Navigating the Proposed Tax Legislation

September 14th, 2021

On Monday, The House Ways and Means Committee released their proposed legislation titled “Responsibly Funding Our Priorities.” The preliminary tax legislation, which circulated on and off Capitol Hill, would raise as much as $2.9 trillion to pay for most of President Biden’s sweeping expansion of the social safety net by increasing taxes on the wealthiest corporations and individuals (those over $400k of income).

While this proposed legislation is only the first draft and is still far from law, so far it is the best glimpse into what we might expect.

Here are some of the key points:

For Individuals:

  • Shrink the 32% bracket a little and the 35% bracket a lot
  • Create a new top bracket of 39.6% for individuals earning over $400k (MFJ Over $450k)

Here are what the rates could look like (not indexed for inflation):

Proposed Tax Rates

  • Increase the top capital gains rate to 25% for people in the top bracket ($400k for single filers and $450k for MFJ) effective 09/13/2021.
  • For taxpayers with Modified Adjusted Gross Income (MAGI) over $5,000,000, they will be subject to a new 3% surtax. Since it is based on MAGI, below-the-line deductions like large charitable gifts won’t do anything to reduce this surtax. This surtax also hits trusts at $100,000 of income.
  • Makes crypto currency subject to wash sales rules as of 01/01/2022.
  • Advanced payments of the child tax credit would continue in 2022.
  • The Child and Dependent Care Credit rules (for 2021) would be permanent, creating much larger potential credits, making them available at higher income amounts, and making them fully refundable.
  • As of now, there was no mention of repealing the SALT (state and local tax deduction).

Retirement Accounts:

  • Eliminates all Roth conversions for high-income taxpayers (highest bracket – $400k Single; $450k MFJ). The effective date is 12/31/2031, so take advantage while you can!
  • Effective 01/01/2022, after-tax amounts in retirement accounts will no longer be eligible for conversion to Roth accounts. This kills the back-door Roth and mega-back-door Roth strategy.
  • Any taxpayer with adjusted gross income (AGI) above $400k single / $450k joint and has IRAs and Roth IRAs valued at more than $10,000,000 cannot make any additional contributions (only applies to IRAs and Roth IRAs, not 401k, SEP, pension plans, etc.) and now will have a required minimum distribution (RMD). For accounts between $10m – $20m, you would be required to distribute 50% of the excess over $10m. So, if you have a $15m IRA, you now have a $2.5m RMD. If your income is over the threshold and your total retirement account balance is over $20m, 100% of the excess over $20m must also be distributed as an RMD. If you have these large balances and must take required distributions, Roth money must come out first followed by traditional IRA.

Estate Planning

  • The current gift and estate tax exemption ($11.7m) gets cut in half beginning in 2022.
  • There was no mention of repealing the step-up in basis, so for now that looks to be safe.
  • Dramatically increases the maximum allowable reduction for real property used in a family farm or family business.
  • Certain grantor trusts such as intentionally defective grantor trusts (IDGTs) or spousal lifetime access trusts (SLATs) will lose their favorable tax status. Any sale to these trusts would become taxable unlike current rules.
  • Eliminates valuation discounts (e.g., minority ownership) for non-business assets.

For business owners

  • Corporate tax rates increase from 21% to 26.5% for businesses that report more than $5,000,000 in income. The rate would be lowered to 18% for small corps making less than $400,000 and remain at 21% for corps between $400k and $5m.
  • For single filers with MAGI more than $400k and joint filers with MAGI more than $500k, S-Corp profits would be subject to the 3.8% net investment tax.
  • Limits the max 199A (20% pass-through deduction) to no more than $400k for single filer and $500k for joint filers. This is a cap on the deduction, not a phaseout based on the amount of income an individual has.
  • Makes permanent the limit on excess business losses.

This tax proposal may change before Democrats craft the final bill they hope to pass through the House in coming weeks. The Ways and Means Committee will debate tax policy when it resumes its markup of the mammoth spending package this week. The Senate will also have their say in the tax proposals, so we certainly anticipate many changes before we see our next law, but again this gives us a glimpse into where we are likely headed and creates many planning strategies and ideas to consider going into the new year. 1

Dave Alison

Author: Dave Alison, CFP®, EA, BPC
President | Founding Partner
Prosperity Capital Advisors