HR 5376 – Build Back Better
HR 5376, released on October 28, 2021, adds several new provisions along with substantially modifying provisions from the earlier September version, including, but not limited to:
• Surtax on High Income Taxpayers: Imposes a 5% tax on modified adjusted gross income in excess of $10 million ($5 million for taxpayers filing as married filing separately). An additional 3% tax would apply to modified adjusted gross income over $25 million ($12.5 million for taxpayers filing as married filing separately).
• Application of 3.8% Net Investment Income (“NII”) Tax to Trade or Business Income: Previously this tax applied only to investment income; under the revised bill, the new NII tax treatment for trade or business income would apply to taxpayers earning more than 400,000 annually ($500,000 for married filing jointly). Net operating losses would no longer be accounted for in determining NII.
• Limited excess small business stock exclusion (QSBS): The bill limits QSBS to 50% for most sales of QSBS after September 13, 2021.
• Restrictions implemented on defined contribution retirement plans.
• Raises the $10,000 cap on state and local tax (SALT) deduction to $80,000.
• Surtax on Non-Grantor Trusts: A 5% tax would apply to the adjusted gross income of a non-grantor trust in excess of $200,000. An additional 3% tax would apply to the adjusted gross income of a non-grantor trust in excess of $500,000.
• Application of 3.8% NII Tax to Trade or Business Income: The exception for trade or business income earned by a non-grantor trust that materially participates in a given business would be eliminated, and all trade or business income would be subject to the 3.8% tax. Net operating losses would no longer be accounted for in determining NII.
• Corporate Alternative Minimum Tax: Imposes a 15% alternative minimum tax on the excess of “adjusted financial statement income” for corporations with a three-year average of financial statement income in excess of $1 billion.
• Stock Redemption Excise Tax: Imposes a 1% excise tax on publicly traded U.S. corporations based on the value of the stock that is repurchased by the corporation.
HR 5376 – What Has Been Removed From the Bill
While HR 5376 brings potential reform to the tax system, major proposals were omitted from the September bill including:
• Top Marginal Individual Income Tax Rate Increase: The September version increased the top rate to 39.6%, which would have applied to married individuals filing jointly with taxable income over $450,000, heads of households with taxable income over $425,000, unmarried individuals with taxable income over $400,000, married individuals filing separate returns with taxable income over $225,000, and estates and trusts with taxable income over $12,500 and would have applied to taxable years beginning after December 31, 2021. This has been replaced by a new 5% and 3% surtax with more limited application.
• Capital Gains Rate Increase: Increased to 25% from the current 20% rate, with retroactive application to gains arising from transactions occurring after September 13, 2021, subject to a binding contract exception. Replaced by the surtax.
• Grantor Trust Changes: Under the September version, the following changes would have been made to grantor trusts, which would largely have eliminated the use of grantor trusts as an estate planning tool.
• Trust assets attributable to contributions made by the grantor after the date of enactment would have been subject to estate tax upon the grantor’s death
• Sales of assets between a grantor trust and its deemed owner would have been subject to income tax
• In-kind payments of appreciated assets from a grantor retained annuity trust would have been subject to income tax
• Accelerated Reduction in Gift, Estate, and GST Exemptions: The gift, estate, and GST exemptions would have been cut in half from their current levels of $11.7 million to approximately $6 million. Under the 2017 Tax Cuts and Jobs Act, these exemptions would still be reduced to $5 million plus an inflation adjustment beginning in 2026.
• Anti-Discounting Rule Modifications: A commonly used estate planning strategy involves selling closely held business interests to an irrevocable trust on a discounted basis. Likewise, minority positions in closely held businesses owned at death (and therefore subject to estate tax) are typically subject to valuation discounts to account for the noncontrolling nature of assets of that type and the fact that they are not readily marketable. Under the previous bill, those discounts would have eliminated to the extent attributable to “passive assets” owned by the business.
• Corporate Tax Rate Increase: The September version replaced the flat corporate income tax with the following graduated rate structure: 18% on the first $400,000 of income; 21% on income up to $5 million, and 26.5% on income thereafter. The benefit of the graduated rate would have phased out for corporations making more than $10 million.