Month: October 2021

Negotiations continue in Washington, D.C., over the future of President Biden’s agenda. Tax law changes may be ahead under two proposed laws, the Build Back Better Act (BBBA) and the Bipartisan Infrastructure Bill (BIB), also known as the Infrastructure Investment and Jobs Act. The final provisions remain to be seen, but the BBBA and, to a lesser extent, the BIB, contain a wide range of tax proposals that could affect individuals and businesses. It’s also unclear when the tax changes would become effective, if one or both of the laws are enacted.

Here’s a summary of many of the proposals that could change the tax landscape in the near future.

Proposed tax provisions for individual taxpayers

The current version of the BBBA includes several provisions that could affect the tax liability of individual taxpayers in ways both positive and negative, depending largely on their taxable income. Among other areas, the legislation addresses:

Individual tax rates. The top marginal tax rate would return to 39.6%, the rate that was in effect before the Tax Cuts and Jobs Act (TCJA) cut it to 37% beginning in 2018. This rate would apply to the taxable income of married couples that exceeds $450,000, single filers that exceeds $400,000 and married individuals filing separately that exceeds $225,000.

A surcharge on high-income taxpayers. The BBBA would establish a new 3% tax on modified adjusted gross income above $5 million for married taxpayers filing jointly and single filers and above $2.5 million for married individuals filing separately.

The capital gains and qualified dividends tax rate. The maximum rate would increase from 20% to 25% for taxpayers in the 39.6% tax bracket. The Biden administration earlier had proposed to raise it as high as 39.6%.

The net investment income tax (NIIT). The BBBA would expand the NIIT to apply to the trade or business income of high-income individuals, regardless of whether they’re actively involved in the business. The NIIT currently applies to certain investment income and business income only if it’s passive. As a result, active business income would go from being taxed at a maximum rate of 37% under the TCJA to a maximum rate of 46.4% (the 39.6% individual income tax rate plus the 3.8% NIIT plus the 3% high-income surcharge).

This change would apply when adjusted gross income (AGI) exceeds $500,000 for married couples filing jointly, $250,000 for married couples filing separately and $400,000 for other taxpayers. Business income subject to self-employment tax would be excluded.

The qualified business income (QBI) deduction. The Section 199A deduction for pass-through entities would be limited to $500,000 for married taxpayers filing jointly, $400,000 for single filers and $250,000 for married taxpayers filing separately.

The qualified small business stock (QSBS) exclusion. Capital gains from the sale of QSBS held more than five years currently are 100% excludable from gross income. The BBBA would limit the exclusion to 50% for taxpayers with an AGI over $400,000, regardless of filing status.

Retirement planning. The BBBA would prohibit IRA contributions by taxpayers whose 1) aggregate IRA and other account balances exceed $10 million and 2) taxable income exceeds $450,000 for married couples filing jointly or $400,000 for single filers or married taxpayers filing separately. These taxpayers also would have to take required minimum distributions equal to 50% of the value that exceeds $10 million and 100% of any amount over $20 million.

Roth IRA conversions. The BBBA would prohibit certain taxpayers from first making a nondeductible contribution to a traditional IRA and then converting it to a Roth IRA (to get around restrictions on who can contribute to a Roth IRA). The proposal would apply to taxpayers with taxable income exceeding $450,000 for married taxpayers filing jointly and $400,000 for single filers and married taxpayers filing separately.

Child and dependent care tax credits. The American Rescue Plan Act (ARPA), enacted earlier this year, temporarily expanded both the Child Tax Credit (CTC) and the Dependent Care Tax Credit (DCTC). The BBBA would extend the CTC through 2025 and make permanent the DCTC.

Premium tax credits (PTCs). The ARPA also expanded the availability of PTCs to subsidize the purchase of health insurance for 2021 and 2022. The BBBA would permanently expand the credits.

Banking activity reporting. The Biden administration has proposed requiring financial institutions to annually report the total amount of funds that go in and out of bank, loan and investment accounts (personal and business) that hold a value of at least $600. Reporting also would be required if the aggregate flow in and out of an account is at least $600 in a year.

As Democrats weigh including this proposal in one of the bills, it has received pushback from banks and privacy advocates. A revised version includes a $10,000 threshold, and exemptions for some common transactions, such as payments from payroll processors and mortgage payments, also are under consideration.

Proposed tax provisions for businesses

The BBBA and BIB would also bring dramatic changes to the tax landscape for some businesses. In particular, their tax bills could be influenced by proposals related to the following:

The corporate tax rate. The BBBA would replace the TCJA’s flat rate of 21% with a graduated rate structure. The first $400,000 of income would be subject to an 18% rate, with the 21% rate retained for income between $400,000 and $5 million. The graduated corporate rate would max out at 26.5% for income exceeding $5 million.

Personal service corporations and corporations with taxable income exceeding $10 million would be subject to a flat 26.5% rate. The pre-TCJA top corporate tax rate was 35%.

Excess business losses. The TCJA limits the amount of excess business losses that pass-through entities and sole proprietors can use to offset ordinary income to $250,000, or $500,000 for married taxpayers filing jointly, adjusted for inflation. The limit is set to expire at the end of 2025, but the BBBA would make it permanent.

The bill also would create a new carryforward for unused excess business losses, rather than carrying them forward as net operating losses.

The business interest deduction. Internal Revenue Code Section 163(j) limits the deduction for business interest incurred by both corporate and noncorporate taxpayers. Under the proposal, the limit wouldn’t apply to partnerships and S corporations at the entity level. It instead would apply to the partners and shareholders.

Research and experimentation expenses. Under the TCJA, research and experimentation expenditures incurred in 2022 and later years aren’t immediately deductible; rather, they generally must be amortized over five years. The BBBA would delay the effective date for the amortization requirement to 2026.

The employee retention credit. The BIB would terminate this credit earlier than originally planned. Instead of being available for all of 2021, it would no longer be available for the fourth quarter, except for recovery startup businesses.

Carried interest. Currently, carried interests are taxed as short-term capital gains unless the gains were on property held for at least three years. The BBBA would extend the holding period to qualify for long-term capital gain treatment to five years — except for real estate businesses and taxpayers with less than $400,000 of AGI. The carried interest rules also would be expanded to cover all property treated as generating capital gains.

International transactions. The BBBA includes numerous proposals that would change the taxation of cross-border transactions and trim some of the tax advantages enjoyed by multinational corporations. For example, it would reduce the deductions for global intangible low-taxed income (GILTI) and foreign-derived intangible income. It would determine GILTI and foreign tax credit limits on a country-by-country basis. It also would make changes to the base erosion and anti-abuse tax.

Estate tax provisions

The BBBA would be much less taxpayer-friendly than the TCJA when it comes to gift and estate taxes and strategies. Most notably:

The gift and estate tax exemption. The TCJA doubled the gift and estate tax exemption to $10 million through 2025. That amount is annually adjusted for inflation (for 2021, it’s $11.7 million). The BBBA would return the exemption to its pre-TCJA limit of $5 million in 2022. The amount would continue to be adjusted annually for inflation.

Grantor trusts. The assets in these trusts would no longer be excluded from a taxable estate if the deceased is deemed the owner of the trust. In addition, sales between individuals and their grantor trusts would be taxed as if they were transfers between the individual and a third party. And distributions from a grantor trust to an individual other than the grantor or the grantor’s spouse would be treated as a taxable gift from the grantor.

Valuation discounts. Taxpayers would no longer be able to claim discounts for gift and estate tax purposes on transfers of interests in entities that hold nonbusiness assets (that is, passive assets held for the production of income and not used for an active trade or business). For example, discounts couldn’t be used to reduce the value of transferred interests in family-owned entities that hold securities.

Note: An earlier proposal to end the stepped-up basis tax break on inherited assets is no longer in the current version of the BBBA.

Stay tuned

It’s impossible to say which proposals will survive the ongoing negotiations intact. We’ll keep you up to date if and when the final legislation is enacted. In the meantime, contact us if you have concerns about how the proposed tax provisions may affect you personally or your business.

© 2021

Are employees at your business traveling again after months of virtual meetings? In Notice 2021-52, the IRS announced the fiscal 2022 “per diem” rates that became effective October 1, 2021. Taxpayers can use these rates to substantiate the amount of expenses for lodging, meals and incidental expenses when traveling away from home. (Taxpayers in the transportation industry can use a special transportation industry rate.)

Background information

A simplified alternative to tracking actual business travel expenses is to use the high-low per diem method. This method provides fixed travel per diems. The amounts are based on rates set by the IRS that vary from locality to locality.

Under the high-low method, the IRS establishes an annual flat rate for certain areas with higher costs of living. All locations within the continental United States that aren’t listed as “high-cost” are automatically considered “low-cost.” The high-low method may be used in lieu of the specific per diem rates for business destinations. Examples of high-cost areas include Boston, San Francisco and Seattle.

Under some circumstances — for example, if an employer provides lodging or pays the hotel directly — employees may receive a per diem reimbursement only for their meals and incidental expenses. There’s also a $5 incidental-expenses-only rate for employees who don’t pay or incur meal expenses for a calendar day (or partial day) of travel.

Less recordkeeping

If your company uses per diem rates, employees don’t have to meet the usual recordkeeping rules required by the IRS. Receipts of expenses generally aren’t required under the per diem method. But employees still must substantiate the time, place and business purpose of the travel. Per diem reimbursements generally aren’t subject to income or payroll tax withholding or reported on an employee’s Form W-2.

The FY2022 rates

For travel after September 30, 2021, the per diem rate for all high-cost areas within the continental United States is $296. This consists of $222 for lodging and $74 for meals and incidental expenses. For all other areas within the continental United States, the per diem rate is $202 for travel after September 30, 2021 ($138 for lodging and $64 for meals and incidental expenses). Compared to the FY2021 per diems, both the high and low-cost area per diems increased $4.

Important: This method is subject to various rules and restrictions. For example, companies that use the high-low method for an employee must continue using it for all reimbursement of business travel expenses within the continental United States during the calendar year. However, the company may use any permissible method to reimburse that employee for any travel outside the continental United States.

For travel during the last three months of a calendar year, employers must continue to use the same method (per diem or high-low method) for an employee as they used during the first nine months of the calendar year. Also, note that per diem rates can’t be paid to individuals who own 10% or more of the business.

If your employees are traveling, it may be a good time to review the rates and consider switching to the high-low method. It can reduce the time and frustration associated with traditional travel reimbursement. Contact us for more information.

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As we approach the holidays and the end of the year, many people may want to make gifts of cash or stock to their loved ones. By properly using the annual exclusion, gifts to family members and loved ones can reduce the size of your taxable estate, within generous limits, without triggering any estate or gift tax. The exclusion amount for 2021 is $15,000.

The exclusion covers gifts you make to each recipient each year. Therefore, a taxpayer with three children can transfer $45,000 to the children every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there’s no need to file a federal gift tax return. If annual gifts exceed $15,000, the exclusion covers the first $15,000 per recipient, and only the excess is taxable. In addition, even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below).

Note: This discussion isn’t relevant to gifts made to a spouse because these gifts are free of gift tax under separate marital deduction rules.

Gift-splitting by married taxpayers

If you’re married, a gift made during a year can be treated as split between you and your spouse, even if the cash or gift property is actually given by only one of you. Thus, by gift-splitting, up to $30,000 a year can be transferred to each recipient by a married couple because of their two annual exclusions. For example, a married couple with three married children can transfer a total of $180,000 each year to their children and to the children’s spouses ($30,000 for each of six recipients).

If gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) that the spouses file. The IRS prefers that both spouses indicate their consent on each return filed. Because more than $15,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $30,000 exclusion covers total gifts. We can prepare a gift tax return (or returns) for you, if more than $15,000 is being given to a single individual in any year.)

“Unified” credit for taxable gifts

Even gifts that aren’t covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $11.7 million for 2021. However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.

Be aware that gifts made directly to a financial institution to pay for tuition or to a health care provider to pay for medical expenses on behalf of someone else do not count towards the exclusion. For example, you can pay $20,000 to your grandson’s college for his tuition this year, plus still give him up to $15,000 as a gift.

Annual gifts help reduce the taxable value of your estate. There have been proposals in Washington to reduce the estate and gift tax exemption amount, as well as make other changes to the estate tax laws. Making large tax-free gifts may be one way to recognize and address this potential threat. It could help insulate you against any later reduction in the unified federal estate and gift tax exemption.

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Low interest rates and other factors have caused global merger and acquisition (M&A) activity to reach new highs in 2021, according to Refinitiv, a provider of financial data. It reports that 2021 is set to be the biggest in M&A history, with the United States accounting for $2.14 trillion worth of transactions already this year. If you’re considering buying or selling a business — or you’re in the process of an M&A transaction — it’s important that both parties report it to the IRS and state agencies in the same way. Otherwise, you may increase your chances of being audited.

If a sale involves business assets (as opposed to stock or ownership interests), the buyer and the seller must generally report to the IRS the purchase price allocations that both use. This is done by attaching IRS Form 8594, “Asset Acquisition Statement,” to each of their respective federal income tax returns for the tax year that includes the transaction.

Here’s what must be reported

If you buy business assets in an M&A transaction, you must allocate the total purchase price to the specific assets that are acquired. The amount allocated to each asset then becomes its initial tax basis. For depreciable and amortizable assets, the initial tax basis of each asset determines the depreciation and amortization deductions for that asset after the acquisition. Depreciable and amortizable assets include:

• Equipment,
• Buildings and improvements,
• Software,
• Furniture, fixtures and
• Intangibles (including customer lists, licenses, patents, copyrights and goodwill).

In addition to reporting the items above, you must also disclose on Form 8594 whether the parties entered into a noncompete agreement, management contract or similar agreement, as well as the monetary consideration paid under it.

What the IRS might examine

The IRS may inspect the forms that are filed to see if the buyer and the seller use different allocations. If the tax agency finds that different allocations are used, auditors may dig deeper and the examination could expand beyond the transaction. So, it’s best to ensure that both parties use the same allocations. Consider including this requirement in your asset purchase agreement at the time of the sale.

The tax implications of buying or selling a business are complex. Price allocations are important because they affect future tax benefits. Both the buyer and the seller need to report them to the IRS in an identical way to avoid unwanted attention. To lock in the best results after an acquisition, consult with us before finalizing any transaction.

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