What’s Going on With the Latest Tax Proposals?

There are a lot of proposals, rumors, and ideas floating around out there when it comes to tax reform. 

The Biden administration recently released its proposals, contained in the American Families Plan. And then the Democrats on the House Ways and Means Committee released their proposed plan on 9/13/2021.

These could (and probably will) change as the legislation continues to make its way through Congress. But the most recent proposed plan at least gives a good outline of the areas & people that will likely be affected.

Will the proposals affect me?

Generally speaking, most people won't be negatively affected by the current proposals. You'll need to be making more than $400K per year ($450K for married filing jointly) in income, or selling a big asset, or be a business owner, or have a relatively large estate when you pass away to be negatively affected.

Some people will even benefit from the proposed changes (those with children without income being too high).

But that leaves a number of people (maybe including you?), in the crosshairs of higher taxes. 

What are the proposed changes?

For taxpayers with income of more than $400K (or $450K for married filing jointly), the proposals include:

• Increased top income tax rate, going from 37% to 39.6%, starting at a lower income threshold ($400K/$450K), meaning more income would be subject to the higher rate.

• Increased top capital gains tax rate, going from 20% to 25% (plus the existing 3.8% Net Investment Income Tax), starting at a lower income threshold ($400K/$450K).

  • Notably, this one is proposed to be effective as of 9/14/2021, so there wouldn’t be any opportunity to sell assets now in order to get the lower rates.

• Elimination of the ability to do Roth conversions, starting in 2032.

• Much, much higher RMDs (required minimum distributions) if you have more than $10 million in retirement accounts, regardless of your age.

The above proposals would affect only those with income above $400K/$450K. However, if you make less than that, you might think they are completely inapplicable to you. But they are likely to affect people on a one-off basis more often than you'd think. For example:

• If you sell a rental property and have a few hundred thousand dollars worth of gains, that gets included in taxable income.

• Or if you're a business owner and you sell your business, the gains from that get included too.

• Or if you're selling your home and some of the gains become taxable, that's included too.

• These examples would bring many people above the $400K/$450K income thresholds from time to time.

Also, interestingly, these proposals amp up the so-called “marriage penalty,” which refers to how people might pay less in taxes if they remain single compared to if they get married.

A few other parts I’ll mention that would apply to more people:

• Elimination of the “backdoor Roth” and “mega-backdoor Roth IRA” contribution strategies.

• The estate & gift tax exemption amount would be lowered from this year’s $11.7 million to $5.85 million (cut in half, but also adjusted for inflation next year).

  • That means any amount of your estate (or gifts prior to passing away) above that “exemption” amount would be subject to estate taxes of around 40%.

• Elimination of many of the benefits of Family Limited Partnerships (FLPs) and “defective” grantor trusts, such as Intentionally Defective Grantor Trusts (IDGTs) and many Irrevocable Life Insurance Trusts (ILITs), effective on the date of enactment of the legislation.

• “Wash sale” rules would apply to cryptocurrencies, commodities, and foreign currencies.

  • Interestingly, this may actually help reduce some of the volatility of cryptocurrenices.

• An extra 3% surtax on income greater than $5 million, making the true top income tax rate 42.6%.

  • This 3% surtax would also apply to trusts with income greater than $100,000. This could have a major impact where a trust is the beneficiary of a retirement account, as any distributions from the retirement account to the trust would likely count as income.

• Additional taxes on higher-income business owners. Corporate taxes would also be raised.

If you want to read (a lot) more about these (and other) proposals, click here for a detailed write-up from Kitces.com.

How about some tax breaks, please?

Well, there’s not much, but the latest proposal does make permanent the enhanced Child Tax Credit that was introduced as part of one of the recent stimulus packages:

• $3,600 credit for children under age 6 and $3,000 for children ages 6-17, for taxpayers with income below $75K (or $150K for married filing jointly and $112.5K for head of household).

• The credit will continue to be paid monthly in advance, similar to what’s happening in the 2nd half of this year.

• The credit will be fully “refundable.”

So, what do I do with this?

I think anytime you're making plans around proposed legislation, you're walking on thin ice. While legislation is in the proposal stage, things change really often. There are compromises, adjustments, temper tantrums, etc. 

Having said that, I think at least considering these proposals at this stage makes sense. Perhaps you can lay the groundwork for potentially taking action later. Most of the proposals wouldn’t be effective until January 1, 2022, which would leave some time to implement changes if the law is passed.

Some ideas might include:

• Accelerate income into 2021, to be taxed at lower levels, rather than 2022, to be taxed at higher levels.

• Defer claiming deductions: Claim more deductions in 2022 rather than 2021, as those deductions may be “worth” more next year. Charitable contributions are a prime candidate.

• Complete backdoor and/or mega-backdoor Roth IRA strategies this year.

• If you were considering creating an IDGT, ILIT, and/or FLP, considering doing it ASAP, prior to the date of enactment of the legislation.

• Give extremely large gifts to children & heirs before the end of the year in order to “use up” the full amount of the current estate & gift tax exemption amount of $11.7 million per person.

• If you hold cryptocurrencies, commodities, or foreign currencies at a loss, consider selling them before the end of the year, and repurchasing them shortly thereafter, to lock in the loss but continue to hold the investment.

Overall, I wouldn’t suggest actually implementing any of this yet, as things may change; and even if the proposals pass as is, you’ll have until the end of the year to implement most of the strategies (the one exception is the IDGT/ILIT/FLP one, which would need to be done prior to the enactment of the legislation).

Happy tax planning!