Ugly Tax Proposals in the House 9-13-2021

More tax changes in the proposed House bill, looks they apply in 2022. The proposals include some bad news for IRA’s & 401k’s. At least they did not ban self-direction or require appraisals to buy assets (those ideas were on the table).

First, they are proposing a limit on how much high-income individuals can contribute to IRA's, 401k's, and other defined contribution plans if they have $10M+ in them.

This limit is on total plan balances per person, and not per plan. Here's the language from the Congressional explanation:

 "Specifically, the legislation prohibits further contributions to a Roth or traditional IRA for a taxable year if the total value of an individual’s IRA and defined contribution retirement accounts generally exceed $10 million as of the end of the prior taxable year. The limit on contributions would only apply to single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation). 

The legislation also adds a new annual reporting requirement for employer defined-contribution plans on aggregate account balances in excess of $2.5 million. The reporting would be to both the Internal Revenue Service and the plan participant whose balance is being reported. The provisions of this section are effective tax years beginning after December 31, 2021.”

On its own, the above is not so bad, just a limit on contributions. But they also require minimum distributions (RMD’s) of half of any amount over $10M (e.g., $11M in total balances = $500k RMD) if one is over the $400k (or so) income threshold for that year. 

To the extent that the combined accounts are $20M+ per person, then the RMD is the amount needed to get down to $20M AND must come from the Roth accounts. Once the balance is down to $20M, then the taxpayer may decide from which accounts the RMD’s come from.

Again, not so bad, at least not until hyper-inflation hits. Then maybe $10M will not seem like a very large amount. 

Here’s where it gets ugly.

Converting from Traditional to Roth in IRA’s, 401k’s, and other plans is banned if the taxpayer makes circa $400k+ in a given year. 

In addition, ALL Roth contributions are prohibited in 401k’s and other employer-sponsored plans starting in 2022. 

ALL After-tax IRA amounts are prohibited from converting to Roth, regardless of income levels.

Another heavy blow: IRA’s are not allowed to invest in anything based on account holder’s status.

For example, any investment that required an investor to be accredited is banned. Bye-bye IRA investments in most PPM’s! This will put a huge hole in self-directed IRA investing. The provision does not appear to apply to 401k’s at present. Pray they do not amend the proposal to include 401k’s. I think this requirement should spark a major letter-writing campaign to Congress.

Note: They give IRA’s 2 years to get out of existing investments that required an accredited investor. I suspect that the statutory language itself will create a lot of ugly gray areas.

Here’s the Congressional explanatory language of the above:

“The bill prohibits an IRA from holding any security if the issuer of the security requires the IRA owner to have certain minimum level of assets or income, or have completed a minimum level of education or obtained a specific license or credential. For example, the legislation prohibits IRAs from holding investments which are offered to accredited investors because those investments are securities that have not been registered under federal securities laws. IRAs holding such investments would lose their IRA status. This section generally takes effect for tax years beginning after December 31, 2021, but there is a 2-year transition period for IRAs already holding these investments.”

 This info is based on the summaries. I need to read the language of the law itself. I think these anti-IRA/401k provisions will survive the negotiation process. Better get those Roth conversions and contributions done before 2022!

Here’s more on non-IRA/401k issues:

 Cap gains on Section 1202 stock are presently 100% excluded once the stock is held for 5 years. That will be reduced to 50% for those who make over $400k in a given year. Meaning: Those who create successful start-ups will be taxed harder.

QBI/Pass-Thru Deduction to be limited for those making over $400k. I need to dig into the details. Not a surprise.

Gift & estate tax credit will drop from $11M to $5M per person, apparently effective immediately, I still need to confirm that.

This is a big one: Grantor trusts get included in the taxable estate. That means estate planning is going to change, cost more, and be less flexible. 

Another big one: Transfer (presumably means "gifting") of non-business assets (that definition will be important) will not receive a discount for transfer tax (i.e. - gift tax) purposes (e.g., no discount for lack of liquidity or control when transferring shares of LLC's and the like). The discount rules presumably still apply to Traditional to Roth conversions (more on that shortly), need to dig into the details.

"The Democratic proposal would raise the corporate tax rate to 26.5% from 21%, people familiar with the matter said Sunday. President Joe Biden's tax and social spending plan called for a 28% rate. A document circulating among members of both parties and obtained by Bloomberg indicated that the corporate rate hike may only apply to larger corporations, while smaller businesses would pay either 18% or 21% depending on their earnings."

I have heard the same from other sources.

The top rate on capital gains would rise from 20% to 25% instead of the 39.6% Biden proposed. It is not clear at what income threshold this rate would kick in. 

Word is that they are looking to include a 3% tax rate hike on those making $5M+ and also looking to make the carried interest tax technique apply only for partnership/LLC interests held for 5 or more years (this could apply to some of you who have "sweat equity" in JV's, depending on the fine print).

The present document includes other tax changes, including a top individual income tax rate of 39.6%. It would also include cryptocurrency in general tax rules, treating it the same as other financial instruments (which is pretty much status quo, just formalized). 

The proposal would halve the $24,000 annual estate and gift tax exemption for married filers on Dec. 31, 2021 instead of sunsetting it in 2025.

Word is that the proposed tax increases would be slimmed down even more than described above due to political pressure from Manchin et al. God bless their versions of Olympia Snowe/Susan Collins/Lisa Murkowski/John McCain.

There is nothing about taking away the step-up-in-basis upon death or taxing property as if sold upon death....at least not so far. No changes to 1031’s either. Knock on wood, the lunatics seem to be finding themselves hemmed in by reality, thereby limiting the damage they can do.

Lots of handouts, we'll see which ones survive. To use the reconciliation process and avoid a Republican filibuster, the spending and taxing are supposed to "balance".

While the numbers never end up balancing in reality, there are some limits on the chicanery. That'll impact the size of the handouts.

-John Hyre

P.S. Advanced Strategies Conference in Atlanta is on January 22nd & 23rd.

Washington Update of changes, opportunities, and planning in the tax law (probably the 800-lb gorilla this year; it may expand to include much of the conference time)

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