Article

Build Back Better bill: individual tax provisions

Nov. 8, 2021

State and local tax cap

The BBB modifies the state and local tax (SALT) cap. Introduced in the Tax Cuts and Jobs Act (TCJA) and currently set to expire after 2025, the SALT cap limits individuals to $10,000 of SALT-itemized deductions ($5,000 for married taxpayers filing separately). This provision was controversial, resulting in various forms of state-implemented “workarounds” and constitutional challenges. A late-filed manager’s amendment to the BBB will increase the SALT cap to $80,000 per taxpayer ($40,000 for married filing separately) and keep this limit in place through 2030. The cap reverts back to $10,000 for 2031, the final year it would be in effect.  

This change has been drafted to be retroactive to the beginning of the 2021 tax year. At this time, expect the Senate to potentially adjust the cap amount or include income parameters to determine eligibility for the increased deduction.

Surcharge on high-income individuals, estates and trusts

Applying to individual taxpayers for tax years beginning after Dec. 31, 2021, the BBB imposes a new 5% surcharge on modified adjusted gross income (MAGI) in excess of $10 million ($5 million for married filing separately) and an additional 3% surcharge on MAGI in excess of $25 million ($12.5 million for married filing separately). For purposes of these surcharges, MAGI equals adjusted gross income (AGI) reduced by investment or business interest expense. Since the section 199A qualified business income does not factor into AGI, it appears these surcharges will apply to income before this deduction. These surcharges apply to all types of income, including long-term capital gains and qualified dividends taxed at preferential rates.

The surcharge is also assessed on trusts and estates, with the 5% surcharge on MAGI in excess of $200,000 and the additional 3% on MAGI in excess of $500,000. Estates and trusts will continue to compute AGI as per current law.

The 5% and 3% would be in addition to any applicable 3.8% net investment income tax, the 0.9% additional Medicare tax as well as the Medicare tax on earnings.

Expansion of income subject to net investment income tax

Currently, the 3.8% net investment income tax (NIIT) only applies to trade or business income to the extent it is passive, generally meaning the taxpayer does not materially participate in the trade or business. The BBB changes the application of NIIT, levying the tax on the “specified net income” (SNI) of certain taxpayers. Broadly, SNI is defined as the taxpayer’s net investment income; however, it will now include income derived in the ordinary course of a trade or business, even if the taxpayer actively participates in such business, or the business is the trading of financial instruments or commodities.

This change affects taxpayers with MAGI in excess of $400,000 ($500,000 for joint filers, $250,000 for married individuals filing separately), and includes trusts and estates. MAGI for this purpose equals AGI recomputed for certain items related to foreign earned income — i.e., it is different than the MAGI computation for the surcharges described above. SNI does not include income subject to self-employment taxes, wages on which FICA taxes are imposed, wages received for performing services for a foreign employer outside of the U.S. or deductions for net operating losses. This provision is effective for taxable years beginning after Dec. 31, 2021.

Limitations on excess business losses

The excess business loss limitation (EBL) caps the amount of trade or business deductions a noncorporate taxpayer can use to offset nonbusiness income. Originally set to expire in tax years beginning after 2025, this TCJA-enacted provision limits these losses to $250,000 (or $500,000 for a joint return), indexed for inflation. For 2021 tax years, net business losses exceeding $262,000 (or $524,000 for joint returns) will be disallowed and carried forward. The BBB makes this provision permanent.

In addition, the BBB makes two important changes to the carryforward of EBLs. Under the new law, an EBL that is carried forward will no longer become part of a taxpayer’s net operating loss. Instead, it is treated as a trade or business deduction and is thus subject to testing and limitation in subsequent years. Additionally, if an estate or trust has an EBL carryforward at the time it terminates, the carryforward will be allowed as a deduction to the beneficiaries.

Please see our annual year-end tax planning letter for additional discussion and examples of how this limitation operates.

Enhanced credit for qualified plug-in electric drive motor vehicles

The BBB provides an enhanced refundable income tax credit for individuals who purchase new qualifying plug-in electric vehicles. The base credit amount of $4,000 can be incrementally increased to a maximum of $12,500. Additional amounts are available if the vehicle meets the following qualifications

(1) battery and gasoline tank capacities meet certain thresholds (additional $3,500)
(2) final assembly occurs in a U.S. facility operating under a union-negotiated collective bargaining agreement (additional $4,500), and
(3) power is generated by battery cells manufactured in the U.S (additional $500)

The credit is not allowed for vehicles with manufacturers’ suggested retail prices that exceed certain thresholds ($80,000 for vans, SUVs and pickup trucks, and $55,000 for any other vehicle) and is otherwise limited to 50% of the purchase price. The credit additionally phases out for taxpayers whose MAGI exceeds certain thresholds ($500,000 for joint filers, $375,000 for head of household and $250,000 for all other filers). Taxpayers are limited to one qualifying purchase per year.

This credit is available beginning after Dec. 31, 2021, and is limited to vehicles purchased prior to Jan. 1, 2032. The BBB additionally provides for and extends several other credits for electric and alternative fuel vehicles, including an individual credit limited to the lesser of up to $4,000 or 50% of the sale price for previously owned qualifying plug-in electric vehicles and a credit for certain qualified non-plug-in commercial electric vehicles equal to up to 30% of their cost.

Changes to retirement account rules

Three important modifications were made to the laws governing retirement accounts in the House-passed version of the BBB. Most of these changes apply only to high-income taxpayers. For purposes of these provisions, high-income taxpayers are defined as those with taxable income over $400,000 for single taxpayers, $425,000 for head-of-household taxpayers and $450,000 for married filing jointly taxpayers (all indexed for inflation).

• New contribution limits for high-income taxpayers with IRAs and defined contribution retirement accounts

Under current law, taxpayers may make contributions to IRAs, including Roth IRAs, regardless of the accumulated value in such accounts. The legislation prohibits high-income taxpayers from making contributions to IRAs or Roth IRAs if the contribution would cause the value of the taxpayer’s IRAs and defined contribution retirement accounts to exceed or further exceed $10 million as of the end of the prior taxable year. To the extent excess contributions are made, the excess amount will be subject to a 6% excise tax. These provisions are effective for taxable years beginning after Dec. 31, 2028.

The legislation also imposes a new annual reporting obligation on employer-defined contribution plans to the extent one or more participants has aggregated account balances in excess of $2.5 million. The reporting would be to the IRS and the participant whose account balance is being reported. This provision is effective for plan years beginning after Dec. 31, 2028.

• Increase in required minimum distributions for high-income taxpayers with large retirement account balances

High-income taxpayers with combined IRA, Roth IRA and defined contribution retirement account balances in excess of $10 million at the end of the prior taxable year will be required to take a minimum distribution. Generally, the distribution will be 50% of the amount by which the aggregate account values exceeded $10 million in the prior year. If total account balances are over $20 million, there is an additional requirement that a portion of the distribution come from Roth IRAs and Roth accounts in defined contribution plans. Failure to comply with this provision would result in a 50% excise tax of the amount by which the required distribution exceeds the actual amount distributed.

This provision is effective for tax years beginning after Dec. 31, 2028.

• “Back-door” Roth IRA conversions and rollovers will no longer be available for high-income taxpayers

Under current law, a taxpayer whose income exceeds the income limitations for contributions to a Roth IRA could make a nondeductible contribution to an IRA and then convert the IRA to a Roth IRA. This Roth conversion strategy is eliminated in the BBB for both IRAs and/or employer-sponsored retirement plans for high-income taxpayers. This provision is effective for taxable years beginning after Dec. 31, 2031.

In addition, regardless of the taxpayer’s income level, all after-tax contributions to qualified plans or IRAs would be prohibited by the proposed BBB from being converted to Roth accounts. This provision is effective for distributions, transfers and contributions made after Dec. 31, 2021.

Worthless securities

The bill makes several changes to the rules for losses on worthless securities, effective for losses arising in taxable years beginning after Dec. 31, 2021.

Most notably, if a partner abandons a worthless partnership interest during the taxable year, the resulting loss shall be treated as a loss from the sale or exchange of the partnership interest. Under current law, if a partner abandons a worthless partnership interest and there are no partnership liabilities allocated to that partner, the partner is entitled to claim an ordinary loss. However, under the BBB, the partner would be required to generally treat the abandonment as a capital loss (subject to the “hot asset” rules under section 751), even if they are not allocated a share of partnership liabilities.

Under the BBB, the definition of “securities” is expanded to include partnership interests and partnership debts. The bill changes also the timing of when a loss is realized from the last day of the taxable year to the time of the “identifiable event” establishing worthlessness. The provision provides that the abandonment of a security or partnership interest is treated as an identifiable event establishing worthlessness.

Wash sale rule modifications

Wash sale rules have historically disallowed losses on stocks and securities when the seller purchases a “substantially identical” stock or security within 30 days of the sale that triggered the loss. The BBB updates the wash sale rules to apply not only to securities but also foreign currencies, commodities and digital assets. Exceptions are provided for business needs and hedging transactions.

In addition, the BBB also extends wash sale rules to related parties. If a taxpayer incurs a loss but a related party purchases a substantially similar asset within 30 days, the original taxpayer will not be able to claim the loss. Furthermore, the disallowed loss that is normally added to the basis of the newly acquired stock will not be added (as it is in the hands of a related party and not the original taxpayer).

Earned income tax credit

The American Rescue Plan Act (ARPA) expanded access to the earned income tax credit (EITC) for taxpayers without qualifying children (often referred to as the “childless EITC”) for the 2021 tax year. Key changes included raising the income phaseout limit, nearly tripling the available credit to a maximum of $1,502, reducing the minimum age to 19 and eliminating the upper age limit. The BBB includes a provision to continue the expanded “childless EITC” through 2022, with amounts indexed for inflation. In addition, taxpayers will continue to have the option to utilize their prior year’s earned income for calculating the EITC in the event their earned income has fallen in the current year.

Child tax credit

The ARPA also created an expanded child tax credit (CTC), in effect for 2021. Qualifying taxpayers received an increased credit of $3,000 per qualifying child ages 6 to 17 and $3,600 for children 5 and under. In addition, for the final six months of 2021, taxpayers received a monthly portion of their estimated CTC deposited into their accounts on file (unless elected out). Taxpayers who phased out of the expanded CTC can claim the original CTC (last updated with the TCJA). The BBB makes the expanded CTC available again for the 2022 tax year.

We encourage you to reach out to your Baker Tilly advisor regarding how any of the above may impact your situation.