House Democrats released a tax plan that will raise between $2.1 trillion to $2.9 trillion (depending on who’s accounting you believe) over the next 10 years and offset a portion of their proposed $3.5 trillion spending plan.
There were some significant differences between this plan and President Bidens American Families Plan which was proposed on April 28th. Of note, a proposal to impose capital gains taxes on appreciated assets held by wealthy individuals until death was left out. Currently heirs may delay taxes on inherited gains until they sell the property. They are also entitled to adjust the assets purchase price to the value on the date of death, which is often much higher than the value at the time of the original asset acquisition. Also not included was the change to the state and local tax deduction, which was capped in 2017 at $10,000. Another big difference was the capital gains rate, which, while increasing, was significantly lower than the rate proposed by the white house.
Here are some of the specifics of the plan and how it might impact you.
Proposed Tax Changes for the Wealthy
We should start off with a definition of what “wealthy” means. In line with Pres. Bidens promise not to raise taxes on those making $400,000 or less, that number is used as the implementation benchmark for many of these changes.
Top Individual Tax Rates – Under this plan in 2022 the top tax rate for individuals making over $400,000, or married couples filing jointly and making over $450,000, would rise from 37% to 39.6%. Currently a single filer would have to earn more than $523,000 to pay the top rate, compared with $628,300 for married couples. The new proposal increases the “marriage penalty” by moving the joint filing limit closer to the individual filing limit. Married couples filing jointly are more likely to exceed their limits.
Surtax – If an individual or married couple is making more than $5 million, or $2.5 million if your married filing separately, they will be subject to a 3% surtax.
Capital Gains and Dividends – for those earning $400,000, or $450,000 if married and filing jointly, the tax rate on capital gains and dividends would rise from 20% to 25%.
Net Investment Income Tax – This 3.8% tax currently only applies to active business income like wages, self-employment income and passive income. Under this proposal it will now include income from investments, income from specified investment businesses or income from personal services businesses and other pass-through companies. This effectively would bring the capital gains tax to 28.8%.
Cap on Pass Through Business Deduction – The Tax Cuts and Jobs Act of 2017 allowed for a 20% deduction on certain income that owners of pass-through businesses – like partnerships, S corporations and sole proprietorships – reported on their individual tax returns. These deductions would now be capped at $400,000 for individuals and $500,000 for married couples. Wealthier households tend to get a much larger share of their income from pass-throughs and receive the largest tax break per dollar of income deducted (since they are in the highest tax bracket).
Land Rights Donations – In a move that would be retroactive to 2016, the proposal would limit deductions for conservation easements. The government feels that these often come with inflated values that overstate tax deductions.
While one of the biggest estate planning changes, the mark to market of assets upon death referred to earlier in this article, wasn’t included in this draft proposal there were other provisions that would directly affect estate planning.
Estate Tax Exemptions – The 2017 Tax Cuts and Jobs Act doubled an estates value that is exempt from estate tax from $11 million per couple ($5.5 million per individual) to $23.4 million per couple ($11.7 million per person). These provisions were to sunset in 2025, slashing the thresholds down to about $6 million and $12 million respectively. The democrats new tax proposal would accelerate the sunset provision, reducing exemption rates at the end of 2021.
Grantor Trusts – These would now be part of a descendant’s taxable estate when the descendant is deemed owner of the trusts. Currently taxpayers are able to use grantor trusts to push assets out of their estate while controlling the trust closely. This would only apply to future trusts and transfers.
Retirement Tax Changes
The house proposal makes a first-ever attempt at creating a mandatory framework for workplace retirement plans, putting them on a par with other statutory benefits like unemployment or workers compensation. This is being done to address the fact that, according to General Accounting Office (GAO) estimates, half of people over age 55 have nothing saved for when they stop working. Trying to address this issue now might save social welfare programs in the future.
Structured Savings – Employers with over five workers would auto sign workers for retirement benefits with contributions auto-deducting from paychecks at 6% then increasing to 10% over time. Employees can opt out or change contributions and employers wouldn’t have to offer matching funds. There would also be a refundable tax credit called the “Savers Credit”. Under this up to $500/yr. would be added to your IRA directly from the treasury.
For companies, failure to provide low-cost retirement option such as 401k or individual retirement account would cost biz an excise tax of $10 for every worker per day of non-compliance, which would add up fast. An expanded tax credit could be used to cover the cost of implementing these plans. This would go into effect in 2023.
Limits to Roth or Traditional IRA Contributions – If the value of your IRA and defined contribution retirement accounts exceed $10 million at the end of the taxable year prior you will not be able to make any further contributions. This would only apply to single taxpayers (or taxpayers married and filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000 and heads of households with taxable income over $425,000 (all indexed for inflation). This would go into effect December 31st, 2021.
Tax Treatment of Rollovers to Roth IRAs and Accounts – Currently only people with income between $125,000 to $140,000 can make contributions to Roth IRAs for 2021.
However, in 2010, similar income limitations for Roth IRA conversions were repealed, which allowed anyone to contribute to a Roth IRA through a conversion, irrespective of the still- in-force income limitations for Roth IRA contributions. As an example, if a person exceeds the income limitation for contributions to a Roth IRA, he or she can make a nondeductible contribution to a traditional IRA – and then shortly thereafter convert the nondeductible contribution from the traditional IRA to a Roth IRA.
In order to close these so-called “back-door” Roth IRA strategies, the bill eliminates Roth conversions for both IRAs and employer-sponsored plans for single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation). This provision applies to distributions, transfers, and contributions made in taxable years beginning after December 31, 2021.
Furthermore, this section prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021.
Increase in Minimum Required Distributions – For those with income levels and savings levels described in the previous paragraph, a minimum distribution of 50% the amount by which the individual’s prior year aggregate traditional IRA, Roth IRA and defined contribution account balance exceeds the $10 million limit. If the balance should exceed $20 million, a distribution would be needed to bring the accounts down to $20 million This would go into effect December 31st, 2021.
Passage of this legislation is anything but certain. More certain is the fact that numerous revisions and compromises are likely to occur as lawmakers continue to debate the make-up of the broader $3.5 trillion spending bill. Democrats have a thin margin in the House and Senate and competing visions on how the top percentage of earners in America should be taxed. The fact that the House proposal fell short of Pres. Bidens plan in some ways – leaving out the step-up in basis on capital gains tax on estates and the deduction for state and local taxes – is itself a testimony to the need for compromise. Democrats from high tax states want to repeal the $10,000 cap on state and local tax deductions while progressive democrats feel that repealing this measure just puts money back into the pockets of the wealthy. Farm state democrats are skittish regarding how a step-up in capital gains at death would effect inherited farms and conservative democrats feel like a $3.5 trillion spending bill is just too much. Republicans are consistent, they aren’t for any of this.
Why watch Monday night football when we have this kind of a show on? At Sound Accounting we are watching with interest and will continue to give you the play by play.