The Infrastructure Investment and Jobs Act (IIJA) is now law, and the Build Back Better Act (BBBA) is potentially on the horizon. Plus, the IRS recently announced the 2022 cost-of-living adjustment amounts. With year-end fast approaching, it’s imperative you understand the new legislation and its impact on you and your business.
Tax Legislation Review
There are numerous proposed tax law changes that will impact businesses as well as individuals. Most notable are as follows:
- Section 1031 Exchanges – This is a benefit for real estate investors that allows for the trade of gains on one property and the ability to roll those gains into another property without paying tax. In the original proposal, the repeal was quickly voted down. Now the House version allows Section 1031 exchanges, just as it is under current law.
- Top Effective Rate or Flow-Through Business Income – Under current law, this rate is 29.6%. Under the House version as proposed, it would increase by 3.8% to 33.4%. The original proposal had it at 43.4%.
- Estate Tax Floor – Currently this is at $10 million (adjusted for inflation, it's $11.7 million). There was to be a proposal to cut this back to $5 million or $7.5 million. This would have caused a considerable number of people to be caught under an estate tax. However, under the House version, it has been eliminated and the floor is back to $10 million where it stands today.
- Ordinary Income – The original proposal of the Build Back Better Act had an increase of the top tax rate to 39.6%. This increase was cut out of the House version so it’s proposed at 37%, which is where we are today.
- Capital Gains – There was a lot of talk about increasing the capital gains rate or eliminating it. Currently it's 20%, the original proposal increased it to 39.6%, and the House version cut it back down to 20%.
- Corporate Tax – The top corporate tax rate currently is 21%. The original proposal was to raise it to 28% but the House version froze that rate at 21%. So there is no increase in corporate taxes for most corporations.
- SALT Cap – There is a tax cut within the proposed tax law which has to do with the SALT (state and local tax) cap. There was a deduction allowed for state and local taxes for any amount prior to the Trump tax cuts. The Trump tax cuts took that deduction away and allowed for the deduction of any amount up to $10,000. The House version wants to raise that cap to $80,000. This is effectively a tax cut especially for upper income earners who pay a lot of state taxes.
- Qualified Business Income (QBI) – In the original proposal by Biden, he wanted to eliminate the Qualified Business Income (QBI) deduction for those that earn over $400,000 or $500,000. That elimination would have effectively raised business income taxes from 30% to 37%. The House version doesn't have this increase in it so we're right back to current law for qualified business income.
- 3.8% Net Investment Income (NII) – There is a tax increase on the net investment income tax that applies to business income. This is one of the tax increases that most affects small to mid-size businesses. The 3.8% net investment income tax originally was proposed that if you had income over $400,000, you would be subject to it. The House version has business income over $500,000. Currently it doesn't exist on active income so this would be a tax increase.
Build Back Better Act (BBBA)
The Build Back Better Act is a bill introduced in Congress to fulfill aspects of President Joe Biden's Build Back Better Plan. It was spun off from the American Jobs Plan, alongside the Infrastructure Investment and Jobs Act. The bill was passed by the House on November 19, 2021 and is expected to receive a formal Senate vote in January 2022.
Proposed Tax Increases
There are some tax increases in the Build Back Better Act but they are much slimmer than what was originally proposed.
- 5% tax on income over $10 million.
- Additional 3% tax on income over $25 million.
- 3.8% Net Investment Income tax on business income over $500,000.
- Section 1202 Stock – This is a corporate stock that if you sell it, currently you don’t have to pay much tax on the gain.
- IRA and Roth Rules – If you earn too much money, you cannot do Roth conversions. Also with IRA and Roth IRA accounts over $10 million, you cannot add additional funds to the accounts.
- Corporate minimum tax if book income is greater than $1 billion.
- Tax on corporate redemptions of stock.
- Foreign provision if a corporation has multinational operations with foreign subsidiaries.
In the Build Back Better Act tax proposals, business trusts get hit hard with these increases. If there is a business within a trust, the 5% tax (which kicks in for individuals at $10 million) applies for the trust at $200,000. The additional 3% tax (that kicks in for individuals over $25 million of income) kicks in at $500,000 for the trust. There is also the 3.8% net investment income tax on business income. If this would pass, there might be a suggestion on restructuring your business if it's owned by a trust. These trusts are going to pay much higher taxes than if it was simply owned by individuals or at least taxed to the individuals.
Proposed Tax Decreases
There are a few proposed tax decreases within the Build Back Better Act:
- SALT (state and local tax) limit, which is currently $10,000, would be raised to $80,000.
- R&D expenses (which have been deductible forever) were scheduled to not be deductible starting in 2022, but instead would have to be capitalized and the deduction spread out over five years.
- One-year extension of the Child Tax Credit of $3,000-$3,600 per child, depending on the age of the child.
What Was Left Out?
The items that are no longer included in the Build Back Better Act are fairly significant compared to what was originally proposed.
- Individual income tax rates don't go up unless you earn over $10 million.
- There is no proposed capital gains rate increase right now.
- The estate tax provisions have been eliminated from the proposal:
- The estate tax floor of $11.7 million will not be decreased.
- There is no capital gains income tax at death.
- The step-up has been preserved.
- A corporate tax rate increase has not been included.
- There is no wealth tax where, in addition to income tax, wealthy individuals would also be taxed on what they're worth.
Infrastructure Investment and Jobs Act (IIJA)
Signed into law on November 15, 2021, the Infrastructure Investment and Jobs Act is not a tax bill per se, but there are some tax items within the bill to be aware of. The most significant item in the bill is the ending of the Employee Retention Credit (ERC). The third quarter of 2021 is the last quarter that employers are able to apply for the ERC and receive those benefits.
Cryptoasset reporting is also included in the bill. Beginning January 1, 2023, brokers will be required to disclose to the government any transfer of digital assets into accounts.
Other minor tax provisions included are automatic extensions in the disaster areas, extension of various highway-related taxes, and reinstatement of certain superfund excise taxes (for example, hazardous substance superfund tax on chemical manufacturing and imports).
Employee Retention Credit
The Employee Retention Credit (ERC) is a valuable tax break that was enacted to encourage employers to hire and retain employees during the pandemic. The ERC is a refundable tax credit against certain employee wages and employment taxes if you had a government shutdown or a decline in receipts in 2021 or 2020 when compared to the same quarter in 2019. Eligible wages depend on the number of full-time employees (FTEs), but owner and related-party wages are not eligible for the credit. Eligible employers can claim the refundable ERC against applicable employment taxes equal to 70% of the qualified wages the business pays.
Originally, a business that received a PPP loan was not eligible to receive the ERC. In January 2021, the IRS retroactivity allows employers who received the PPP loan to claim the ERC for qualifying wages that are not treated as payroll costs in obtaining PPP loan forgiveness.
Employee Retention Credit Qualifications
To qualify for the Employee Retention Credit in 2020, a company needed a 50% decline in gross receipts during any quarter in 2020 compared to that same quarter in 2019. A business could also qualify if they experienced a full or partial government shutdown.
In 2021, a business needed a 20% decline in gross receipts during any quarter in 2021 relative to that same quarter in 2019. Again, a company could also qualify if they experienced a full or partial government shutdown.
What are the Eligible Wages?
The eligible wages that qualify for the Employee Retention Credit are dependent on the number of full-time employees in the business.
*Between 2020 and 2021, the full-time equivalent increased from 100 to 500 employees.
- 2020 average FTE is less than 100 employees: All employee wages are eligible.
- 2020 average FTE is greater than 100 employees: Only wages paid for not working are eligible.
- 2021 average FTE is less than 500 employees: All employee wages are eligible.
- 2021 average FTE is greater than 500 employees: Only wages paid for not working are eligible.
Maximum Employee Retention Credit
How much of a credit can a business actually receive?
In 2020, the credit is capped at $5,000 per year, per employee (this is a 50% tax credit up to $10,000 of wages). In 2021, it is $7,000 per quarter, per employee credit (this is a 70% tax credit up to $10,000 of wages). It is a quarter maximum, so you could feasibly save $28,000 per employee, per year if you had 80% or less in receipts when comparing each quarter with the corresponding quarter in 2019.
How Does the Employee Retention Credit Interact with the PPP?
A business cannot use the same wages for the PPP and the ERC. For the PPP, you must use at least 60% or more for wages, but you could use up to 40% for expenses such as employer portion of health insurance benefits, mortgage interest, rent, utilities, workforce training, and COVID-related expenses relating to supplies, equipment, and technology (e.g., sanitizers, air purification systems, HVAC systems, etc.).
It’s important to note that the PPP loan is based on 2.5 months of payroll wages and the forgiveness period is based on 5.5 months (24 weeks). So if you do qualify for the ERC, you should have plenty of wages available for the PPP as well as the ERC.
Other Tax Considerations
In the state of Wisconsin, there was a bracket reduction for individual taxes for 2021. The tax bracket rate was adjusted from 6.27% down to 5.3% for income between $32,330 and $355,910. For married couples earning over $355,000, this could produce a tax reduction of approximately $3,000. For single individuals earning over $260,000, this would amount to about a $2,000 savings. This reduction in rates can also affect a business’s entity tax election in regards to pass-through income. Other states may have other adjustments and opportunities to take an entity level tax election if you're a business owner with pass-through income.
There was also a 5.1% cost of living increase for 2022. There is a greater opportunity to defer more money into 401(k) accounts but there may be some deduction limitations.
Be prepared to make some quick moves that can affect your tax liabilities if the Build Back Better Act is passed. Know where your 2021 income is at because the net investment income tax could affect businesses going forward so you may want to recognize a bit more income in 2021 versus 2022.
Continue to follow SVA. As the Senate resumes discussions on the Build Back Better Act in January, SVA will keep you updated on all the latest information. Keep informed by signing up for SVA’s Tax eAlerts today!
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