Democratic lawmakers have advanced legislation containing many elements of President Biden’s original ‘American Families Plan’. These tax increase would raise more than $2 trillion over the next decade, according to the Center on Budget and Policy Priorities estimates. President Biden has repeatedly stated that his tax package would not increase taxes on people earning less than $400,000.
The tax proposals may continue to change before Democrats create the final bill they hope to pass. A major change from the previous proposal is this one does not include the elimination of the stepped-up basis loophole. Below I’ll go over some of the most notable points.
Top Ordinary Income Tax Rate would return to 39.6% up from 37%
One of the most notable parts of the bill is the top income tax rate going back to 39.6%. That was the top tax rate from 2013 through 2017 and was reduced in 2017 as part of the Tax Cuts and Jobs Act. If approved, this would go into effect for the 2022 tax year.
The proposal also lowers the amount of income a taxpayer can have to be in the top tax bracket. Currently, for married filers you need more than $628,300 of taxable income to be in the top tax bracket. With the new proposal it would be on income above $450,000! For single filers, the top tax bracket includes income more than $523,600 and would be changed to income above $400,000.
New Long Term Capital Gains Rate of 25%
The proposed long term capital gains rate would be effective immediately. This would include capital gains incurred on or after September 14, 2021. The new proposal increases the capital gains tax to 25% for single filers with income over $400,000 and married filers over $450,000. The 25% rate is lower than President Biden’s original proposal of 39.6% capital gains tax rate for high income earners.
Long term capital gains tax is a tax on profits from the sale of an asset held for more than a year.
Changes to Roth IRA Conversions
Roth IRA conversions would be limited to joint filers with $450,000 or single filers with $400,000 or less of taxable income. In a Roth conversion, savers normally transfer assets from a Traditional IRA to a Roth IRA and pay income taxes on the switch. Future payouts from the Roth IRA are tax free and do not require RMDs. This proposal wouldn’t take effect until 2032.
Another provision would prohibit all after-tax contributions to company retirement plans and to Traditional IRAs from being converted to a Roth IRA regardless of income level. This is the so called “mega-backdoor Roth” strategy that is similar to the backdoor Roth. It would take effect December 31st, 2021 and apply to everyone, regardless of income.
For 2021, you can contribute $19,500 to your 401(k). However, the total contribution limit, which include employer contributions and after-tax contributions (if allowed by your employer) is $58,000. You will no longer be able to convert the after-tax contributions to a Roth IRA.
Reduction In The Unified Credit Amount For Estate and Gift Taxes
The current estate and gift tax exclusion amount will be cut in half from its current level ($11.7 million) and be reduced to $5 million per individual (estimated to be $6 million in 2022 adjusted for inflation). The Tax Cuts and Jobs Act doubled the unified estate tax from $5 million to $10 million starting in 2018 and was scheduled to automatically end at the end of 2025. The proposed bill shifts forward that time frame, reducing the exemption amount back for 2022.
Child Tax Credit Would Be Extended
The current Child Tax Credit with advance monthly payments extended to 2022 and beginning in 2023 the Child Tax Credit is formally transitioning into a monthly tax credit of $250/month/child ($3,000 per year/child) for children 6 and older and $300/month/child ($3,600 per year/child) for each child under the age of 6.
3% Surtax for Ultra-High Income
An additional 3% rate would apply to taxpayers’ modified AGI exceeding $5 million. The new threshold applies to single and joint filers. Taxpayers would not be able to use below-the-line deductions to reduce their exposure to the surtax. This would create a top ordinary tax rate of 42.6% (39.6% + 3%) and would be effective starting in the 2022 tax year.
New RMDs would apply to single filers making $400,000 or more ($450,000 for joint filers), and retirement accounts worth more than $10 million. Taxpayers must meet both these requirements to be subject to the new RMDS. It would take effect starting in 2022 and there is no age requirement.
The amount would be equal to 50% of retirement account dollars in excess of $10 million and less than $20 million. For example, if you had $750,000 of taxable income and $18 million in combined IRAs, 401(k) accounts, and 403(b) accounts. You would have a RMD of $4 million (50% x ($18 million – $10 million).
If the aggregate value of an individual’s traditional IRA, Roth IRA, and defined contribution plans exceed $20 million, the RMD for the following year is required to come from any Roth components. For example, Peter Theil who was reported to have a Roth IRA of $5 billion (article here), would be required to withdraw all but $20 million of his account. He wouldn’t owe any taxes upfront but the money would no longer be in tax advantaged accounts.
Corporate Tax of 26.5%
The new proposal would change the corporate tax rate from 21% to 26.5% on income above $5 million. This is less than the 28% rate that was previously suggested. It also cuts the tax rate for businesses with income less than $400,000 to 18%.
Crypto Included in Wash Sale Rule
Currently, you can take loses in crypto and buy it back immediately without incurring a wash sale. With the new proposal you will have to wait 30 days to buy it back if you want to deduct the loss. It would be the same wash sale rule that applies to individual stocks. It may help reduce volatility in the crypto market because there will not be as much of an incentive to sell and lock in losses.
The bill is not in its final form yet and there are weeks of negotiations before it could be passed. That said, we will continue to monitor its progress and any future changes. If you have any questions, please don’t hesitate to reach out.
Disclaimers and Sources:
Proposed legislation released by the House Ways and Means Committee
Capital Gains Calculator: Link Here
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