Tax proposals axed from the Build Back Better Act

Financial advisers breathed a sigh of relief this fall as many of what they regarded as the most onerous potential tax increases Congress was considering fell by the wayside as the massive spending and tax bill worked its way through the House.

The tax policies left out of the nearly $2 trillion Build Back Better Act that the House approved on Nov. 19 are almost better known than those that were included. Here are some that were left out:

Ending step-up-in-basis. Taxing unrealized capital gains on inherited assets has been a top policy goal of progressives who insist that the wealthy pay their fair share of taxes. It seems to have succumbed to bipartisan concern that eliminating step-up-in-basis would hurt small business owners and farmers.

Raising income and capital gains tax rates. The original House Ways and Means Committee contribution to the Build Back Better bill, approved by the panel’s Democratic majority with no Republican support, included provisions to raise the income tax rate to 39.6% for individuals earning more than $400,000 annually and couples earning more than $450,000. For the same group, the capital gains tax rate would have increased from 20% to 25%, plus the 3.8% Medicare surcharge on investment income. Those rate increases were scuttled after resistance from moderate Senate Democrats.

Lowering the estate and gift tax exemption. The House Ways and Means Committee approved resetting the exemption from $11.7 million to $6 million as of Jan. 1, four years earlier than the higher exemption was due to sunset under the 2017 tax reform bill. This provision was removed in the final House version of the Build Back Better bill.

Taxation of grantor trusts. The House Ways and Means Committee advanced a provision that would have changed tax rules surrounding the use of grantor trusts to transfer assets to beneficiaries. This provision was removed from the final House bill, but the fact that it emerged during the legislative process caused a stir among estate lawyers. “It was going to completely rewrite how trusts are done,” said David Handler, partner at Kirkland & Ellis.

Surcharge for ultra-high earners. Although the provision to raise individual rates for high earners didn't make it, the House bill expanded a surcharge on ultra-high earners. What was originally a 3% tax on adjusted gross income over $5 million was raised to a 5% tax on AGI over $10 million and an additional 3% on AGI over $25 million. The 5% surcharge also applies to estates or trusts that generate $200,000 in income, and the extra 3% is applied to those whose income exceeds $500,000. “Congress believes everyone who has a trust must be a trillionaire,” Handler said. “The fact is most trusts have less than $1 million in them.”

Billionaires tax. During congressional negotiations over the Build Back Better bill, Senate Finance Committee Chairman Ron Wyden, D-Ore., introduced a so-called billionaires tax that would be levied on unrealized capital gains of assets of people with more than $1 billion in assets or $100 million in income over three consecutive years. This proposal appeared and vanished within days.

STILL IN PLAY

Tax measures of interest to advisers and their clients that remain in the final House version of the Build Back Better legislation include:

State and local tax deduction. The final version of the measure included a provision to raise the current $10,000 cap on the federal tax deduction for state and local taxes to $80,000 through 2031. The question is whether that will survive in the Senate, where Republicans and progressive Democrats view it as a benefit for wealthy taxpayers.

“That’s great news for most of my clients,” Alyson Nickse, a partner at Crestwood Advisors, said of the lifting of the so-called SALT deduction. “But who knows what’s going to happen. They’re all over the place.”

For now, Richard Pon, a San Francisco financial adviser and CPA, is waiting to see how the SALT provision fares in the rest of the legislative process. “I’ve told my clients to wait until the last minute to pay their property taxes and estimated taxes.”

Mega IRAs, Roth conversions. Reform of retirement savings taxation was included in the original House bill, removed in a White House compromise framework and then reinserted in the final House bill to pay for spending, such as paid medical and family leave, that also was added back. The final House bill includes provisions to impose required minimum distributions on individual retirement accounts that exceed $10 million, phase out Roth conversions in 10 years for people who make more than $400,000, and prohibit after-tax contributions to Roth IRAs for all income levels beginning in 2022.

The tax reform ground could shift again as the Senate takes up the Build Back Better bill. 

Rob Kuharic, director of tax managed solutions at Russell Investments, isn’t counting out any of the provisions that seem to have died.

“I’ve seen these things rearing their ugly head again,” Kuharic said. “The Senate still needs to have their way with the bill.”

As the Senate gets to work, advisers will be keeping their eyes on Washington.

“They’re making every accountant and estate planning attorney’s life miserable in the last two weeks of December,” said Bruce Weininger, principal at Kovitz Investment Group.