Proposed Surcharge on High-Income Individuals, Estates and Trusts
The House version of the Build Back Better Act would impose a 5% surcharge on modified adjusted gross income that exceeds $5 million for married individuals filing separately, $200,000 for estates and trusts and $10 million for all other individuals. An additional 3% surcharge would be imposed on modified adjusted gross income in excess of $12.5 million for married individuals filing separately, $500,000 for estates and trusts and $25 million for all other individuals. The proposal would be effective for taxable years beginning after December 31, 2021 (i.e., beginning in 2022).
While keeping the proposed surcharges in mind, taxpayers should consider whether they can minimize their tax bills by shifting income or deductions between 2021 and 2022. Ideally, income should be received in the year with the lower marginal tax rate, and deductible expenses should be paid in the year with the higher marginal tax rate. If the marginal tax rate is the same in both years, deferring income from 2021 to 2022 will produce a one-year tax deferral and accelerating deductions from 2022 to 2021 will lower the 2021 income tax liability.
Long-Term Capital Gains
The long-term capital gains rates for 2021 and 2022 are shown below. The tax brackets refer to the taxpayer’s taxable income. Capital gains also may be subject to the 3.8% Net Investment Income Tax.
Long-term capital gains (and qualified dividends) are subject to a lower tax rate than other types of income. Investors should consider the following when planning for capital gains:
- Holding capital assets for more than a year (more than three years for assets attributable to carried interests) so that the gain upon disposition qualifies for the lower long-term capital gains rate.
- Considering long-term deferral strategies for capital gains such as reinvesting capital gains into designated qualified opportunity zones.
- Investing in, and holding, “qualified small business stock” for at least five years. (Note that the House version of the Build Back Better Act would limit the 100% and 75% exclusion available for the sale of qualified small business stock for dispositions after September 13, 2021.)
- Donating appreciated property to a qualified charity to avoid long term capital gains tax (also see Charitable Contributions, below).
Net Investment Income Tax
An additional 3.8% net investment income tax (NIIT) applies on net investment income above certain thresholds. For 2021, net investment income does not apply to income derived in the ordinary course of a trade or business in which the taxpayer materially participates. Similarly, gain on the disposition of trade or business assets attributable to an activity in which the taxpayer materially participates is not subject to the NIIT.
Social Security Tax
The Old-Age, Survivors, and Disability Insurance (OASDI) program is funded by contributions from employees and employers through FICA tax. The FICA tax rate for both employees and employers is 6.2% of the employee’s gross pay, but only on wages up to $142,800 for 2021 and $147,000 for 2022. Self-employed persons pay a similar tax, called SECA (or self-employment tax), based on 12.4% of the net income of their businesses.
Employers, employees, and self-employed persons also pay a tax for Medicare/Medicaid hospitalization insurance (HI), which is part of the FICA tax, but is not capped by the OASDI wage base. The HI payroll tax is 2.9%, which applies to earned income only. Self-employed persons pay the full amount, while employers and employees each pay 1.45%. An extra 0.9% Medicare (HI) payroll tax must be paid by individual taxpayers on earned income that is above certain adjusted gross income (AGI) thresholds, i.e., $200,000 for individuals, $250,000 for married couples filing jointly and $125,000 for married couples filing separately. However, employers do not pay this extra tax.
Long-Term Care Insurance and Services
Premiums an individual pays on a qualified long-term care insurance policy are deductible as a medical expense. The maximum deduction amount is determined by an individual’s age.
Retirement Plan Contributions
Individuals may want to maximize their annual contributions to qualified retirement plans and Individual Retirement Accounts (IRAs) while keeping in mind the current proposed tax legislation that would limit contributions and conversions and require minimum distributions beginning in 2029 for large retirement funds without regard to the taxpayer’s age.
Foreign Earned Income Exclusion
The foreign earned income exclusion is $108,700 in 2021, to be increased to $112,000 in 2022.
Alternative Minimum Tax
A taxpayer must pay either the regular income tax or the alternative minimum tax (AMT), whichever is higher. The established AMT exemption amounts for 2021 are $73,600 for unmarried individuals and individuals claiming head of household status, $114,600 for married individuals filing jointly and surviving spouses, $57,300 for married individuals filing separately and $25,700 for estates and trusts. For 2022, those amounts are $75,900 for unmarried individuals and individuals claiming the head of household status, $118,100 for married individuals filing jointly and surviving spouses, $59,050 for married individuals filing separately and $26,500 for estates and trusts.
The unearned income of a child is taxed at the parents’ tax rates if those rates are higher than the child’s tax rate.
Limitation on Deductions of State and Local Taxes (SALT Limitation)
For individual taxpayers who itemize their deductions, the Tax Cuts and Jobs Act (TCJA) introduced a $10,000 limit on deductions of state and local taxes paid during the year ($5,000 for married individuals filing separately). The limitation applies to taxable years beginning on or after December 31, 2017 and before January 1, 2026. Various states have enacted new rules that allow owners of pass-through entities to avoid the SALT deduction limitation in certain cases.
The House version of the Build Back Better Act would extend the TCJA SALT deduction limitation through 2030 and increase the deduction limitation amount to $80,000 ($40,000 for estates, trusts and married individuals filing separately). The proposal would be effective for taxable years beginning after December 31, 2020, therefore applying to the 2021 calendar year.
The Taxpayer Certainty and Disaster Relief Act of 2020 extended the temporary suspension of the AGI limitation on certain qualifying cash contributions to publicly supported charities under the CARES Act. As a result, individual taxpayers are permitted to take a charitable contribution deduction for qualifying cash contributions made in 2021 to the extent such contributions do not exceed the taxpayer’s AGI. Any excess carries forward as a charitable contribution that is usable in the succeeding five years. Contributions to non-operating private foundations or donor-advised funds are not eligible for the 100% AGI limitation.
Estate and Gift Taxes
The House version of the Build Back Better Act does not include any changes to the estate and gift tax rules. For gifts made in 2021, the gift tax annual exclusion is $15,000 and for 2022 is $16,000. For 2021, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $11,700,000 per person. For 2022, the exemption is $12,060,000. All outright gifts to a spouse who is a U.S. citizen are free of federal gift tax. However, for 2021 and 2022, only the first $159,000 and $164,000, respectively, of gifts to a non-U.S. citizen spouse are excluded from the total amount of taxable gifts for the year. Tax planning strategies may include:
- Making annual exclusion gifts.
- Making larger gifts to the next generation, either outright or in trust.
- Creating a Spousal Lifetime Access Trust (SLAT) or a Grantor Retained Annuity Trust (GRAT) or selling assets to an Intentionally Defective Grantor Trust (IDGT).
Net Operating Losses
The CARES Act permitted individuals with net operating losses generated in taxable years beginning after December 31, 2017, and before January 1, 2021, to carry those losses back five taxable years. The unused portion of such losses was eligible to be carried forward indefinitely and without limitation. Net operating losses generated beginning in 2021 are subject to the TCJA rules that limit carryforwards to 80% of taxable income and do not permit losses to be carried back.
Excess Business Loss Limitation
A non-corporate taxpayer may deduct net business losses of up to $262,000 ($524,000 for joint filers) in 2021. The limitation is $270,000 ($540,000 for joint filers) for 2022. The House version of the Build Back Better Act would make permanent the excess business loss provisions originally set to expire December 31, 2025. The proposed legislation would limit excess business losses to $500,000 for joint fliers ($250,000 for all other taxpayers) and treat any excess as a deduction attributable to a taxpayer’s trades or businesses when computing excess business loss in the subsequent year.
GJC is an Independent Member of the BDO Alliance USA