Tax Planning for 2022

Continued Uncertainty for Taxpayers as We Approach the Last Quarter of 2021

BY KAREN R. MILLER, INSTRUCTOR, CULVERHOUSE SCHOOL OF ACCOUNTANCY

With the arrival of October, many of us had hoped that we might have more certainty regarding the key individual and business tax proposals which could become effective for 2022 and future years. As the negotiations continue on Capitol Hill, practitioners and their clients now face the likelihood that the enactment date for these provisions may occur later in the fourth quarter, leaving practitioners with the daunting task of quickly assessing the final legislation and calculating the impact of the provisions before the start of the year-end work. With a large number of potential tax revenue raisers and tax incentive provisions still under consideration, it is likely that we could see a scenario similar to what we faced in late 2017 with the enactment of the Tax Cuts and Jobs Act.

As of the time of publication for this issue, the Infrastructure Bill, which was previously passed by Senate, is still pending in the House of Representatives. Taxpayers and practitioners are closely monitoring the ongoing negotiations to determine if the provision in the Senate bill which required the early termination of the Employee Retention Tax Credit on 9/30/2021 will remain in the final version of the House legislation. With the uncertain timing of the final vote in the House, practitioners will need to ensure that their clients are aware of the potential cash flow impact resulting from the loss of the credit. The Senate version of the Infrastructure Bill also contains additional provisions which would strengthen the reporting and compliance requirements for cryptocurrency transactions, an initiative which has been a top priority for the IRS over the past two years.

The timing of the final vote on the Infrastructure Bill is also uncertain due to the desire by many members of the House to link the votes for this legislation to the vote for the Biden Administration’s broader tax and job creation plan, the Build Back Better legislation. Many moderate Democrats continue to express concerns over the size and scope of the legislation, preferring a fiscal impact which would be significantly less than the originally proposed $3.5 trillion plan. Negotiations will likely focus on the potential tax incentives included in the Build Back Better legislation, including the proposed extension of, and enhancements to, the child tax credit, the child and dependent care credit, and the earned income tax credit. As we await the final decisions concerning those proposals, our focus will be on the draft legislation released by the House Ways and Means Committee, which contains significant changes to the individual and business proposals which were outlined in the Green Book released by the Biden Administration this summer.

Individual Provisions

In an effort to secure the needed votes for the legislation in the House of Representatives, two of the more controversial provisions from the original Green Book have been removed:

• Taxation of unrealized gains at the time of death or gift; and

• Restrictions on the ability to utilize a like kind exchange for real estate transactions with gains in excess of $500,000 per taxpayer.

It is noteworthy that the current draft of the legislation released by the Ways and Means Committee does not contain any provisions related to the existing $10,000 limitation on the deduction for state and local taxes. However, the Chairman of the House Ways and Means Committee issued a statement on September 13 which indicated that meaningful relief for the state and local tax deduction cap would appear in the final legislative package. The details of this relief have not been disclosed as of the time of publication for this issue.

In order to replace the lost tax revenue from the Green Book proposals which were removed, the House Ways and Means Committee has included additional tax revenue raisers such as:

• A new 3% surcharge on high income taxpayers;

• New restrictions on IRAs and defined contribution plans for high income taxpayers; and

• A reduction in the estate tax, gift tax, and GST exemption; and

• Restrictions on valuation discounts and trust-related estate tax planning strategies.

While the effective date for the majority of these proposals will be for taxable years beginning after 12/31/2021, provisions which have a different proposed effective date are highlighted in the discussion which follows.

New 3% Surcharge on High Income Taxpayers

The proposed new 3% surcharge would apply to taxpayers with modified adjusted gross income (AGI) greater than $5 million ($2.5 million if married filing separately) and trusts or estates with modified AGI in excess of $100,000. The provisions include an exception for charitable trusts “all the unexpired interests in which are devoted to one or more purposes described in section 170(c)(2)(B).” For individual taxpayers, modified AGI is defined as AGI reduced by the deduction allowed for investment interest expense. For trusts and estates, modified AGI would be calculated under the provisions of Internal Revenue Code (IRC) Section 67(e).

The new provisions also state that the surcharge will not be considered a tax for purposes of calculating the amount of any credit under this chapter of the IRC or for purposes of the alternative minimum tax under IRC Section 55. The ASCPA State Taxation and Legislation Committee will continue to monitor the status of these provisions and any potential impact on the ability of taxpayers to deduct the surcharge as a component of the federal income tax deduction for Alabama tax purposes.

New Restrictions on IRAs and Defined Contribution Plans for High Income Taxpayers

In an effort to restrict the ability of high-income taxpayers to utilize traditional IRAs, Roth IRAs, and defined contribution plans for retirement tax planning, the draft version of the legislation released by the House Ways and Means incorporates a number of new restrictions, including:

• New limitations on contributions to IRAs and defined contribution plans for taxpayers with aggregate account balances in excess of $10 million as of the end of the prior tax year, if the taxpayer has adjusted taxable income above $400,000 if single; $450,000 if married filing jointly; and $425,000 if filing as a head of household.

• New required minimum distributions for taxpayers with aggregate account balances in excess of $10 million, if the taxpayer has adjusted taxable income above $400,000 if single; $450,000 if married filing jointly; and $425,000 if filing as a head of household.

• Prohibition on investments in certain non-publicly traded entities if the IRA owner has direct or indirect ownership in the entities of 10% or greater or if the IRA owner is an officer or a director.

• Prohibition on investments in unregistered securities which are only available to accredited investors who have a specified minimum amount of income or assets, must complete a specified minimum level of education, or hold a specific license or credential.

• Prohibition on conversions from traditional IRAs, 401(k) accounts, 403(b) accounts, 457(b) accounts to Roth accounts for any taxpayer if the taxpayer has adjusted taxable income above $400,000 if single; $450,000 if married filing jointly; and $425,000 if filing as a head of household. Note that this proposal would apply to distributions, transfers, and contributions made in tax years beginning after 12/31/2031.

• Prohibition on conversions of after-tax contributions held in a traditional IRA, or in a non-Roth account in an employersponsored retirement plan, to a Roth IRA. Note that this proposal would apply to distributions, transfers, and contributions made after December 31, 2021.

Reduction in the Estate, Gift, and GST Exemption

Despite the exclusion of this provision in the Green Book, the proposed legislation released by the House Ways and Means Committee incorporates the long-expected reduction of the estate tax, gift tax, and GST exemption to the $5 million level, indexed for inflation, which was previously in effect as of 2010. The Joint Committee on Taxation has considered the inflation adjustments which would be applied and currently projects that the exemption level would be approximately $6.02 million. Under current law, the existing exemption level is $11.7 million.

Restrictions on Certain Valuation Discounts and Trust-Related Estate Tax Planning Strategies

The draft legislation includes two new IRC sections which would significantly impact certain estate tax planning strategies:

• Newly created IRC Section 2901 would require that all grantor trusts be included in a deceased owner’s taxable gross estate when that deceased individual is deemed to be the owner of the trusts for income tax purposes.

• Additionally, newly created IRC Section 1062 would treat sales between a grantor trust and the deemed owner as sales between the owner and an unrelated third party, thus triggering the recognition of gain on any appreciated assets. In connection with this proposal, the definition of “related taxpayers” in IRC Section 267(b) would also be modified to include a grantor trust and the person treated as the owner of the trust. This modification would therefore disallow the deduction of any losses realized from a sale between a grantor trust and the deemed owner.

These provisions would apply to trusts created on or after the date of enactment and to the portion of the trust attributable to contributions made on or after the enactment date.

Business Provisions

While the draft legislation includes many business tax proposals which closely mirror those in the Green Book, there were several significant changes. As anticipated, the draft legislation released by the Ways and Means Committee incorporates a revised new top tax rate for corporations, reducing the Green Book proposed rate of 28% to a new top rate of 26.5%. However, several moderate Democratic Senators have continued to express concerns that the rate should not exceed 25%, and thus it is likely that the final legislation may incorporate a corporate tax rate which is closer to that level.

The need to secure additional votes in the House and the Senate also led to several noteworthy changes to the business provisions previously announced in the Green Book, including:

• The removal of the controversial provisions which would have enacted a new alternative tax based on GAAP income for some of the largest US corporations.

• The removal of the provisions which would have disallowed many of the favorable deductions currently available to companies in the fossil fuel industries, including restrictions on the use of percentage depletion and the expensing of intangible drilling costs.

• A delay in the effective date of the Tax Cuts and Jobs Act provisions which would have required capitalization of research and experimentation expenses beginning in 2022.

One of the surprises in the draft legislation released by the House Ways and Means Committee was the inclusion of a provision which would allow S corporations to convert to a partnership structure through a tax-free liquidation which would occur over a two-year period beginning on 12/31/2021. An eligible S corporation is defined as one which has been an S corporation at all times since 5/13/1996, the time period during which the check-the-box regulations were released. Practitioners who have S corporation clients should consider the potential benefits of this limited time opportunity.

The draft legislation released by the Ways and Means Committee also incorporates a significantly enhanced restriction on conservation easement deductions, another area which has been a top priority for the IRS over the past year. The new provisions would result in the denial of a charitable deduction for contributions of conservation easements by partnerships and other pass-through entities, if the amount of the contribution exceeds 2.5 times the sum of each partner’s adjusted basis in the partnership related to the donated property. The proposed effective date for this provision incorporates a significant retroactive component, applying to contributions made on or after 12/23/2016 (the date of the relevant IRS Notice on this topic). Practitioners who have clients which have taken conservation easement deductions since that time should closely review these provisions to identify any potential impact for their clients.

In a year filled with legislative developments, it appears that 2021 will end in the same way in which it began, with the potential enactment of significant individual and business tax provisions and a very short time period for practitioners and clients to evaluate the impact. As developments occur, the ASCPA State Taxation and Legislation Committee will continue to provide frequent updates through the weekly email alerts and through special webinars, as needed.