expansion of the wash-sales rules
• Expansion of the constructive sales rules
• A tax credit for cash contributions to public universities for research infrastructure property
• A deduction for union dues and employee uniforms
• Extension of the statute of limitations for certain legally married same-sex couples

Unless otherwise noted, the individual tax provisions contained in the BBBA would be effective in 2022.

Surcharge on High-Income Taxpayers

One of the largest revenue raisers in the BBBA is a surcharge on high income taxpayers. Specifically, for individual taxpayers with modified adjusted gross income (AGI) in excess of $10 million, a five percent surcharge would apply to that excess, resulting in a maximum federal income tax rate for these taxpayers of 45.8 percent. (This surcharge would apply to married taxpayers that file a separate tax return when modified AGI exceeds $5 million.)

An additional three percent surcharge – for a total surcharge of eight percent – would apply to individual taxpayers with modified AGI in excess of $25 million, resulting in a maximum federal income tax rate for these taxpayers of 48.8 percent. (This surcharge would apply to married taxpayers that file a separate tax return when modified AGI exceeds $12.5 million.)

Notably, the five percent surcharge would apply to estates and trusts whose modified AGI exceeds $200,000, and the additional three percent surcharge would apply to estates and trusts whose modified AGI exceeds $500,000. Thus, the surcharge would likely impact more estates and trusts than individuals.

Expansion of the Net Investment Income Tax

The BBBA expands the Net Investment Income Tax so that it applies to non-passive trade or business income of individuals, estates, and trusts with modified AGI in excess of the following thresholds:

As a result, essentially all income earned by these taxpayers would be subject to a 3.8 percent tax via payroll tax, self-employment tax, or Net Investment Income Tax.

The BBBA also provides that certain foreign-sourced income (e.g., controlled foreign corporation income, Global Intangible Low-Taxed Income, and qualified electing fund income) constitutes net investment income, and that net investment income is not reduced by a net operating loss.

Increase in Cap on the Deduction for State and Local Taxes

The BBBA provides that, effective for 2021 through 2031, the cap on the deduction for state and local taxes (SALT) is increased to $80,000 for single individuals and married individuals filing a joint return, and to $40,000 for everyone else.

Increased Funding for the Internal Revenue Service

The Biden administration estimates a better funded Internal Revenue Service (IRS) could bring in $400 billion over a decade through more aggressive audits of corporations and wealthy individuals. The BBBA provides almost $80 billion of increased funding for the IRS – $44.9 billion of which is specifically earmarked for enforcement.

Permanent Disallowance of Excess Business Losses

The BBBA makes the disallowance of excess business losses permanent beginning in 2021. The Tax Cuts and Jobs Act introduced Internal Revenue Code (IRC) Section 461(l) that limits business losses for non-corporate taxpayers to $500,000 for married-filing-jointly taxpayers and $250,000 for everyone else. Section 461(l) originally applied beginning in 2018, but the CARES Act changed the effective date to 2021 with an expiration date of 2026.

The BBBA eliminates the expiration date, thus making the excess business loss disallowance permanent, and changes the treatment of an excess business loss carryover from a net operating loss to an expense for purposes of determining an excess business loss in a subsequent year. The BBBA also provides that an unused excess business loss carryover of an estate or trust is allowed as a deduction to the beneficiaries of the estate or trust when the estate or trust terminates.

IRA Contribution Restrictions

The BBBA includes several provisions that restrict the amount wealthy taxpayers with high incomes can accumulate in retirement plans. These tax provisions would take effect in 2029.

One such provision prohibits certain taxpayers – called “applicable taxpayers” – from contributing to traditional and Roth IRAs once their aggregate vested balance in all applicable retirement plans exceeds $10 million. An applicable taxpayer is an individual with modified AGI in excess of the following thresholds:

A six percent excise tax would be imposed on contributions to IRAs by applicable taxpayers who have more than $10 million in applicable retirement plans, and plan administrators would be required to report to the IRS all retirement plans that they administer with a vested balance greater than $2.5 million.

Additional Required Minimum Distributions

Another retirement plans provision contained in the BBBA would require applicable taxpayers with vested retirement plan balances in excess of $10 million to take additional required minimum distributions of such excess. The exact amount of an additional required minimum distribution for a particular year would depend on whether or not the applicable taxpayer has vested retirement balances in excess of $20 million and the amount of such balances accumulated in Roth IRAs. In general, the additional required minimum distribution rule is designed to reduce an applicable taxpayer’s aggregate retirement plans balance to $10 million over a two-year period.

Restrictions on the use of Roth IRAs

Beginning in 2022, the BBBA would prohibit any taxpayer from rolling over or converting a balance in any eligible retirement plan, other than a designated Roth account, to a Roth IRA if any portion of the rollover or conversion would not be included in the taxpayer’s gross income. This provision eliminates so-called “back-door” Roth IRA contributions whereby a taxpayer makes a nondeductible contribution to a traditional IRA and shortly thereafter converts the traditional IRA to a Roth IRA.

Beginning in 2032, the BBBA would prohibit an applicable taxpayer from rolling over or converting a balance in any eligible retirement plan, other than a designated Roth account, to a Roth IRA, regardless of whether or not any portion of the rollover or conversion would be excluded from the taxpayer’s gross income. As a result, except for rollovers from a designated Roth account, high income taxpayers will no longer be able to make any additions to a Roth IRA after 2031.

Reduction of Qualified Small Business Stock Gain Exclusion

The BBBA would restrict the 75 percent and 100 percent gain exclusion from the sale of qualified small business stock to those eligible taxpayers with AGI less than $400,000. Also, all estates and trusts would be prohibited from claiming the 75 percent and 100 percent exclusion. The 50 percent gain exclusion would, however, still be available to all eligible individuals, estates, and trusts.

Expansion of Eligibility for the American Opportunity Tax Credit

The BBBA would eliminate a rule that denied the American Opportunity Tax Credit to taxpayers that have been convicted of a felony drug offense.

Expansion of Wash-Sales Rules

The BBBA would expand the wash-sales rules under IRC Section 1091 to apply to new asset classes (including commodities, foreign currencies, and digital assets) and related-party transactions.

Expansion of Constructive Sales Rules

The BBBA would expand the definition of an “appreciated financial position” in the constructive sales rules under IRC Section 1259 to include digital assets. The new constructive sales rules would apply beginning the day after the date of enactment of the BBBA.

Tax Credit for Cash Contributions to Public Universities

The BBBA contains a tax credit for cash contributions to public universities for the purchase, construction, or improvement of research infrastructure property. The credit is equal to 40 percent of “qualified cash contributions” made during the year.

Deduction for Union Dues and Employee Uniforms

The BBBA contains a deduction to arrive at AGI for union dues and employee uniforms. Each such deduction is limited to $250 per year per taxpayer.

Extension of Statue of Limitations for Same-Sex Couples

The BBBA extends the statute of limitations for legally married same-sex couples that filed separate returns before 2013 to enable them to amend those returns to claim married-filing-jointly status.

For information about any of the provisions discussed in this article, contact us. We are here to help.

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