The Stage Is Set for Build Back Better Act 2.0

House Democrats set the stage for the Build Back Better Act with proposed legislation introduced September 13th (H.R. 5376) and, after intense negotiations, the House Rules Committee released revised versions of the Act on October 28th and again on November 3rd – BBB Act 2.0. What is remarkable about BBB Act 2.0 as it relates to our clients is not only what is included in BBB Act 2.0, but what was cut from BBB Act 1.0. We expect even more changes before final legislation, if any, is signed into law by President Biden, but the process is moving forward.

Many provisions of BBB Act 1.0 are gone, at least for now.

• Early Sunset.  BBB Act 2.0 does not include an early sunset of the temporary increase in the gift, estate, and generation-skipping transfer tax exclusion. Thus, the present $10 million adjusted for inflation exclusion amount ($11.7 million in 2021) would remain in effect until it is scheduled to revert to $5 million, adjusted for inflation, on January 1, 2026. A deadline can be our friend, getting us to do things we would otherwise defer, and many clients have moved forward with planning in the face of a potential early reduction in the exclusion amount. Planning to utilize the current higher exclusion continues to be advantageous in many circumstances, and if BBB Act 2.0 remains intact, that planning can be done more purposefully and less frenetically.
   
• Grantor Trusts.  BBB Act 2.0 does not include changes to the grantor trust tax rules that would have impaired many beneficial wealth transfer planning alternative, including irrevocable life insurance trusts, gift trusts with spouse beneficiaries, grantor retained annuity trusts, and sales to grantor trusts. We consider this to be one of the most welcome changes in BBB Act 2.0 as we continue to plan using these strategies to efficiently transfer wealth from generation to generation.
   
• Valuation Discounts.  The proposed limitations on valuation discounts for lifetime gifts of interests in entities holding non-business or passive assets that was part of BBB Act 1.0 was not included in BBB Act 2.0. We have faced imminent limitations on valuation discounts on interests in partnerships and limited liability companies holding non-business assets in the past and we anticipate that these limitations will be resurrected in the future. But for now, gift planning with valuation discounts to leverage the power of the gift tax exclusion remains viable.

The BBB Act 2.0 has not, however, shifted the focus on high income taxpayers and corporations. The approach has just changed.

For individuals:

• Surcharge.  Perhaps the most material provision of BBB Act 2.0 for high-income taxpayers is a tax of 5% of modified adjusted gross income in excess of $10 million and an additional tax of 3% of  modified adjusted gross income in excess of $25 million, for a total surcharge of 8% (applicable to trusts and estates at $200,000 and $500,000, respectively). Thus, the highest applicable tax rates on income in 2022 would be 31.8% for capital gain income (up from 23.8% in 2021) and 48.8% for ordinary income (up from 40.8% in 2021), inclusive of the 3.8% net investment income tax. The top tax rate on ordinary income would increase to 51.4% in 2026 when the top ordinary income tax rate reverts to 39.6%. Taking the average state income tax rate of 6% into account, in 2026 the U.S. would have the highest tax rate on personal income in the Organization for Economic Co-operation and Development (OECD) countries. And non-grantor trusts and estates would be bumped into the surtax at much lower levels of income than individuals. 
   
• • Modified adjusted gross income for this purpose means adjusted gross income reduced by any deduction for investment interest. Modified adjusted gross income is determined before any other deductions, such as the charitable deduction, and therefore cannot be managed with deductions other than investment interest. Thus, planning to mitigate the impact of this tax will focus on managing adjusted gross income. For example, like-kind exchanges of real property to defer gain, contributions of appreciated assets to tax-exempt charitable organizations, and contributions of appreciated assets to charitable remainder trusts (unless the rules with respect to charitable remainder trusts are changed).
• • By way of comparison:
     

• • ​​​For business planning, these changes could impact entity selection as between C-corporations with income taxed at the corporate level and dividends taxed to shareholders, and pass-through tax entities such as partnerships, limited liability  companies, and S-corporations, income of which is taxed directly to the owners.
• 3.8 % net investment income tax. BBB Act 2.0 retains the expanded application of the 3.8% net investment income tax currently imposed on passive income to include active business income for taxpayers with taxable income greater than $400,000 (single filers) or $500,000 (joint filers) and for trusts and estates, thus expanding the reach of this tax substantially.
   
• Small business stock. Like BBB Act 1.0, BBB Act 2.0 limits the exclusion of gains on the sale of Section 1202 qualified small business C-corporation stock for taxpayers with adjusted gross income of $400,000 or more. The current 100% and 75% exclusions are reduced to 50% for sales and exchanges after September 13, 2021 (subject to exception for binding contracts). The baseline 50% exclusion remains in effect for all taxpayers.
   
• Wash sale rules. BBB Act 2.0 also retains provisions expanding the wash-sale rules under Section 1091 to include not only stock and other securities, but also commodities, currencies, and digital assets, precluding capturing tax losses on a sale and reinvesting within 30 days in substantially identical property.

For corporations:

• Corporate AMT. BBB Act 2.0 does not raise the corporate income tax rate across the board but rather provides for a 15% minimum tax on adjusted financial state income (AFSI) for corporations with AFSI in excess of $1 billion over a consecutive three-year period.
   
• Surtax on stock buybacks. BBB Act 2.0 would also impose a new 1% excise tax on publicly traded U.S. corporations for the value of its stock that the corporation repurchases during the taxable year. This could potentially influence decisions at the corporate level when making the choice between a shareholder dividend and a stock buyback.
   

It is common for tax legislation to undergo change in the legislative process, from introduction, to passage by Congress, to signing into law by the President. The Build Back Better Act is still under construction. Wealth and business planning is impacted by tax changes, but the cornerstone of planning is its purpose – successful wealth, business, and philanthropic succession from generation-to-generation for a better future. We will continue to follow the tax law changes that relate to successful succession planning.

To discuss planning in the current environment, do not hesitate to reach out to the Trusts & Estates Group.