Individual Tax Increases in the Build Back Better Plan

Enacted in 2010, the Net Investment Income Tax (NIIT) applies an additional tax of 3.8% on a high-earning taxpayer’s net investment income. Originally, this tax applied only to investment or passive income (interest, dividends, capital gains, income from pass-through investments, etc.) Currently, however, there is an exclusion from the 3.8% tax for any business in which the taxpayer actively participates. Under the framework, the exclusion for active participation will be removed for any single taxpayer earning more than $400,000 or a married couple making more than $500,000.


We don’t know all the final details or effective dates of what might pass in the new laws, but we should know more by mid-December or sooner.  Under current law the NIIT would not be charged on a sale of a company in which owners were materially participating in the business.  The new proposal suggests pass-through companies would be charged the NIIT tax on current income and on capital gains when sold.  For example, the Net Investment Income Tax on a $5MM sale would be about $190,000 if charged in 2022.   


The idea of an installment sale is worth mentioning in case a document could be crafted that allowed a sale to be deemed transacted in 2021, while leaving substantial payouts to happen later, perhaps after remaining matters are completed by the buyer in 2022, or later.  That way, the seller can decide whether to declare all the gain in 2021 to yield tax savings, or whether to declare as the installments are collected.  The taxpayers would have to decide whether to elect out of installment treatment before the filing of the 2021 return.  Of course, we leave it to the attorneys as to what constitutes a completed sale, and the actual tax treatment will be determined based on the facts of the transaction and the laws in place at that time.


 Here is a definition of what I am talking about in connection with opting out of installment rules if desired:


An installment sale is a sale of property where you’ll receive at least one payment after the tax year in which the sale occurs. You’re required to report gain on an installment sale under the installment method unless you “elect out” on or before the due date for filing your tax return (including extensions) for the year of the sale. You may elect out by reporting all the gain as income in the year of the sale on Form 4797, Sales of Business Property, or on Schedule D (Form 1040), Capital Gains and Losses and Form 8949, Sales and Other Dispositions of Capital Assets.


 Hopefully, this information will inspire companies to take action now.  If they are flexible in structuring terms in order to take advantage of changing tax laws, it might allow a choice of which year to pay the minimized taxes.