The Tax Provisions in Joe’s (negotiated) Build Back Better Plan

It seems like that the powers that be in Washington DC are getting closer to a “reconciliation” bill centered around spending on social and climate issues. What was once a $3.5 Trillion wish list has been reduced back to $1.75 Trillion… still a healthy pile of dough.

A pragmatic person may ask “How is this going to get paid for?”… drumroll please… TAXES!

Now, mind you, this isn’t law yet, but it’s getting close so we may want to start paying attention. I’ll stay out of the politics of this, but our President has declared that the legislation is:  1/ fully paid for; 2/ will help reduce the federal budget; and 3/ no one making less than $400,000 will “pay a penny more” in taxes and will likely get a tax cut (via expansions of credits and reduced costs related to health care and childcare). We shall see. Note to self… no mention of inflation (oftentimes referred to as a hidden tax)…I guess the big picture doesn’t matter… details, smhhetails.

 The plan would raise revenue by levying a tax surcharge on those making more than $10 million a year, raising taxes for some “high-income” business owners and strengthening IRS tax enforcement, according to the outline.

The framework isn’t heavy on details – why would we expect it to be? We’ve learned that these bills need to be passed before we know what is in them anyway. Right Nancy? One thing that is clear is that the overarching policy goal of targeting the wealthy is present.

Business income

There are two primary provisions in the framework related to business income.

The first would apply a 3.8% “Medicare surtax” to income from pass-through businesses – for high earning taxpayers.

Currently, the owners of most pass-through businesses (partnerships and sole-proprietors) are subject to a 3.8% self-employment tax or net investment income tax.

However, some flow-through profits (those of S corporations, and we love S-corps) aren’t subject to the 3.8% net investment income tax, or self-employment taxes – regardless of income level (provided the shareholder is an active participant in the company). The proposal would address this. Single taxpayers with more than $400,000 in taxable income or married couples filing a joint return with more than $500,000 in taxable income would now be subject to the 3.8% Medicare surtax.

The second proposal address the ability of pass-through business owners to utilize business losses against other forms of income in their tax returns. Importantly, the language here is incredibly vague, and I haven’t quite digested fully yet. It appears the proposal permanently disallows excess business losses (meaning, net tax deductions that exceed their business income).

Again, this applies to businesses that aren’t structured as a corporation, e.g. S-Corporations, Partnerships, Sole-Proprietorships.

This provision would affect tax returns for 2022 and forward.

IRS enforcement

The Build Back Better Plan would give $79 billion in new funding to the IRS to help close the so-called tax gap.

According to the White House – The top 1% evade more than $160 billion per year in taxes.

The IRS would hire enforcement agents and specifically train them to pursue those wealthy tax dodgers. Also included in the increase to the IRS budget would be significant investments in up-dating technology and taxpayer services. I’d just love if they would answer the phone.

Millionaire and billionaire surtax

This is the main provision that directly taxes the wealthy. There would be a 5% surtax on modified adjusted gross income of more than $10 million, and an additional 3% (or, a total 8% surtax) on income of more than $25 million. Essentially, an 8% surtax would mean the highest earners pay a top 45% federal marginal income tax rate on wages and business income. (They currently pay 37%.) They’d also pay a top 28% top federal rate on long-term capital gains and dividends, plus the existing 3.8% net investment income tax on high earners. (Taxes on long-term capital gains apply to growth on stocks and other assets sold after one year of ownership. The top tax rate is currently 20%.)

The difference between modified adjusted gross income (magi) and taxable income is significant. Your MAGI is calculated before certain discretionary deductions such as charitable giving.

This provision would affect tax returns for 2022 and forward.

Fun Fact: There were 22,112 tax returns reporting income of more than $10 million in 2018, according to most recent IRS data.

A few headliners that didn’t seem to make the cut:

A “Wealth Tax”

Changes to the Qualified Business Income Deduction (QBI)… already set to sunset in 2025.

Changes to the current step-up basis rules on inheritance.

Changes to the current top income tax rates:  37% on income other than capital gains which is 20%. (with exception to surtax discussed previously).

No imposing of distributions from “big” retirement accounts.

Rules regarding estate taxes don’t appear to being altered.

It’s important to keep in mind this is still at the proposed stage… but they (DC politicians) are here after a lot of pressure has been applied, negotiating and politicking. Will it pass? Your guess is as good as mine.

Here’s the full document for any of you gluttons for punishment out there.