On September 15, 2021, the Internal Revenue Service sent out the third set of Advance Child Tax Credit (ACTC) payments. Over 35 million families received a total of approximately $15 billion in payments. Most of the payments were direct deposits to bank accounts.
The remaining ACTC payments are scheduled for October 15, November 15 and December 15. Qualifying families will receive payments of up to $300 per month for dependent children under age 6 and up to $250 per month for children ages 6 through 17.
The IRS reminded families who have not filed a 2020 income tax return that they still are eligible to sign up. There is a Non–Filer Signup Tool on IRS.gov
This week a House of Representatives committee took action on the Build Back Better (BBB) Act. It includes a four-year extension of the Child Tax Credit. The bill is now pending in the House of Representatives, but a vote may take place by the end of September. House and Senate leaders hope to have a final bill enacted in October.
In addition to the child tax credit, which has a potential cost of $100 billion per year, the BBB Act would make permanent the dependent care tax credit and expand the earned income tax credit (EITC).
Another provision of the bill would provide a payroll tax credit on wages for childcare workers. There would be a tax credit for up to $2000 per year toward caregiver expenses.
The Advance Child Tax Credit payments are designed to lift many families with children out of poverty. The cost of these programs to benefit families, those caring for minor children and caregivers are planned to be offset by increased taxes on corporations and upper-income individuals. Your editor does not take a position on specific provisions of this bill. This information is offered as a service to our readers.
BBB Tax Increases for High-Income Individuals
The Build Back Better (BBB) Act was passed by the House Ways and Means Committee on September 15, 2021. The bill now proceeds to the full House of Representatives for a vote expected to occur in late September. A substantial section of the more than 1,870-page bill is devoted to specific tax increases on upper-income individuals.
- Income Tax Increases — The top marginal tax rate would increase from 37% to 39.6%. This rate would apply in 2022 to individuals with taxable income over $400,000 and married couples filing jointly with incomes over $450,000. The 39.6% top bracket would apply to trusts and estates with income over $12,500.
- Capital Gains Tax Increases — The capital gain rate for upper-income taxpayers will increase from 20% to 25%. The increased rate will apply in future years, but the final language may make the increased rate applicable for gains resulting from transactions that are binding prior to the date of the BBB Act's introduction.
- Net Investment Income Tax on Active Income — Section 1411 would levy a 3.8% tax on net investment income. Previously, this tax has not been applied to active business income. The Act would make the tax generally applicable for active business income if the individual has over $400,000 of taxable income (or over $500,000 of taxable income for a married couple filing jointly).
- Qualified Business Income Limit — The Section 199A deduction is generally 20% for qualified business income (QBI). Individuals with incomes over $400,000 or couples filing jointly with incomes over $500,000 would no longer qualify for the QBI deduction. The QBI limit would also apply to trusts or estates with over $10,000 of income.
- Surtax of 3% on High–Income, Individuals, Trusts and Estates — Individuals with modified adjusted gross income (MAGI) over $5 million would be subject to an additional 3% surtax. Modified adjusted gross income equals "adjusted gross income reduced by any deduction allowed for investment interest." Trusts with incomes over $100,000 would also pay the 3% surtax. The new surtax would apply in 2022.
These provisions have not yet passed the House of Representatives. However, an avalanche of Washington lobbyists descended upon Senate Finance Committee staffers to seek to modify these provisions. This BBB Act summary does not include advocacy for any of these provisions by your editor, but is offered as a service to our readers.
Top Combined Income and Capital Gain Rates
If the provisions of the Build Back Better Act included in the House bill are enacted, there will be a return to very substantial state and federal tax rates.
The top income tax rate of 39.6% would be increased by 3% for individuals with modified adjusted gross income (MAGI) over $5 million. This 42.6% rate could also be increased by the Section 1411 net investment income tax 3.8% rate, for a total federal rate of 46.4%.
State and local taxes may be added to this number in certain locations. The top rate in New York City and other states will be determined by adding the maximum rate to the federal rate. Because the BBB Act does not change the $10,000 state and local tax (SALT) limits, upper-income individuals will use that amount against property taxes and may pay state and local income tax with no corresponding federal tax deduction.
With a combined state and local rate of 14.8%, the top New York City rate would be 61.2%. The top combined rates in other states would be 59.7% in California, 57.2% in New Jersey and 57.4% in Hawaii.
There would also be substantial increases in top capital gains rates for these locations. The federal top long-term capital gains rate for single taxpayers with incomes over $400,000 and married couples with incomes over $450,000 would be 25%. With the additional Section 1411 tax of 3.8%, the top federal rate would be 28.8%. Individuals with incomes over $5 million would pay 31.8%.
Because most states do not have an exemption for capital gain, the full tax is generally applicable. The top capital gain rate in New York City would be 46.6%. The rates would be 45.1% in California, 42.6% in New Jersey and 42.8% in Hawaii.
These high income and capital gains rates may be modified in the Senate Finance Committee version of the BBB Act. However, the clear trend is toward substantially higher tax rates for upper–income persons in cities and states with substantial local taxes. Individuals in these locations will be very interested in speaking with their CPAs and other tax advisors about tax–saving strategies. Many of these tax advisors will recommend charitable plans and gift strategies.
BBB Gift and Estate Tax Proposals
A significant section of the BBB provisions will have a dramatic impact on estate planning. The exemptions from estate tax, changes in valuation for family farms, a new rule for deemed ownership and gain recognition for grantor trusts, and elimination of certain valuation discounts will require major revisions for estate plans.
- Reduction in Unified Credit — The Tax Cuts and Jobs Act (TCJA) of 2017 doubled the estate tax exemption from $5 million to $10 million (indexed for inflation). The 2021 basic exclusion amount of $11.7 million per individual is scheduled to sunset after 2025. The BBB Act would eliminate the TCJA exemption increase after 2021. The projected gift or estate exemption per individual for 2022 would be $6,020,000.
- Family Farms Protected — In 1992, Representatives Richard Gephardt and Henry Waxman proposed reducing the estate exemption from $600,000 to $200,000. There was strident opposition to this change from family farmers. In order to avoid a repeat of the demonstrations by family farmers in front of local offices of members of Congress, the BBB Act would expand the Section 2032A special valuation rules for family farms. The property used in a family farm (with material participation by qualified heirs) has been previously subject to a reduction in value for estate tax purposes of $750,000 (plus indexed increases). The Section 2032A allowable reduction would be set at $11.7 million. This massive increase in the Section 2032A amount eliminates estate tax for virtually all family farms.
- Grantor Trust Limits — Grantor trusts are widely used for many purposes by estate planners. A new Section 1062 would treat a sale between grantor trust and the deemed owner as equivalent to a sale between that person and a third party. This provision is designed to require recognition of gain when the grantor trust is created and there is an asset sale to the trust. There are also provisions that may require inclusion of grantor trust assets at the date of death or at a trust's termination. These provisions may limit the economic benefits of sales to intentionally defective irrevocable trusts (IDITs), grantor retained annuity trusts (GRATs) and qualified personal residence trusts (QPRTs).
- Discounts Denied on Public Securities — Many individuals have created family limited partnerships (FLPs) and other entities that hold both business and non-business assets. When interests in the FLPs or other entity are transferred to family members, an appraiser often reduces value based on discounts for minority interest and lack of marketability. Generally, the BBB Act would no longer permit valuation discounts for public securities. Discounts would be permitted for business interests and the working capital of a business.
The BBB Act includes multiple changes designed to tax larger estates and reduce planning opportunities to discount value and reduce estate tax. The most significant omission in the BBB Act is the proposed recognition of capital gain held in an estate or when appreciated property is gifted. Several Senators have expressed interest in adding this provision to the Senate bill. While this provision would be very complex to administer, it is possible that it could be added to the Senate bill.
Retirement Plan Limits for High-Income Taxpayers
There have been media reports of individuals with substantial wealth who have funded traditional IRAs, Roth IRAs and other qualified plans with millions or even billions of dollars. The BBB Act proposes numerous rules to reduce the ability of upper-income taxpayers to build vast wealth in an IRA. These new rules apply to contributions and required distributions for qualified plans by upper-income individuals.
- Contribution Limits for High–Income Individuals — Taxpayers who have accounts with a balance over $10 million would no longer be able to contribute to either a Roth or traditional IRA. This limit applies to individuals with larger accounts if they have taxable income over $400,000 or married taxpayers filing jointly with income over $450,000. There is also a new annual reporting requirement for employers who have employees with account balances in excess of $2.5 million.
- Increased Required Minimum Distributions — Taxpayers who have large retirement accounts would be required to take substantial distributions. If the aggregate of all retirement accounts is over $10 million, the required minimum distribution (RMD) would be 50% of the excess balance. If the aggregate retirement accounts are over $20 million, the RMD would be 100% of the excess amounts. This rule effectively limits the aggregate retirement account balance to $20 million.
- Rollovers to Roth IRAs — Roth IRAs have income limits for contributions that are designed to restrict use by upper-income individuals. The 2021 limit for Roth IRA contributions is $125,000 (phased out by $140,000) for an individual. However, some taxpayers have used a "back-door" Roth IRA strategy and converted a traditional IRA funded with after–tax contributions to a Roth. The BBB Act eliminates Roth conversions for individuals with income over $400,000 or married taxpayers filing jointly with income over $450,000.
- Limits on IRA Investments — IRAs would be prohibited from investing in securities in which an IRA owner has a 10% direct or indirect ownership interest or is an officer in the entity. This provision is intended to direct IRA investments into public securities.
Applicable Federal Rate of 1.0% for October -- Rev. Rul. 2021-18; 2021-40 IRB 1 (15 Sep 2021)
The IRS has announced the Applicable Federal Rate (AFR) for October of 2021. The AFR under Section 7520 for the month of October is 1.0%. The rates for September of 1.0% or August of 1.2% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2021, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.