Compliance News | November 30, 2021
In December, the Senate is scheduled to consider the House-passed Build Back Better Act (BBBA), a reconciliation bill subject to special rules in the Senate. This bill, if unchanged, could have a significant negative impact on single-employer DB plans because of a 15 percent tax on a company’s book income.
The BBBA (H.R. 5376) passed the House on November 19, 2021. In addition to the 15 percent tax, the bill has several revenue raisers that would have an impact on high-income individuals’ DC and IRA accounts as well as all taxpayers’ ability to make “Roth conversions” of after-tax contributions. This insight discusses the ones that are most significant to the BBBA’s retirement provisions.
In its search for revenue from corporations that pay little or no tax, the House bill would impose a new 15 percent alternative minimum tax on a corporation’s “book” income if the average three-year book income exceeds $1 billion. Book income is the income shown on the sponsor’s adjusted financial statement. It’s an accounting concept that differs from taxable income under the Internal Revenue Code.
For some corporations, depending on their accounting methodology, taxing book income could result in single-employer DB plans being taxed on pension plan earnings even though these earnings are not available to the corporation and are not available to pay the tax. In addition, any decrease in the value of the pension liability due to an increase in interest rates could increase book income and generate additional tax. Further, employer contributions to a single-employer DB plan would not be deductible under the 15 percent minimum tax rule (as they are under current income tax rules). These consequences could lead to underfunding or termination of single-employer DB plans.
The impact on DB plans appears to be an unintended consequence of the search for revenue raisers. With the impact on single-employer DB plans now receiving attention, the Senate could decide to create an exception from the 15 percent tax for DB plans.
Taxing book income would have no impact on DC plans or multiemployer DB plans.
The House bill would make the tax effective in 2023.
The BBBA would cap the total amount that an individual can have in IRAs or DC plans at a combined $10 million. A DC plan includes not only a traditional DC plan but also a 403(b) plan and a 457(b) governmental plan. The $10 million cap is indexed. The cap would only apply to those with high adjusted taxable income for the year (i.e., more than $450,000 for those who are married and file jointly, more than $425,000 for heads of households and more than $400,000 for those who are single, all indexed).
A portion of the excess (50 percent) would be treated as a required minimum distribution in the following year. Under the calculation, the portion of the excess that is treated as a required minimum distribution is greater if more of the assets are Roth amounts and, for accounts over $20 million, the account would generally have to withdraw Roth amounts first until the accounts were no longer over $20 million.
The process would be repeated each year the taxpayer’s adjusted taxable income exceeded the cap. The 50 percent penalty for not distributing required minimum distributions applies.
This provision would take effect for 2029, if the House bill becomes law. The delayed effective date is intended to push conversions into the window counted for measuring the revenue effect.
Current tax rules limit certain taxpayers from making Roth contributions to IRAs. The rules also limit the amount of Roth contributions a taxpayer can make to a 401(k) plan. However, taxpayers are not prohibited from converting voluntary after-tax contributions to an IRA or 401(k) plan to a Roth IRA or Roth account in a 401(k) plan.
Normally, a Roth conversion results in immediate taxable income. However, if structured properly, the conversion of voluntary after-tax contributions can be done with minimal or no immediate taxable income. Because earnings on Roth amounts are not taxed, by the conversion the taxpayer can obtain tax-free growth.
The BBBA would prevent Roth conversions of after-tax contribution effective for 2022, if the BBBA becomes law.
This provision would prohibit high-income taxpayers (using the same $400,000, $425,000 and $450,000 amounts noted above) from making any Roth conversion, not just backdoor conversions. The provision would be effective in 2032. This would force those who want to do conversions to do it by 2032, thereby raising more revenue in the measurable period.
The House Ways and Means Committee had included two other major provisions in its reported bill which were deleted by the Rules Committee before the bill reached the House for a vote. Those provisions would have:
The BBBA is now being considered by the Senate. The Senate bill is likely to differ from the House bill. First, the Senate rules have many restrictions on what can be included in a reconciliation bill; some of the House bill provisions are likely to be deleted because of those restrictions. Second, there are provisions in the House bill that are not acceptable to individual Senators that also may be amended or deleted.
One of the provisions to which there is objection is the 15 percent alternative tax. The 15 percent tax raises considerable revenue. If it is dropped by the Senate, they will have to find an alternative approach to raise the revenue. Many of the suggested alternative approaches have their own opposition. The Senate is expected to begin its process in December. After the Senate is finished, there will need to be a combined bill that is acceptable to both bodies before it can go to President Biden for signature.
It is unclear whether that all can be done before the Democrats’ target of Christmas.
This page is for informational purposes only and does not constitute legal, tax or investment advice. You are encouraged to discuss the issues raised here with your legal, tax and other advisors before determining how the issues apply to your specific situations.
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