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House Democrats recently released their American Families Plan which includes major proposed changes to the tax code that investors should be aware of. While most of the changes stand to impact higher income earners, there are certain items that may effect a large majority of taxpayers.
There's a lot to unpack with this 800-page behemoth of a tax proposal, complete with enough technical jargon to put you to sleep faster than a bottle of Pinot and a handful of ambien. But the key word here to remember, however, is "proposal." Accordingly, I would caution on making major changes to your portfolio or overall financial plan until this is set in stone AND you've consulted with a professional.
Here are the 12 most important proposed tax changes that investors should be aware of:
But before I dive in, please remember to consult your tax or financial professional for further details on how the American Families Plan may affect your personal financial situation. This is not tax or financial advice but merely a summary of some of the proposed tax changes.
1. Top Marginal Tax Rate - Increase to 39.6% From 37%
Pretty straightforward and only a marginal increase in the top tax rate.
Note that this would apply to those individuals and couples making more than $400,000 and $450,000 per year, respectively, starting January 1, 2022.
2. S Corporation Profits Subject to 3.8% Surtax and Limits on the Section 199A Deduction.
Ultimately what this could mean for some higher income earning S Corporation business owners making more than $400,000 is a top tax rate of something more like 43.4% which is higher than the top marginal tax rate noted above.
3. Top Capital Gains Tax Rate - Increase to 25% From 20%
What's important to note here is not the 5% increase but rather that this would be effective September 13, 2021! This means unless you've already entered into a contract to sell an asset on or prior to this date, you would stand to pay 25% on long-term gains if you're in the highest tax bracket. And even if you did, the exceptions regarding the timing and nature of the contract are very specific:
Must have been entered into on or before September 13, 2021;
Must be in writing;
Cannot me "materially" modified after September 30, 2021); and
Must close before the end of 2021
4. Extension of Increase in Child Tax Credit
Some families have already begun receiving monthly checks from the government which represent an advance on a portion of their child tax credit. With the American Rescue Plan, President Biden increased the child tax credit to $3,000 (or $3,600 if under the age of 6) for qualifying children.
Under American Families Plan, this increase would be extended with monthly advance payments continuing through 2025.
5. Child and Dependent Care Tax Credit Increase to be Permanent
Taxpayers with qualifying child and dependent care expenses would now be eligible to include a total of $8,000 for one qualifying individual and $16,000 for multiple in calculating their child and dependent care tax credit. The total credit varies from 0% - 50% of total qualifying expenses and is based on income.
Lastly on the credit side...
6. New Non-refundable Tax Credit for Caregiver Expenses
For qualifying caregiver expenses paid or incurred by a qualified care recipient, the maximum credit would be $4,000 with income phaseouts beginning at $75,000.
Listen up now because this next one may be critical and effect A LOT of people...
7. Backdoor Roth IRA Conversions Prohibited
This popular planning strategy of converting after-tax retirement funds to a Roth IRA for those investors exceeding the income limitations for Roth contributions, otherwise know as a backdoor Roth IRA would now be disallowed, effective 1/1/2022!
Additionally, those in the highest tax bracket of 39.6% would be prohibited from doing even a traditional Roth conversion, however this wouldn't go into effect until 1/1/2032. So if you're a high earner and accustomed to making Roth conversions, you would have a 10-year window to do so.
8. Roth AND Traditional IRA Contributions Prohibited for the Wealthy
If your taxable income is > $400k (Single), $450k (Married Filing Jointly), AND if the value of your IRA and defined contribution plans is > $10M, any IRA contributions would be prohibited effective 1/1/2022.
9. Required Minimum Distributions to be Imposed on the Wealthy
If your taxable income is > $400k (Single), $450k (Married Filing Jointly) AND you have combined IRA/defined contribution plans > $10M, you'll need to start taking RMDs from your retirement accounts regardless of age, effective for 2022. And the higher your account balance, the higher the RMD.
10. Wash Sale Rule to Include Cryptocurrency
So if you weren't already aware, the IRS treated cryptocurrency as property rather than a security which meant the wash sale rules didn't apply. Meaning, you could sell for example ETH and realize a $10,000 loss, then re-purchase ETH a day or two later without any repercussions. Now, this tax loophole looks to be closing effective 2022.
11. Estate Tax Exemption Cut in Half
The new exemption amounts would be $5.85M for individuals, $11.7M for couples effective 2022 (indexed for inflation). Note this reduction was initially intended to automatically take effect in 2025 as the Tax Cuts and Jobs Act provisions sunset.
12. Grantor Trusts to be Included in the Decedent's Estate.
This would mean some of the popular estate planning strategies such as an IDGT, or intentionally defective grantor trust, which allowed investors to shift assets out of their estate while still keeping their income taxed and individual income tax rates, could essentially be rendered useless.
If you're concerned about how some of these potential tax changes may effect you, or would like to learn more, please call or email me...I will respond to you personally.
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Thanks as always, and we'll see ya in the next one.