As you may have heard, the House Ways and Means Committee drafted a tax law proposal that came out on Monday. There has been much talk of a new tax bill since President Biden took office. This is the first proposal we have seen come from the Democrat controlled House. We are following this closely and even though there is a low probability the entire proposal passes Congress as is; we still want to address a few of the major points in the proposal to keep you informed. If a bill does pass, chances are it will look slightly different than what is laid out below.
As your financial planner, we will be standing by ready to make any changes to your plan, as they become impacted by this proposed legislation.
Income Tax Increase
- An increase in the top marginal tax bracket, to 39.6% (up from 37%). This would apply to taxable incomes of:
- Married filing joint – Over $450,000
- Single – Over $400,000
This widens the eligible pool for those in the top tax bracket. Currently a single filer must have taxable income over $523,601 to fall into the top bracket, and joint filers must be over $628,301.
There is also a new proposed surtax of 3% on income over $5 million.
The Affordable Care Act surtax of 3.8% on the lesser of net investment income or income exceeding a certain amount still applies. This applies for single filers with income (modified adjusted gross income) above $200,000 and married filers with income above $250,000. Suffice it to say there will be some high income earners paying close to 46% in federal tax, and in high income tax states the total marginal tax rate will be well over 50%.
The new tax rates that would be effective in 2022 would also lead to an even more severe marriage penalty for two high income spouses. We will go into more detail about this if the bill passes with the marriage penalty. We suspect this is one issue that might be reworked.
Capital Gains Tax Increase
- An increase in Long-Term Capital Gains tax to 25% (up from 20%).
This would again apply to married filing joint over $450,000 and single over $400,000 in taxable household income. If the bill does pass, the capital gains tax rate would be backdated to 09/14/2021, which means you are out of luck for trying to sell before the end of the year and taking advantage of a lower rate.
This is a back off from President Biden’s original proposal which was to equalize capital gains tax rates with ordinary income tax rates.
- Prohibits contributions to traditional IRAs and ROTHs for individuals who have more than $10,000,000 in IRA and defined contribution plans IN ADDITION TO income above the limit ($400k for single and $450k for married).
- If an individual has over $10,000,000 in combined IRA, ROTH and defined contribution retirement plans AND taxable income over the threshold ($400k for single and $450k for married filing joint), they must make a required minimum distribution the following year. The distribution would be 50% of the amount over $10,000,000.
- Elimination of ROTH conversions and “back door” ROTHs for individuals with taxable income over $400,000 and married filing joint over $450,000.
- The prohibition on Roth IRA conversions would not take effect until 2032, giving a window of time to ramp up the conversions. We suspect this is done intentionally to try and boost tax revenue over the next decade by encouraging conversions.
- Elimination of “Mega Backdoor” ROTH contributions within employer sponsored defined contribution plans.
- Prohibits IRAs for holding securities that require the account holder to be an accredited investor.
Corporate Taxes (currently 21% flat tax)
- 18% tax on first $400,000 in income.
- 21% tax on next $5,000,000 in income.
- 26.5% tax on income exceeding $5,000,000.
Adding in state income tax to these federal corporate taxes, and the United States would have one of the highest corporate tax rates of any major developed country.
Elimination of SALT
- Eliminating the $10,000 deduction limitation on State and Local Taxes.
- This will make certain high income state taxpayers happy as they will be able to deduct a lot more of their local taxes on the federal return once again.
Extend the Child Tax Credit
- Making the Child Tax Credit of up to $3,600 per child for kids 5 and under and $3,000 for kids between ages 6-17 permanent and refundable.
- Credits phase out full at $200,000 taxable income for single filer and $400,000 taxable income for married filing joint.
- Hypothetical, you have two children under 5, you are under the income thresholds stated above, and also happen to pay zero federal tax, you will still receive $7,200 a year from the US Government.
- Rolling back the current estate tax and lifetime gift exemption of $11.7 million per person to $5 million per person (which will be indexed for inflation and expected to be close to $6 million for 2022).
- Eliminating defective grantor trusts.
Things Notably Not Included
- Elimination of step up in basis provisions.
In President Biden’s earlier tax proposal, he mentioned eliminating a step up in basis for gains over $1 million. Step up in basis is a reset in cost basis at the death of the original account holder. This could be a topic the Ways and Means committee wants to avoid, to gain support from across the aisle, which is still unlikely. It appears the overall aim of this proposal is to tax earners over $400,000, corporations, and estates.
- Closing the carried interest loophole.
Closing the carried interest loophole is always a topic in political TV debates, but when tax proposals come out they always seem to forget to include it. Maybe next time!
What We Think
This is another piece of legislation that provides permanent job security for well rounded accountants.
While many people will look at the income ranges listed above and gather these changes will not impact them, they certainly will have an impact on everyone. It could be a positive impact on some people, and negative on others.
The capital gains taxes are an interesting subject, as there does not appear to be any data showing that increasing capital gains tax rates increases capital gains tax revenue. It incentivizes the holder of large unrealized gains to continue deferring realization of the tax (especially if step up in basis laws are staying). Jimmy Carter had the capital gains tax reduced under pressure from the House, and they saw a large influx of capital gain tax revenue from doing so. People were more willing to realize the gain at a lower tax rate.
Part of our job is to stay on top of these laws and analyze how they could impact you. As we are all aware, we have a divided Government, and it is hard imagining this proposal passing in its entirety. We will be following any new developments and will keep you posted. Please let us know if you have any questions in the meantime.