A glance at the House tax proposals

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House Democrats this week released draft legislation proposing about $2 trillion in tax increases.

The House Ways and Means Committee released the draft legislation, Responsibly Funding Our Priorities, as part of the broader budget reconciliation process. The proposals will face intense debate in Congress.

While these proposals will be subject to revision as discussions proceed, here are key provisions that would impact individual taxpayers.

Increase in the top marginal income tax rate on ordinary income from 37% to 39.6%

• Applies once income exceeds $400,000 in taxable income ($450,000 for married couples filing a joint return) beginning with taxable years after December 31, 2021 (for reference, the current highest marginal tax rate is applied at income levels of $523,600 for single filers, $628,300 for joint filers)

Increase in the top tax rate on long-term capital gains to 25%

• Applies once income exceeds $400,000 in taxable income ($450,000 for married couples filing a joint return) for transactions occurring after September 13, 2021. Note that this does not include the 3.8% surtax on net investment income, which would bring the maximum tax rate on long-term capital gains to 28.8%

New 3% surtax for households exceeding $5 million in income

• The provision begins for taxable years after December 31, 2021, with the definition of income for threshold purposes being modified adjusted gross income (MAGI)

Acceleration of the sunset provision for lifetime estate and gift tax exclusion

• The doubling of the lifetime exclusion amount under the Tax Cuts and Jobs Act (TCJA) expires on December 31, 2021, instead of at the end of 2025
• For 2021, the lifetime exclusion is $11.7 million per person. Beginning next year, the lifetime exclusion would revert to the level in place prior to the TCJA ($5.49 million adjusted for inflation)

Expand the scope of the 3.8% surtax on net investment income

• Currently, the 3.8% surtax only applies to passive income generated from pass-through business entities. This provision would subject active business income to the surtax as well (applies to individual taxpayers exceeding $400,000 in taxable income, $500,000 in taxable income for married couples filing a joint return)

Restrictions on large IRA balances

• Once the balance of an IRA (aggregate balance of all IRAs and funds held within defined contribution plans) exceeds $10 million, additional contributions are not allowed and a required distribution is triggered the following year
• The required distribution is based on 50% of the amount exceeding the $10 million threshold (additional rules apply if the aggregate balance of IRAs and defined contribution plans exceeds $20 million)
• The new required distribution rule and disallowance of additional contributions only applies to taxpayers with taxable income exceeding $400,000 for single filers and $450,000 for joint filers

“Backdoor” Roth IRA strategy disallowed

• Beginning for taxable years after December 31, 2021, Roth conversions are limited to pre-tax funds (for example, converting after-tax IRA funds to a Roth IRA is no longer allowed)
• This provision also prohibits the direct transfer of after-tax funds held within a qualified retirement plan into a Roth IRA
• Roth conversions for IRAs and qualified retirement plans are disallowed for higher-income taxpayers ($400,000 for single filers, $450,000 for joint filers) beginning with taxable years after December 31, 2021

Prohibit certain investments from being held within an IRA

• Beginning with taxable years after December 31, 2021, investments that require an individual to be an “accredited investor” in order to invest in a security are not allowed to be owned within an IRA. Additional restrictions apply to certain assets in which the owner has a beneficial interest. For example, a corporation or partnership where they have a 50% or greater interest)
• A two-year transition period applies for IRA owners currently holding investments that will be prohibited under the provision

Changes to the tax treatment of grantor trusts

• Assets held within grantor trusts are included in the decedent’s taxable estate if the decedent is determined to be the owner of the trust
• Sale of assets to a grantor trust is considered a taxable event for income tax purposes if the grantor is deemed an owner of the assets
• The effective date for these provisions is the date of enactment (when the legislation is signed into law)

Taxpayers will monitor the proposals

Advisors and investors will be monitoring developments around these tax proposals in the coming weeks as Congress starts to move through the budget reconciliation process. The draft legislation released this week is an initial markup from the House Ways and Means Committee. These proposals will likely change during the debate process in the broader House and, eventually, the Senate.

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