Tax Policy Update: September 2021 Tax Proposals


Howard Essner, JD, Managing Director, Family Wealth Advisor

The House Ways and Means Committee recently released draft legislation containing the proposed tax increases that will help fund up to $3.5 trillion in anticipated social policy programs. The proposed changes impact corporate, individual income, gift, estate and retirement account taxes. Many of these proposals are very different than the tax proposals introduced by the President earlier this year, and are likely to be very different than the proposals coming out of the Senate Finance Committee, details of which are just starting to emerge.

These proposals are just the opening salvo in what will surely be a long and bruising battle in Congress. In the face of unanimous Republican opposition, the Democrats can afford to lose only 3 votes in the House, and no votes in the Senate, to pass any legislation. Senator Joe Manchin (D-W.VA) recently called for a “strategic pause” in the Democrats’ push on the $3.5 trillion bill, so passage in the Senate is far from a foregone conclusion. Assuming both houses do finally approve legislation, a reconciliation process will start to produce final legislation to go the President’s desk for approval. So, it appears we will be in for an “interesting” few months, and this uncertainty will make tax planning over the next few months a very dicey proposition.

With these caveats in mind, we are providing a summary of the key provisions of the House Ways and Means Committee proposal that affect individual taxpayers. The changes described below would, in theory, go into effect for the 2022 tax year, unless otherwise noted. But, as we indicated, there is much ground to cover on Capitol Hill before any aspect becomes final.

Individual Income Changes

The House proposal:

  • Increases the top income tax rate to 39.6% on taxable income above $400,000 for individuals and $450,000 for joint filers. Note that these income levels apply to many of the changes discussed below, so for simplicity’s sake, we will just call these taxpayers the “High Income Taxpayers.” These income thresholds are lower than the President’s proposal and much lower than the current thresholds for the top rate.
  • Imposes a 3% income surtax on taxable income exceeding $5 million, a provision also not included in the President’s proposal.
  • Limits the qualified pass-through business income deduction of Section 199a to $400,000 for individual filers and $500,000 for joint filers.
  • Expands the 3.8% Net Investment Income Tax (NIIT) to cover net investment income derived from a trade or business for High Income Taxpayers. Essentially, this change will subject all income for High Income Taxpayers from pass-through entities, whether passive or active, to either the 3.8% Medicare self-employment tax or the NIIT.
  • Increases the highest long-term capital gain tax rate to 25%. This is lower than the top ordinary income rate proposed by the President for taxpayers with taxable income exceeding $1 million. The effective date for this change was September 13, 2021, with transition rules for binding contracts signed before that date but closing after.

Estate and Gift Tax Changes

The House proposal:

  • Accelerates the sunset of the increase in the estate and gift lifetime exclusion that was increased in 2017. This means that the lifetime exemption per individual will revert to $5 million (the prior 2017 figure, but adjusted for inflation will probably be closer to $5.85 million) from the current $11.7 million level. This change was not in the President’s proposal, who instead focused on changing the rules regarding the step-up in basis at death. Those changes are not included in the Committee’s proposals.
  • Makes technical changes that will cause grantor trusts to be included in the grantor’s taxable estate and treat sales between the grantor and a grantor trust as a sale to a third party. These changes will effectively end the use of specialized grantor trust strategies in estate and gift planning, such as grantor retained annuity trusts and sales to intentionally defective grantor trusts. The changes will not apply to existing trusts.

Retirement Account Tax Changes

The House proposal:

  • Eliminates any new contributions to a retirement plan or IRA if High Income Taxpayer’s total retirement accounts (traditional IRAs, Roth IRAs, and employer qualified plans) exceed $10 million.
  • Requires High Income Taxpayers with $10 million or more in retirement account balances to take a minimum distribution each year. The minimum distribution will be 50% of the value of the retirement accounts above $10 million. Additional distributions are required if the account values are more than $20 million.
  • Prohibits IRAs from investing in any investment vehicle that requires “accredited investor” status, such as private partnerships and hedge funds. This change, under the initial proposal, would be effective in 2022 for new investments, with existing investments required to be liquidated over 2 years starting in 2022. These changes, none of which were part of the President’s proposal, are clearly a reaction to the recent news about tech entrepreneur Peter Theil’s $4 billion Roth IRA.
  • Eliminates the “back-door” Roth IRA strategy by eliminating all Roth conversions for High Income Taxpayers. This change is effective as of December 31, 2031, although some commentators have questioned whether this is a typographical error with the intended effective date to be next year. The elimination of Roth conversions is ironic because liberalization of the Roth conversion rules several years ago was considered a revenue-raising item to offset other tax cuts.
  • Eliminates the “Mega Roth” strategy by disallowing all after-tax contributions to a retirement plan regardless of income level.

As we said, tax planning with this uncertainty is very difficult. Many times, we have seen individuals take irrevocable actions based on some assumed future tax law change, only to regret it later when Congress acted in an unexpected way or simply did not act. However, here are a few planning ideas to prepare if Congress does act:

  • Prepare for ways to accelerate ordinary income into 2021 and defer deductions into 2022.
  • If allowed, prepare to take extra distributions from retirement accounts to pay tax in 2021 and avoid the higher rates in 2022 and the more onerous distribution requirements.
  • Make sure that trust documents are prepared and in place to accept funding to use up lifetime exemptions if the law changes.

As always, we stand by to answer your questions and address your concerns.

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