- \ Gerard Gruber
- September 27, 2021
As promised in the last presidential campaign, President Biden's administration has proposed two different proposals for the 2022 fiscal year—the American Jobs Plan and...
As promised in the last presidential campaign, President Biden’s administration has proposed two different proposals for the 2022 fiscal year—the American Jobs Plan and the American Families Plan.
As often happens in the U.S. legislation process, there have been lots of negotiations and compromises going on behind the scenes., but the Ways and Means Committee recently released their votable version of the American Families Plan with significant changes from President Biden’s original plan this past week. While neither of the tenets of these bills has been passed as legislation, the details are worth sharing since many of these are likely to pass.
Overall, the combined effect of the two proposals would be to increase federal spending by $4 trillion over 10 years. But who will pay for these increases? High-earning taxpayers and corporations.
So, What Does This Mean for You?
If you are an individual earning less than $400,000 or a family earning less than $450,000, not too much. All the tax increases and disqualifications apply to individuals with income above $400,000 or married couples filing jointly with income above $450,000 and are slated to be effective 1/1/2022.
- Increased Ordinary Income Tax Rates
The bill would leave most tax rates and brackets in place but increase the top tax rate from 37% to 39.6%. The new rate has been used periodically since 1993, so this is nothing new. In fact, the current rate, which has been in place since 2018, was set to revert in 2026.
- Capital Gains Tax Increase
Currently, the U.S. short-term capital gains (securities held for less than one year) are taxed as ordinary income. Long-term investments (held for more than a year) are currently taxed at lower rates ranging from 0% to 20%.
President Biden’s initial proposal increased capital gains rates to 39.6% for those with income above $1M, which would have effectively doubled the tax on capital gains and qualified dividends for wealthy individuals. Instead, the proposed bill increases the highest capital gains rate from 20% to 25%.
- Business Tax Hikes
There are three ways the new bill proposes to increase taxes on businesses:
(1) C-Corps: The current flat tax of 21% would be replaced with a graduated structure with a lower rate of 18% on the first $400,000 of profits, followed by a 21% tax on income between $400,000 and $5M, and a maximum rate of 26.5% for income above $5M.
(2) Net Investment Income Tax (NIIT) Expansion: The 3.8% NIIT would apply to income from S-Corps that is otherwise not subject to FICA tax when the recipient of the income has AGI above $400,000 for single filers and $500,000 for joint filers.
(3) Limits on 199A Qualified Business Income Deduction: The Tax Cuts and Jobs Act (TCJA) included a complicated 20% deduction of taxable income for pass through businesses, which left many businesses out based on income thresholds or actual business definitions. The new plan would limit the deductions to a maximum deduction of $400,000 for single filers, and $500,000 for joint filers. Business owners with profits below $2M ($2.5M for joint filers) will still get the full benefits of the QBI deduction.
An additional concern is that all the federal spending, past and proposed, is driving an increase in inflation. The actual annualized inflation rate for the U.S. is 5.4% for the 12 months ended July 2021.
- Limits on Retirement Accounts
This proposed law would put restrictions on IRA accounts for ultra-high net worth individuals, by limiting future contributions and requiring distributions from IRA accounts when assets are above $10M. (The required distributions would be 50% of the cumulative sum of retirement accounts over $10M and 100% of amount over $20M.)
- Backdoor Roth Limitations
The proposal will essentially eliminate the Back Door Roth strategy, which has been very effective for some clients. This strategy will be phased out over a period of time to allow high-earners to make conversions now and owe their hefty tax penalties on conversions while they still can.
The Impact on Your Retirement Planning
For many Americans with a higher income, the proposed tax increases make it crucial to maximize investments by choosing when to pay taxes. The tax changes are currently driving attention toward tax-advantaged retirement accounts like Roth IRAs and 401(K)s as alternative strategies to address the capital gains tax increases, as well as grow your retirement capital through tax-free or tax-deferred investments.
For business owners, the tax increases mean reversing the Trump 2017 Tax Plan. That plan set a 21% flat tax for all business, which, under the Biden plan will increase the rate to 28%, with a 15% minimum tax on corporate earnings.
For the higher-income families, the Biden top income tax rate of 39.6%, which will be applied to long-term capital gains of $1 million or more, will dramatically reduce the proceeds (income) for their sale of assets.
The proposed Biden tax hike could also affect lower and middle-income taxpayers as well, especially those in “hot” housing markets. Homes are considered to be capital assets by the IRS. Both single and joint tax filers are exempt from paying capital gains taxes on the first $250,000 and $500,000, respectively. Home prices in certain “hot” markets could easily elevate gains above the $1 million trigger.
Additionally, if the proposed higher taxes lead to a major stock market sell-off (as investors realize that future gains and income will be lower on an after-tax basis) the value of securities, businesses, and hard assets could decline.
How to Help Protect Your Retirement Income
Move funds into a Roth IRA While You Still Can: Investors who transfer retirement funds into a Roth IRA will have to pay taxes upfront, but will also be able to take tax-free distributions after age 59.5, so long as you maintain the Roth account for at least five years. Use the window made available to take advantage of backdoor Roth conversions while they are still available for use. Of course, these proposed timelines could change so you’ll need to keep in contact with your financial advisor about your next best move.
Transfer Funds into a 401(K): Investors, and especially business owners, can move money into tax-deferred accounts, such as the 401(K) to eliminate taxes on gains until distributions are withdrawn. Investors that can do this will have more flexibility on tax payments by limiting the amounts of the withdrawals to keep their income beneath the top federal tax rate.
Position Your Portfolio to Weather Inflation: We have enjoyed years of low or no inflation. But now, many are concerned about increasing prices. Costs for cars, food, and gasoline are up, mainly because demand spiked when the economy reopened after the worst of the pandemic. Some think it’s a short-term situation, but others are expecting longer-term inflation. Make sure your portfolio isn’t overconcentrated with low return investments that barely outpace or fail to outpace the rate of inflation.
Talk Taxes with Your Financial Advisor: Your financial advisor (and/or a tax professional in conjunction with your financial advisor) can work with you to create a tax-planning and minimization strategy to protect your investments. See what adjustments, if any, are necessary to reduce your tax liability.
The financial professionals at Harbor West appreciate the value in calculated tax planning. We work to ensure our clients are taking advantage of the best strategies available to them and use state of the art tax analysis software for all our clients. If you are looking for ways to reduce your taxable income and keep more money in your pocket, we’d be happy to help you evaluate your options. Schedule a Complimentary Consultation with us today to learn how Harbor West can help you build wealth and secure financial peace for your future.
This information is for general purposes and is not intended to provide specific investment advice or recommendations. Opinions, estimates, forecasts, and statements of financial market trends are based on current market conditions and are subject to change without notice. Individuals should always consult their own financial or tax advisor regarding their specific situation before acting on any information provided. Harbor West and Geneos Wealth Management, Inc. do not provide tax or legal advice.
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