Have you heard or read about the recently passed and proposed tax bills? In this podcast, we sit down with our host Tom Wadelton and Dave Danic, our Director of Tax to discuss about the new Infrastructure Law and the Build Back Better bill (BBB). Diving deeper into the facets it may impact taxes from the perspective of business owners and individuals.
" What we're learning through this whole process is that using the tax code to impact programs that Congress wants is the easiest way to do it for them. For your friendly tax accountant, it's crazy because there's not a lot of consistency, but it certainly makes our lives more interesting."- Dave Danic
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Tom Wadelton: Welcome to the Clear Diagnostics Tax podcast. This is presented to you by Summit CPA Group. I'm Tom Wadelton. I'm one of the virtual CFOs at Summit CPA Group. I'm the host for today's session. Joining me is our knowledge expert, Dave Danic, who is the Tax Director at Summit CPA Group. Dave, welcome.
Dave Danic: Hi Tom. Can you believe this? We had our pilot episode a couple of weeks ago and they actually loved it. So, they brought us back for one more, a whole season. That's right. We've been picked up. It's awesome to be here. Thanks again for having us. I do want to reiterate for our audience, including my wife, who said, what does the Clear Diagnostics Tax podcast stand for? Well, again, for us tax professionals we cannot complete a tax return until all those diagnostics are cleared. So, it's a very celebratory moment for all of us when that's done. So, we see this title as a celebration of our tax knowledge and helping our clients out. So, thanks again, Tom, for suffering through our title, but we are going to make it.
Tom Wadelton: I was just happy that I could say it correctly. So, in the news recently, a couple of really big things that could impact taxes. I know we're going to talk about them, both the infrastructure tax legislation, and also the build back better bill. Can we start with the infrastructure bill? Talk a little bit about what that is.
Dave Danic: Yeah, that's the one that's actually been passed and signed into legislation. So, remember our civics class, you know, you have a bill and then the house has to pass it. Then the Senate has to pass it and then it gets signed by the president. So, it was signed by the president and there are a few tax reporting issues in that bill. Not as big as the build back better, but a couple of items that I think are important to talk about, the first one is the early termination of the ERTC. That's the employee retention tax credit. I know Tom you've had several of your clients on the CFO side take advantage of the employee retention credit. It's an opportunity for clients to get some of those payroll taxes back as well as get credits on top of it for keeping employees hired and retained. That is now canceled effective third quarter of 2021. So, we took advantage while we could. We had a lot of clients that were able to get some very nice shots in the arm of some credits. Unfortunately, that has been canceled affected the third quarter of 2021. And the other item, which will come down the pike probably in 2023 is the new reporting of transactions with digital assets. That sounds really exciting, but really is Congress going off on the crypto boom? Yup. Yup. Right now, that is not held to the same standard of reporting that you would a stock of Apple or Facebook where a brokerage has to report at the end of the year. So now there's going to be some changes on how they want to do it, but that was the first congressional action that said you will be reporting, or the brokerage house will be reporting to their clients, the owners of the crypto, of all the transactions that have happened. And then the IRS will have information on your crypto transactions.
Tom Wadelton: So with reporting, that legitimizes many of the cryptocurrencies, right?
Dave Danic: That's yeah, that's a very good perspective on it and saying, hey, is this just a fad or a fly by night sorta thing? No, but when the IRS starts getting involved saying there's so many people in the economy that are utilizing crypto for investment purposes and just regular transactions, it has legitimized crypto.
Tom Wadelton: Yeah, very cool. One of my nieces on Thanksgiving was talking about how she's had multiple people try to explain cryptocurrency to her and her standard response now is, oh, it's just like Kohl's dollars.
All: Laughing [in audible]
Dave Danic: It’s getting easy to access. So, once you start getting the government regulating it, it's here to stay
Tom Wadelton: Yeah. I always thought it was sort of something on the periphery and I have one client that is getting paid in crypto by one of their clients. I've got another one that has workers down in South America and they're paying many of them in cryptocurrency by the employee's choice where they're paying and it's, there's a couple of different ones and we've had a little bit of challenge with it. It's becoming maybe not mainstream, but I'm seeing it more and more.
Dave Danic: Well, there's so many rules regarding the flow of money too. Like you have to report money moving overseas, you have to report how you are paying foreign contractors. Crypto isn't under that purview right now. It's like giving a piece of property. So, over the next few years we're going to see a lot of legislation on how its reported. How is it going to be a 10 99? If I pay a foreign contractor, how do I report that to the IRS? Even if it's in crypto. I think they wrote the legislation pretty broad to say, we don't officially know how we're going to do this. But we are going to do it. So, bringing in the lobbyists, I'm sure.
Tom Wadelton: Yeah. So, from a tax return standpoint, individuals and businesses didn't hear much from the infrastructure bill that impacts them directly.
Dave Danic: Yeah. Not too much. It's a lot of the ERTC. That’s the big change to report from the infrastructure bill. Unless you're a startup recovery business, which if you began after 2020, I mean, you have average receipts under a million bucks, you can still claim it. I think our listening base and our clients, a lot of our clients are more established, so they didn't start after 2020. So that's the biggest change to come from the passing of the infrastructure bill.
Tom Wadelton: So, the build back better bill is the next.
Dave Danic: I want to reiterate that this is a proposal. So, they draft legislation to try to pass through the house and then to the Senate and then to the president and Senate have to agree on this, but someone has to start the process and the house has done that with some legislation right now that has been written, but not signed. So to our listeners, this is not. But this is stuff that we're talking about with our clients that might be coming and what can we do to start planning around these things. So, there's about seven items that I think we can cover. We're going to go through them. But if you fall into one of these camps and you want to learn more, reach out to us and we can certainly cover it more. But the first one is the larger corporate tax provision. So, these are corporations with over billions of dollars of profits and billions of dollars in revenue, publicly traded companies. And the big one is that they're instituting a corporate alternative minimum tax on your adjusted financial statement income. So, this is going to take your book income, which might not translate to taxable income and apply a tax to it.
Tom Wadelton: Interesting. So, with the big companies, I'll often talk about their effective tax rate. It's much lower than the statutory. And so for many of them, if it gets too low, it sounds like this would impact it.
Dave Danic: Yeah. Yes. It's kind of like how people have said Amazon hasn't paid tax in how many years? This is the first provision that they're going after.
Tom Wadelton: Interesting. So not yet defined exactly how to calculate?
Dave Danic: The alternative minimum tax has not yet been defined on the $1 billion threshold of adjusted a financial statement income. The other one for the big corporations is a 1% excise tax on stock redemptions. So, this may trickle down to, you know, ma and pop investor. How that may come out is when you start taxing these transactions of stock, that might be held in a mutual fund or something like that, you know, it starts working on returns, but its another way to start taxing money flowing from big corporations to the investors.
Tom Wadelton: So, if you sell your stock you're paying a capital gain rate. Is this then on top of that and saying, then there's also a redemption or am I misunderstanding?
Dave Danic: Wellyou have a large corporation with a lot of profit and they want to send money to shareholders, you can do that by a dividend, or you can do that by buying their stock via redemption. They're applying an additional tax on the stock redemption side of it.
Tom Wadelton: Okay. Interesting.
Dave Danic: There will be a lot more to come. The theme that we're going to see is that President Biden is pretty clear that if you make over $400,000, that's where he wants the tax increases to come from. So, you it’s those investors that have over $400,000 of income that we're going to start seeing getting taxed on some of these. This next one is called Section 1202 stock. So, we do have a handful of clients that this may impact, but 1202 stock is called qualified small business stock, and what it allows you to do is exclude gain on your side. So, on stock, if you've held it for more than five years and you're a C Corp. So, we have some C Corp clients that are looking into some merger and acquisition activity. And we say, hey, if you sell your stock and you meet some certain other provisions, you can actually exclude up to 100% of the gain. Congress says that's really generous. So, we're going to pair that back. So, depending on when you bought it, they said at certain dates, you could exclude 75% of the gain and a 100% of the gain. They took out those two levels. So now if you sell your stock after September 21st, 2021, so this is one of those retroactive provisions, you can only exclude up to 50%. So that is a pretty big ding for clients that were looking at selling their stock.
Tom Wadelton: It is interesting, that will keep people from jumping in and having some acquisitions and mergers in the right before.
Dave Danic: Exactly. Now I'm going to shift a little bit away from the business side and go to the individual provisions and one is for high-income taxpayers, a 5% surtax on your modified adjusted gross income over $10 million. So, if you're in this modified AGI bracket this new provision is taking away some investment interest deductions. And then if you make over $25 million, there's an additional 3% surtax on income. So, all those football coaches that are making $15 million you can feel bad for them to have an additional surtax.
All: Laughing [in audible]
Dave Danic: The next is the net investment income tax of 3.8%. So, this was instituted when Obamacare came in and that was a way to finance the Affordable Care Act. And so, they applied a 3.8% investment income tax on rents, royalties, pretty much like non-active trader business. The proposal right now is to apply a 3.8% surtax on trader business income. So, this is going to hit our S Corp shareholders, limited partners, LLC members, and taking away that benefit of what you have seen. And this is if you're making $500,000 married, filing jointly, and we have a lot of clients that are flow-through entities, that if you're having a good year, you're easily getting over $500,000 of income. So, this is where I think we're going to see a lot of our clients, if this passes have an increase in their tax bill. So, in our planning right now we've been telling our clients we could see this.
Tom Wadelton: Is the $500,000, is that measured at the company's profitability or that's measured at how much flows to the end of the year?
Dave Danic: If I have a spouse, that's a physician making $400,000 and I've got an S-corp and my wages are $150,000 I'm already at $550,000 without even looking at my S-corp income. So you can see how you can quickly get up to that $500,000.
Tom Wadeton: That's a good one. Maybe not good one, but that is a good one to address because it's going to impact a lot of owners of small businesses.
Dave Danic: Yep. And the next one is the SALT deduction, salt and local tax deduction. And that is, this is the New York, California, New Jersey senators, duking it out on how we want to do it. But right now at the individual side, you can only deduct $10,000 of your state and local taxes paid. This increased a lot of our client's taxes because they might be paying up to $50,000 of state taxes and now lost a deduction of $40,000. Now they are going to raise that cap under this proposal to $80,000. So, it allows a lot of our clients to be able to deduct those state and local taxes. And that goes through like 2031. And then in 2032, they're going to lower it to 10% for one year. It's really funny the games that Congress plays because they want to say, hey, it's going to pay for itself, or it's not going to impact the deficit. So they say, so for one year, it's going to go back to a $10,000 in 2032. I don't know what I'm doing in 2032, Tom. I'm probably going to be retired, sitting on a hammock, not worrying about the SALT deduction.
Tom Wadelton: Interestingly, that's when it feels like it's a give back to a lot of people, right? I mean, that would still be a little bit wealthier people, maybe not completely, but people paying more than $10,000 in state and local tax.
Dave Danic: Yeah. We're not going to get into politics here. We'll save that for another podcast, but for sure, this has been one where it's a lot of the blue states are giving a tax deduction to their high-income earners by allowing them to deduct their state and local taxes. Where before under the current rules, they have not been able to do that. Um, top individual tax rates. They were going to think about raising it to 39.6% from 37%. That is not happening. It's not in the proposal right now. And the top capital gain rates to 25% is not happening. So that was, I thought that was interesting that they're not messing with the rates right now. They're looking at different proposals to raise taxes. And then I think the last item to talk about is. I don't know if this is going to stick or not, but they want to take away the backdoor Roth IRA proposal. And what that is is that's for people that, are unable to contribute to a regular IRA because they're participating in a 401(k) plan or they make too much, it allows them to make a non-deductible. IRA contribution, convert it to a Roth IRA. And that's nice. Why is that nice? Well, one, it starts diversifying the client's retirement holdings. I got pre-tax money and now I got some post-tax money that's growing tax-free, so we have a lot of clients in that $500,000 income level that do that every year. Bank another into a Roth and another bank into a Roth via this backdoor Roth IRA conversion. That looks like it's going to be canceled. And that's certainly a bummer because those dollars start adding up once you're into the retirement age. You know, there's no income limits on saying I'm going to put money into a non-deductible IRA and then converting it to a Roth IRA. That would be off the table. So just taking away little bit of these planning opportunities and just like tax planning, tax legislation has little bits here or there. Raise taxes on people. Usually, it's not this big one big swoop that says, that hurts. That's taken away a little bit here giving a little bit here, taking some here.
Tom Wadelton: Interesting. It is good look out for that because headlines can be misleading because there are so many promises on who this change will and will not effect. My guess is that it’s harder to explain so most people aren't going to read into it.
Dave Danic: Yes, that's right. The message is you have not raised ordinary income tax rates, right? Well, that's not a sexy headline. So, we're continuing to monitor these proposals. We've been through this a few times and it changes up to the last minute. I've been hearing that they're looking at hopefully signing this by December 29th or something like that.
Tom Wadelton: So, in terms of, you know, it is now it just the beginning of December of 2021, the house has proposed.
Dave Danic: Yeah it will have to go to the Senate and, you know, the Senate can make their changes. So, it's going to be a busy December in terms of reading proposed tax legislation. It’s a great way to spend the Christmas season .
Tom Wadelton: And my guess is consistent with what we've seen so far. Most of the news about this probably will be what the spend side looks like, right? What are people putting in programs? And that's what I've been hearing more of the opposition around. You shouldn't put this much money into this kind of a program or this is going to cost too much.
Dave Danic: What we're learning through this whole process is that using the text code to impact programs Congress wants it to be the easiest way to do it for them. It's crazy because there's not a lot of consistency, but it certainly makes our lives more interesting.
Tom Wadelton: Well, good. Thanks for the description for both of these. I think people who understand these and then have any clients who say, I'm hearing about these things on the news, what does it mean? I know this certainly gives me some things to share with my clients around that, including some saying, should we be doing some really big things this year because the taxes are going up like crazy. At least what we're seeing right now is for many people, there's not a great big number coming right at the beginning of 2022.
Dave Danic: You know, I know you have some clients in the manufacturing space. In buy some equipment. Do we think about taking all the depreciation in 2021? Or do we say, do we stretch the depreciation out for five years and save those deductions for when the surtax might be in play? You know, so there are little nuggets here that you can start thinking about. How's your cashflow clients?
If you want more, we can take the deduction, but from an effective rate, it might be better to stretch it out. So, there's always things to talk about and it very quickly comes into the realm of reality even if your client is a smaller client there are ways that it will flow to the, eventually as all of these things are proposed.
Tom Wadelton: Yeah. You want to be giving clients advice through all of this.
Dave Danic: Yes. Well, Tom, his was good. Episode two in the books.
Tom: Okay, great. I'll look forward to our next episode then. Thanks Dave.