The Tax Proposal Merry-Go-Round 2.0
October 30th, 2021
On Thursday afternoon (October 28, 2021), The House Rules Committee released a draft of the reconciliation text outlining the framework for what was President Biden’s original $3.5 trillion social safety net proposal. As many of you saw, I released an article on September 14th titled Navigating The Proposed Tax Legislation, in which I outlined The House Ways and Means Committee’s proposed legislation titled “Responsibly Funding Our Priorities.” This preliminary tax legislation, which circulated on and off Capitol Hill, would have raise as much as $2.9 trillion to pay for most of President Biden’s infrastructure proposal by increasing taxes on the wealthiest corporations and individuals (those over $400k of income).
As you can see in my previous article, I claimed that this proposed legislation was far from law and we would certainly see changes, and changes there are!
Here we are a little more than a month later and the changes from the original proposal are substantial.
In order to satisfy two Senators, Manchin (D-WV) & Sinema (D- AZ), the $3.5 trillion spending bill was slashed down to between $1.5 and $2 trillion and they needed to rework their original plan to tax the highest earners and corporations to pay for the safety net expansion in order to get Manchin and Sinema to back the bill in the Senate.
While the original proposal would have increased the top tax bracket for anyone making over $400,000 (Single) or $450,000 (MFJ), enacted major reform on retirement accounts (including eliminating strategies such as Roth conversions and Back-Door Roth conversions), increased capital gains tax on high income earners, rolled back the large estate & gift tax exemption, as well as all but shut down advanced estate and transfer techniques such as the use of GRATS (Grantor Retained Annuity Trusts), the new proposal has pretty much done a 180 degree turn.
It is still important to note that this proposal is still far from final, as it needs to get approved by the House and the Senate still, so anything can happen between now and the end of the year!
Instead of starting with what is in this new proposal, were going to go ahead and start with what IS NOT in this bill that was in the original:
- Increasing the top income tax rate from 37% to 39.6%.
- Increasing the long-term capital gains bracket from 20% to 25%.
- Reducing the Estate & Gift Tax Exemption from $11.7m ($23.4m for a couple) by half.
- Rules to curtail the use of advanced trusts such as GRATs (Grantor Retained Annuity Trusts), SLATs (Spousal Lifetime Access Trusts), IDGTs (Intentionally Defective Grantor Trusts), and ILITS (Irrevocable Life Insurance Trusts).
- A mark-to-market “Billionaire’s Tax”.
- RMDs on mega-sized IRAs.
- No mention of the back-door Roth IRA conversion, which means it lives on (for now)!!!
It is also notable that there was still no mention of the SALT (State and Local Tax) Deduction relief or the unlimited step-up in basis, which many have expected. For clients in high tax states such as California or New York, this is one of their biggest deductions and was capped at $10,000 as part of the 2017 Tax Cuts and Jobs Acts, ultimately creating a higher tax burden on individuals who are subject to high state taxes. The unlimited step-up in basis allows people to pass non-retirement (IRA/401k) assets such as stock or real estate to their beneficiary income tax free at death.
So, what is left in the proposed bill?
First off, instead of raising taxes, the proposal provides a substantial budget to help fund the IRS in their efforts for enforcement of existing tax law. Former IRS commissioner Charles Rossotti and current Treasury official Natasha Sarin has said the IRS could raise as much as $1.4 trillion in additional tax revenue with better data, technology and personnel (although the proposed bill is projecting to raise only $400 billion from this effort) . The administration has pledged to infuse the IRS with approximately $80 billion, a massive increase from the current $12 billion budget.
So outside of the chance that your audit risk will increase, what else could impact your taxes & wealth?
Well quite frankly for many of you, not much!
- If you own an S-Corp and have Modified Adjusted Gross Income (MAGI) over $400k Single / $500k Joint, there is a good chance you will now be hit with the 3.8% Net Investment Income Tax (NIIT) on pass-through income. This could make S-Corps less attractive for high-income earners.
- For our mega-earners, if you earn over $10,000,000 per year (MAGI), there would be a 5% surtax on income above $10m. For our mega-mega-earners, if you earn over $25,000,000 per year there would be an additional 3% surtax. So essentially you could be at a top Federal rate of 48.8% (37% Bracket + 5% Surtax + 3% Surtax + 3.8% NIIT). It is fair to say that most people will never pay those surtaxes, but it could come into play in a year you sell a highly valued asset such as a business or large investment.
- For our cryptocurrency clients, this bill would subject crypto transactions to wash sale rules (this has been around on stocks and equities for a long time), which are currently exempt. We have shared this in other posts where if you own crypto, you can sell for a loss, bank that loss for your taxes, and then quickly buy the crypto back again.
- The increased Child Tax Credit would be extended through 2022 as a prepayment (for those under a certain threshold of income).
As you can see, not very many things that could impact your taxes for next year! So where is this $1.5 – $2.0 trillion going to come from?
- Enforcement increased at the IRS: $400 billion
- Overhaul of international tax code: $350 billion
- New 15% corporate minimum tax: $325 billion
- New taxes on wealthy businesses: $250 billion
- New surtax on mega-earners: $230 billion
- Taxing stock buybacks: $125 billion
The good news for most of the population earning under $10,000,000 of income is that it appears we could see similar taxation to what we have experienced over the last few years. In addition, we still have many fantastic retirement planning strategies at our disposal such as Roth conversions, mega-back door Roth conversions, and historically low brackets for income bracket bumping Roth conversion strategies.
To learn how to maximize your “after-tax” wealth, we highly encourage you to reach out to one of our advisors to put a plan in place today!
Author: Dave Alison, CFP®, EA, BPC
President | Founding Partner
Prosperity Capital Advisors