By now, you’ve likely seen that the House Ways and Means Committee released a draft of major tax legislation last week.
Significant changes to U.S. tax policy for 2022 seem likely, including around income tax rates, rules regarding retirement accounts, estate and transfer laws and much more.
Many of the features of Biden’s original plan are included in the House plan, most significantly the raising of income and capital gains tax rates on high earners.
The changes that have been made suggest that a lot of negotiations have already taken place among Democrats so, if the legislation becomes law, its final form will likely be similar to the House plan.
How will this impact you?
We’ve already parsed through the draft and have started building some of the proposed changes into our tax planning tools so that we will be able to illustrate, on a “what if” basis, the potential impacts to our clients compared to the current tax law.
While we do that, we wanted to provide you with a quick summary of some of the key points of the proposed legislation (as best as we can glean at the present time):
Single filers with income below $400,000 and Married Filing Joint filers with income below $450,000 will probably not see significant impact right away.
Taxpayers with income over those thresholds should expect higher marginal rates and higher capital gains rates.
The bill brings back the 39.6% marginal bracket on ordinary income while compressing the existing 32% and 35% brackets.
For folks over the $400K/$450K thresholds, capital gains increase from 20% to 25%. While unpleasant, recall that President Biden’s original proposal included a top capital gains rate of 39.6%.
The strategy of making non-deductible IRA contributions and then converting them to a Roth IRA – or the “backdoor Roth” – looks like it’s on its way out starting in 2022. The same goes for the “mega backdoor Roth” strategy inside of 401k plans.
Increases to both the Child Tax Credit and the Child and Dependent Care Credits.
Elimination of Roth conversions for folks over the income thresholds…but not until 2031!
The gift and estate tax exemption amounts would effectively be cut in half starting in 2022. That would still be over $5 million/person, though.
Application of the 3.8% Net Investment Income Tax (NIIT) to S-corp distributions for taxpayers with income higher than $400,000 (individual) or $500,000 (married filing jointly).
Limitations of the QBI Deduction (199A deduction) for high income taxpayers
One additional item worth keeping track of is a 3% surcharge on very, very high-income people. But that’s also going to apply to trusts with income of over $100,000. For clients who have left IRAs to a trust for the benefit of minor children, this income threshold may come faster than you think given the 10-year requirement to deplete an inherited IRA.
REMEMBER: Tip your server, not the IRS
The legislation will now be debated in Congress and finalized in the weeks to come.
We continue to monitor developments and strategize around this plan to give you the best possible outcomes when this new tax reality arrives.
That seems likely with a $2 trillion American Jobs Plan (that could eventually cost trillions more) on the table to bolster America’s crumbling infrastructure and invest in R&D.1
What could those tax hikes look like? Let’s consider the possibilities.
Though President Biden committed to not raising taxes on folks earning less than $400,000 per year, it seems hard to believe that he’ll be able to keep that promise with such a massive bill to cover.2
Also, it appears that married folks filing jointly could find themselves facing a big marriage penalty if they get swept over the $400k threshold as a household.2
One option on the table is a new auto mileage tax, which would raise money for highway infrastructure. Another is higher fuel taxes, which could increase what Americans pay at the pump.3 However, both proposals would be difficult to get through Congress, so they seem unlikely to come to fruition.
Some economists favor funding long-term infrastructure spending with ultra-long bonds and it’s possible Treasury Secretary Yellen will consider issuing 50-year bonds for the first time since 1911 to take advantage of low interest rates.4
Bottom line: we don’t know exactly what will ultimately come out of Congressional haggling; however, it’s smart to prepare ourselves for potentially higher tax rates in 2022.
What could those look like? While I don’t have a crystal ball, the following changes seem very possible:
A higher top income tax rate
A higher capital gains tax rate
A higher corporate tax rate
A lower estate tax exemption amount
We’ll know more as the final deal shakes out, but it’s clear these possibilities make 2021 even more critical for tax and estate planning.
In other tax news, the IRS has extended the deadline for making 2020 IRA and HSA contributions to May 17, giving folks an extra few weeks to get them in.5
Also, folks who already filed and paid taxes on 2020 unemployment benefits and are due money back under the recent rule change will automatically get refunds from the IRS, avoiding the need to file an amended return (unless they became newly eligible for additional credits or deductions).6
There’s a lot going on right now in Washington and we can’t know what the final resolution will be until all sides have their say.
However, it’s wise to remember that laws and circumstances change all the time. All we can do is stay on top and plan ahead as best we can.