Businesses and individuals should prepare for potentially dramatic changes to the tax landscape. Congress is currently debating a substantial budget reconciliation bill to fund President Joe Biden’s infrastructure and social policy initiatives with tax increases aimed at high- income taxpayers.
Most of the proposals are expected to have an effective date of Jan. 1, but some might have retroactive dates. Additionally, tax laws enacted by the 2017 Tax Cuts and Jobs Act, or TCJA, are set to expire at the end of 2025.
Below is a top-level overview of the provisions getting the most attention right now.
Individual tax changes
High-income taxpayers could see several tax increases. The top individual income tax rate could increase to 39.6% from 37% for individuals with income over $400,000 ($450,000 for married couples).
The proposal includes an additional 3% surcharge on income in excess of $5 million for individuals and married couples ($100,000 for trusts and estates).
The bill also proposes changes to the Section 199A business deduction and the 3.8% net investment income tax that would affect high- income taxpayers (see further below).
Capital gains
Under the proposal, the top capital gains tax rate could increase to 25% from 20% for individuals with income over $400,000 ($450,000 for married couples). The rate would apply retroactively to transactions occurring after Sept. 13, 2021.
Notably, the bill did not include changes proposed by the Biden administration to eliminate the step-up in basis on unrealized gains at death.
Business tax changes
For C corporations the corporate tax rate could be increased to 26.5%, with the current 21% flat tax replaced with a graduated rate structure. Income in excess of $5 million would be subject to the maximum 26.5% rate. The proposed rate is still much lower than the corporate rates in effect before the TCJA.
For owners of pass-through entities, the bill limits the Section 199A qualified business income deduction to $400,000 for individuals ($500,000 for married couples).
The bill also expands the 3.8% net investment income tax for high-income taxpayers to include their trade or business income. Under current law the 3.8% tax applies only to passive investment income, such as interest, dividends and capital gains.
Estate tax
Under the TCJA the current estate and gift tax exclusion amount of $11.7 million is scheduled to revert back on Jan. 1, 2026, to $5 million (subject to adjustments for inflation). The current proposal in the draft bill accelerates the reversion date to Jan. 1, 2022.
The draft bill also limits several estate planning techniques, such as the use of grantor trusts and valuation discounts for transfers of certain assets.
Hawaii tax proposals
In Hawaii several tax bills were introduced in the 2021 legislative session, including a number of income tax proposals that would have raised Hawaii’s individual income tax rate to the highest in the nation and several estate tax proposals to lower the current Hawaii estate tax exclusion amount significantly. Although these measures failed to survive in the Legislature, they signal a growing effort among lawmakers to increase state revenue and bolster a pandemic- weary local economy.
Final thoughts
Given the uncertainty surrounding substantive tax law changes and effective dates, taxpayers would be wise to consult with their advisers to discuss strategies to plan for a new regulatory landscape. While the details are yet to be finalized, it is certain that significant changes are on the horizon.
Vasana Chiu is an associate in the tax and estate planning and transactional practice groups at Carlsmith Ball LLP. She can be reached at vchiu@carlsmith.com.
