Build Back Better 2.0 – What’s In, What’s Out, and What’s Next?
November 8, 2021
The Build Back Better Act, a sweeping set of tax increases particularly aimed at corporations and the wealthy, continues to evolve. Democrats are looking to hammer together a coalition sufficient to pass the bill through reconciliation and into law. Here’s a look at what the Build Back Better Act (BBB) would mean for higher-income taxpayers, high net worth individuals, and business owners.
Congressional Democrats scored a victory on Friday, November 5th, successfully passing a $1.75 trillion infrastructure bill through Congress on Friday, November 5th, sending it to Biden’s desk, where he is expected to sign it into law. But the Build Back Better Act has encountered a few snags, as key members of Congress raise concerns about costs.
The resistance led bill sponsors to drop some of the Build Back Better Act’s provisions. But they’ve added some other provisions, and even added back some things they had taken out of the bill just days ago. The bill continues to change every few days, and could well evolve again. But here’s an update, as of November 6th, 2021.
- Restrictions on Grantor Trusts. Congress dropped a provision that would have limited the usefulness of grantor trusts, including gift trusts with spouse beneficiaries, irrevocable life insurance trusts, and others when it comes to wealth transfer planning. The new version of the Build Back Better Act retains these techniques as valuable legacy planning tools.
- Valuation Discounts on Passive or Non-Business Assets. The earlier version of the bill limited valuation discounts on lifetime gifts of interests in LLCs and partnerships. This would have resulted in an effective tax increase on transfers of businesses to heirs and others. Congress dropped this provision from the current version of the bill.
- Early Sunset of Higher Gift, Estate, and Generation-Skipping Transfer Tax Exclusion. The original BBB Act text targeted the current $11.7 million exclusion on these taxes for reduction to $5 million. Congress dropped this provision, which means that unless Congress changes the bill or otherwise passes new legislation, the current higher exclusion will remain in place until the scheduled sunset date of January 1st, 2026.
What’s Still In?
The Build Back Better Act still has several provisions in it that would affect higher-income Americans:
- SALT Deduction Increase. High-end homeowners in high-income tax states got a Halloween treat in the second iteration of the Build Back Better Act: The new version of the bill change would raise the state and local tax exemption (SALT) cap to $80,000 from 2021-2030, reverting to $10,000 for 2031.
- High-income surtax. A surtax of 5% of modified adjusted gross income over $10 million per year, and an additional tax of 3% of MAGI in excess of $25 million. So incomes over $25 million per year would face an additional 8% tax, over and above existing income taxes. Trusts and estates would face the same tax at income thresholds of $200,000 and $500,000, respectively.
- Restrictions on Contributions to ‘jumbo’ IRAs. The bill would stop individuals with more than $10 million in combined IRA and workplace retirement plan balances from making new contributions, effective tax year 2029.
- New type of RMD for ‘jumbo IRAs’ and other retirement accounts. The bill introduces a new type of required minimum distribution for retirement accounts over $10 million. Owners of IRAs and other retirement accounts over that threshold must begin taking distributions – and paying taxes on the income. The rules will apply to those with incomes over $400,000 for individuals and $425,000 for couples, beginning in tax year 2029. The effective date was moved back from 2022 in an earlier version of the bill.
- “Backdoor Roth” conversions restricted. The law will prohibit any conversions of after-tax 401(k) and other workplace plan contributions and non-deductible IRA contributions to Roth accounts. Those with incomes above $400,000 (singles) and $450,000 (married filers) would not be allowed to convert pre-tax to Roth IRAs, effective 2032.
- 3.8 % net investment income tax on active business income. Under current law, there’s a 3.8% net investment income tax on net investment income, or all MAGI over $125,000 per year for single filers, $250,000 for married filers, and $200,000 for everybody else. The Build Back Better bill expands this tax to include active business income for single taxpayers with taxable income greater than $400,000 single filers, or $500,000 for married filers, as well as for trusts and estates.
- Higher Taxes on Sales of Small Businesses. Currently, Section 1202 allows sellers of qualified small business stock (QSBS) exclude up to 100% of gains from tax, up to a limit of $10 million, or 10 times the original investment annually. The Build Back Better act would increase taxes on sales these qualified C-corporation shares substantially by reducing the maximum exclusion to 75% or 50%. If the bill passes, this tax would be backdated to September 13th, 2021, except for those sales under binding contracts prior to that date.
- Expanded ‘Wash Sale’ Rules. The Build Back Better Act expands Section 1091 30-day wash sale rules to include currencies, cryptocurrencies and other digital assets, and commodities. This means that these assets will be subject to the same wash sale rules that have long applied to securities: If you want to claim a capital loss on these assets, you must wait at least 30 days before buying a substantially identical asset.
- Child Tax Credit Extended. The American Rescue Plan Act (ARPA) Child Tax Credit is extended through 2022, if the bill passes. It’s also made fully and permanently refundable.
Tax increases on Corporations
- New 15% Corporate Alternative Minimum Tax. The current version of the Build Back Better Act imposes a new alternative minimum tax of 15% on book income for corporations reporting adjusted financial state income (AFSI) of $1 billion or more over three consecutive years.
- 1% tax on stock buybacks. The BBB creates a new 1% tax on share repurchases on publicly-traded U.S. corporations. This could influence corporations to use excess cash issue a (taxable) dividend to shareholders, rather than buy in stock from existing shareholders.
- GILTI Tax Increase. The bill would reduce the tax on Global Intangible Low-Taxed Income to 5%, resulting in an effective tax rate of 15% on this income. GILTI would also be exempt from expense allocation rules.
- Qualified Business Asset Investment (QBAI) Tax increase. The Build Back Better Act would reduce the QBAI exemption to 5%.
- Reduced Foreign Income Tax credit. The Foreign Income Tax Credit would be slashed to 5%. They can be carried forward for five to ten years. Carrybacks are disallowed under the bill.
- FDII Tax Increase. The BBB Act reduces the deduction for foreign-derived intangible income (FDII) to 21.875 percent, resulting in a tax rate of 15.8 percent, effective with the 2023 tax year.
The Build Back Better Act could well see some significant changes between now and eventual passage – if it passes at all. However, the more onerous provisions affecting corporations and high-income individuals don’t have much of a voting constituency.
Meanwhile, the recent Republican victories in the hotly-contested Virginia governor’s race and the unexpectedly strong GOP showing in the New Jersey governor’s race have complicated Democrats’ plans for a quick passage. Some moderate Democrats who were on the fence or represent vulnerable districts may seek cover.
On Friday, November 5th, House Democrats reached a deal in which hesitant Representatives agreed to vote for the bill provided the Congressional Budget Office scores the costs of the bill in line with White House budget estimates.
With the recent passage of the Infrastructure Bill, which received bipartisan support, eventual passage of some form of the Build Back Better Act seems likely at this point.
Clients should reach out to their tax advisors and take a close look at plans to transfer small business interests, harvest losses on certain kinds of assets, and otherwise reduce exposure to tax increases as soon as practicable.
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