With so many potential changes in flux in the second half of this year, it’s been a whirlwind trying to keep track of the latest proposals and implications. Significant changes to the estate and gift tax regime have been at the forefront of a lot of minds heading into year-end, as we’ve discussed and planned around the possible reduction of the unified gift and estate credit, loss of the tax-free sale of assets to a grantor trust and the potential inclusion of assets held in a grantor trust in the grantor’s estate, among other concerns. We were also concerned about an increase in the top marginal ordinary and capital gains rates and phase out of the qualified business income (QBI) deduction for taxpayers filing jointly earning over $500,000.
In late October, the House Ways and Means Committee threw us a curveball in its updated Build Back Better (BBB) Act draft, but many of the changes we feared were left out. There’s a good chance some of these measures may have shifted one way or another by the time you read this article, but below, we’ve done our best to capture some of the significant provisions that may impact you and your business.
Win: no changes to estate/gift taxes
After months of speculation over forthcoming unfavorable changes, the October BBB draft removes all the provisions impacting gift and estate taxes.
Without significant changes to estate tax mechanisms, owners can continue to leverage advantageous planning techniques to pass their wealth to future generations. We encourage taking steps toward assessing the considerations and decisions that go into planning for wealth transfer and having discussions with your advisors to ensure that you are positioned to make strategic decisions as the gift and estate tax landscape changes. And don’t forget that under current law, the lifetime credit is set to revert back to $5 million, indexed, on Dec. 31, 2025.
Win: no capital gains or marginal tax rate increases
President Biden’s original framework floated an increase in the capital gains rate to equate it with ordinary income tax rates for some taxpayers, with a potential retroactive effective date that had both taxpayers and tax advisors on pins and needles awaiting Congress’s reaction. We breathed a collective half-sigh of relief when we saw an earlier proposal increased the capital gains rate to “only” 25%, with an effective date of the enactment of the legislation. We can release the other half of that sigh now, as the latest proposal does not change the capital gains tax regime.
In other favorable news, the proposed increase in the top individual ordinary income tax rate to 39.6 percent from 37% was excluded from the latest draft.
Loss: high-income surcharge
The latest proposal would implement a 5% surtax on noncorporate taxpayers’ modified adjusted gross income (MAGI) over $10 million and an additional 3% on MAGI over $25 million. These thresholds apply to single taxpayers and those who file jointly. The thresholds are halved for those filing separately and are only $200,000 (5%) and $500,000 (3%) for trusts and estates.
This provision is set to apply to taxable years beginning after Dec. 31, 2021, as currently written. If you’re considering a post-2021 exit, exploring an installment sale may be an option to stay under the $10 million or $25 million thresholds. If possible, consider closing by the end of 2021 and electing out of installment treatment, if applicable, to avoid this surcharge.
Win: QBI deduction remains
Another significant win for franchisees and other pass-through owners: the 20% QBI deduction appears as if it will remain intact. Both the Senate Finance Committee and House Ways and Means Committee had proposed a streamlined version of section 199A, which would have removed the distinction between “qualified” businesses and “specified service trades or businesses” (SSTBs), fully phasing the deduction out for single individuals earning more than $400,000 and joint filers earning more than $500,000 while eliminating the deduction for estates and trusts with taxable income exceeding $10,000. The latest framework does not change the QBI deduction, and thus means pass-through owners will continue to receive this benefit on their income from their clubs.
Loss: wider application of net investment income tax
The BBB draft would broaden the application of the net investment income tax, which currently applies a 3.8% tax to income above $250,000 for joint filers, other than that generated from the active conduct of a trade or business. We advise our franchisee clients as to the minimum participation requirements that allow for the exclusion of both their income from operating their clubs and their eventual gain from the sale of their clubs from this additional tax. If passed as currently written, income from an active trade or business would become subject to this additional 3.8% tax for joint filers with income in excess of $500,000, effective for tax years beginning after Dec. 31, 2021.
Loss: change to excess business loss limitation
The Coronavirus Aid, Relief and Economic Security (CARES) Act suspension of the application of the section 461(l) excess business loss limitation for 2018-2020 prevented most taxpayers from being negatively impacted by this Tax Cuts and Jobs Act change to date. This section, effective for 2018 through 2025 as passed under TCJA, limits noncorporate taxpayers’ losses incurred from a trade or business to $500,000 for joint filers. Any losses limited under this section carry forward to subsequent years as a net operating loss (NOL). The BBB proposal makes the section 461(l) limitation permanent and changes the nature of the carryover of the limited losses — rather than carrying forward as NOL, the limited loss would now carry forward as a net business loss and would therefore continue to be subject to the limitation in subsequent years. The limitation on losses applies beginning in 2021 regardless of whether this legislation passes, since the CARES Act deferral ended in 2020.
By the time you read this article, we may be looking at an entirely different bill having been passed into law as Congress continues to haggle over spending and revenue generation.
With the debt limit extension, surface transportation funding and continuing resolution to continue government funding all set to expire on or around Dec. 3, hopefully at least some of the tax landscape for 2021 and the next couple of years will have been made more certain by the time you’re reading this. One thing’s for sure — we’ll be keeping our eyes on Congress and will be reaching out to our clients as the outlook starts to become clearer.
A version of this article was originally published in Geared Up, the official magazine of the Planet Fitness Independent Franchisee Council and is reprinted with permission.