The House Ways and Means Committee recently proposed new tax legislation as part of President Biden’s “American Families Plan”. There are a lot of proposals in the bill, but we’ll focus on the parts that will affect the majority of our clients.
The purpose of the bill is to raise tax revenue for President Biden’s economic and social policies. It’s not as aggressive as President Biden’s original plan, but it will increase taxes on what they deem as “high income” people and corporations.
Make note, this bill is not yet in its final form. There may still be weeks of negotiation before it’s passed. There are still a few proposals Democrats want to see added into the bill before it’s voted on. That’s important because House Democrats can only afford to lose three votes to pass this bill on to the Senate. The Senate needs all 50 Democrats to vote ‘yes’ for it to be passed into law.
So, how will the new tax bill affect you? Below is a summary of the changes most likely to affect our clients, read on for more information.
- Elimination of Roth conversions for high income earners (starting in 2032)
- Increase to the Child Tax Credit
- Reduced Gift and Estate Tax Exemptions
Increased Tax Rates
Bottom line, if you’re single and have taxable ordinary income above $400,000 or married filing jointly and have taxable income above $450,000 you’ll see an increase in your tax rate. Ordinary income includes salary/bonus/commissions, most business profits, social security, rental income, and withdrawals from IRAs and 401(k)s.
The proposal is to increase the top tax rate from 37% to 39.6% and at the same time, reduce the amount of income it takes to get you there.
Currently, you hit the top tax rate of 37% at $523,601 of income as single and $628,301 as married filing jointly. The new top tax rate of 39.6% kicks in at income of $400,000 and $450,000, respectively
| Single | ||
| Tax Rate | Current | Proposed |
| 10% | $0 - $9,950 | $0 - $9,950 |
| 12% | $9,951 - $40,525 | $9,951 - $40,525 |
| 22% | $40,526 - $86,375 | $40,526 - $86,375 |
| 24% | $86,376 - $164,925 | $86,376 - $164,925 |
| 32% | $164,926 - $209,425 | $164,926 - $209,425 |
|
35% |
$209,426 - $523,600 |
$209,426 - $400,000 |
|
37% / 39.6% |
$523,601+ |
$400,000+ |
| Married Filing Jointly | ||
| Tax Rate | Current | Proposed |
| 10% | $0 - $19,900 | $0 - $19,900 |
| 12% | $19,901 - $81,050 | $19,901 - $81,050 |
| 22% | $81,051 - $172,750 | $81,051 - $172,750 |
| 24% | $172,751 - $329,850 | $172,751 - $329,850 |
| 32% | $329,851 - $418,850 | $329,851 - $418,850 |
|
35% |
$418,851 - $628,300 |
$418,851 - $450,000 |
|
37% / 39.6% |
$628,301+ |
$450,0001+ |
In addition to raising ordinary income tax rates, capital gains tax rates will increase under the same framework. Singles making above $400,000 and couples making over $450,000 will see an increase in their capital gains tax rate.
The proposal is to increase the top capital gains rate from 20% to 25% and reduce the amount of income to get you there.
Currently, the top rate is 20% at income of $445,851 for singles and $501,601 for married filing jointly. The top rate will increase to 25% at income of $400,000 and $450,000, respectively.
| Single | ||
| Tax Rate | Current | Proposed |
| 10% | $0 - $40,400 | $0 - $40,400 |
|
15% |
$40,401 - $445,850 |
$40,401 - $400,000 |
|
20% / 25% |
$445,851+ |
$400,000+ |
| Married Filing Jointly | ||
| Tax Rate | Current | Proposed |
| 10% | $0 - $80,800 | $0 - $80,800 |
|
15% |
$80,801 - $501,600 |
$80,801 - $400,000 |
|
20% / 25% |
$501,601+ |
$450,001+ |
If the bill passes, the increase in the capital gains tax will be retroactive to September 14, when the proposal was announced. They’ve included this provision to mitigate the impact on mass selling in the market to realize gains at the current, lower rates.
It’s important to note that these proposals substantially increase the “marriage penalty” and can create a big incentive for couples not to get married.
Take for example, an unmarried couple with both people earning $300,000. As singles, neither of them sees an increase in their tax rate. However, if they were to marry, their joint income of $600,000 puts them well into the top marginal tax rate.
Elimination of Back Door Roth IRA Contributions
Many of our clients are over the income limit to contribute directly to a Roth IRA ($140,000 single and $208,000 joint). An effective strategy we’ve used in the past to circumvent those income limits is a backdoor Roth IRA contribution.
We accomplish this by making a non-deductible contribution to a Traditional IRA and then converting it to a Roth IRA.
The proposal is to ban backdoor Roth contributions starting in 2022.
On that same note, mega-backdoor Roth contributions will also be banned. A mega BDR is like a regular BDR but done through the after-tax portion of a 401(k) plan.
Elimination of Roth Conversions
Another effective tax-saving strategy many of our clients have benefitted from are Roth conversions – the practice of converting money from pre-tax accounts, like a Traditional IRA or 401(k) to a Roth IRA. Interestingly enough, this wouldn’t take effect until 2032 and would only apply to singles with taxable income above $400,000 and married filing jointly above $450,000.
Pushing it out ten years encourages high income individuals and couples to convert as much as they can, which will result in additional tax revenue in the short-term.
Increase to the Child Tax Credit
Earlier this year, President Biden expanded the Child Tax Credit to $3,000 per qualifying child and $3,600 per qualifying child under six years old. He also made the credit fully refundable (meaning you still get the full amount even if it reduces your tax liability to zero) and paid in advance. The proposal is to extend these increases out to 2025.
Phase-outs for the credit begin at income of $75,000 for individuals, $112,500 for head of households, and $150,000 for married filing jointly. Full phase-out, or the point at which you don’t receive any part of the credit comes at income above $200,000 for individuals, $300,000 for head of households, and $400,000 for married filing jointly.
| Child Tax Credit Amounts | ||
| Age of Child | Annual Amount | Monthly Amount |
| Under 6 | $3,600 | $300 |
| 6 & Over | $3,000 | $250 |
| Child Tax Credit Phase-Outs | ||
| Filing Status | Phase-Out Range | |
| Single | $75,000 | $20,000 |
| HOH | $112,500 | $300,000 |
|
MFJ |
$150,000 | $400,000 |
Reduced Gift and Estate Tax Exemption Amounts
The unified gift and estate tax exemption would be cut in half starting in 2022. In 2018 it was doubled from $5 million to $10 million and adjusted for inflation each year. Under the proposal, it would be set back to $5 million for 2022 plus an inflation adjustment each year (most likely to be about $6 million in 2022 after the inflation adjustment).
Notables
In addition to the proposals above quite a few more will impact business owners and ultra-wealthy people.
- Increase the top corporate tax rate from 21% to 26.5%.
- Profits of S corporations will be subject to the 3.8% net investment income tax (NIIT) for single filers above $400,000 of income and joint filers above $500,000.
- A new 3% surtax on all individual filers with modified adjusted gross income that exceeds $5 million.
- The Qualified Business Income tax deduction, which is 20% on pass through income from a business, would be capped for single filers above $400,000 of income and joint filers above $500,000.
- Higher required minimum distribution amounts for taxpayers with high income and account balances above $10 million.
- Wash sale rules would apply to cryptocurrency which closes the loophole that allows some investors to generate losses that can be used to offset other gains, without truly disposing of their crypto.
Bottom Line
Many of the proposals made by President Biden during his campaign and shortly after becoming President didn’t make it into the bill. Most notably, the removal of the step-up in basis on inherited assets, and even higher proposed marginal and capital gains tax rates.
However, President Biden is making good on his promise to only raise taxes on high income earners and corporations.
As noted, before, the bill is currently being debated and revised by the House and will most likely see some changes before it passes on to the Senate. For now, we’re keeping ourselves informed about the various proposals but holding off on any tax planning with clients until we know the official and full extent of the bill.