Strategies to consider due to the recent tax law proposals

By now, you probably have heard that the House Ways & Means Committee released proposed changes to the tax code last week.  If you’d like to read the full 881 pages, here is a link.

For those of you who don’t have the time or desire to read all 881 pages, you may be wondering how this impacts you and what actions you should consider before the end of the year.  While every person’s tax and financial situation is unique, here is a summary of some of the changes for individual taxpayers:

Everyone

Proposal: No more Roth conversions on after-tax retirement account assets to Roth IRAs

Effective Date: January 1, 2022

Potential Action: Unfortunately, 2021 may be the last year of the “Backdoor and Mega-Backdoor Roth IRA,” a popular strategy for many people in the early retirement community.  If you have after-tax contributions in your IRAs or other retirement accounts, you should consider converting them to a Roth IRA before December 31st.  Check with your plan administrator to see if in-service distributions are allowed.  However, if you’re still working and/or are temporarily in a high tax bracket this year, this may not be your best option unless most or all of your IRAs consist of after-tax contributions.

—

Proposal: Application of wash sale rules to cryptocurrencies, foreign currencies and commodities

Effective Date: January 1, 2022

Potential Action: Consider taking any losses on these assets now and then repurchasing them, if desired.

Individuals and Families with Dependent Children

Proposal: Increased Child Tax Credit (CTC) extended through 2025 (for taxpayers with adjusted gross incomes (AGI) below $75,000 for individuals, $112,500 for head households and $150,000 for married filing jointly)

Effective Date: Current law would continue, with changes beginning in 2022 and 2023

Potential Action:  Since the phaseouts are steep, considerable attention should be made for taxpayers who are near these thresholds with qualifying children.  Deferring income using qualified retirement accounts or other methods could make a substantial difference.  Note that in 2022, the CTC would be based on the lower of 2021 or 2022 AGI, helping families with volatile income.

High Income Earners

Proposal: New top ordinary income tax bracket of 39.6% (starts at taxable income of $400,000 for single filers, $450,000 for married filing jointly and $12,500 for estates and trusts)

Effective Date: January 1, 2022

Potential Action: If you’re currently in the top tax bracket and expect to be there for the foreseeable future, you may want to consider accelerating income through Roth conversion and other measures.

—-

Proposal: New top long-term capital gains rate of 25% (starts at taxable income of $400,000 for single filers and $450,000 for married filing jointly)

Effective Date: September 14, 2021

Potential Action: If you’re in this tax bracket and have sizable brokerage accounts, donating appreciated stock either directly to charity or a donor advised fund is even more tax efficient than before.  If you’re only temporarily in the top tax bracket, you may want to hold off on selling appreciated stock until you’re able to do so in a lower rate.  If you need income, consider turning off reinvested dividends and instead receiving the dividends as cash instead of selling appreciated stock.  But at the end of the day, remember “don’t let the tax tail wag the investment dog,” which means having a properly diversified portfolio that you can tolerate in market swings may be more important than saving some on taxes.

—

Proposal: No more Roth conversions (starts at $400,000 for single filers and $450,000 for married filing jointly)

Effective Date: January 1, 2032

Potential Action: Since this will not be effective for 10 years (if passed), there is still plenty of time to consider converting pre-tax retirement accounts.  It’s also rare that Roth conversions make sense when you’re in the top tax bracket, unless you’re converting the assets for estate tax or legacy planning issues.

—

Proposal: 3.8% net investment income tax for S-Corp business owners (starts at $400,000 of taxable income for single filers and $500,000 for married filing jointly)

Effective Date: January 1, 2022

Potential Action: Considerable planning should be reviewed for S-Corp owners just above this income range.  Solo 401(k)s, defined-benefit plans and other ways to defer income should be evaluated.

—

Proposal: New 3% additional tax (starts at $5 million of modified adjusted gross income (MAGI) for both single filers and married filing jointly and $100,000 of income for trusts)

Effective Date: January 1, 2022

Potential Action: Consider ways to defer income, if possible.  For example, if you’re selling a business and it’s a one-time event, is there any way you can defer part of the gains, such as in an installment sale?

—

Proposal: New required minimum distributions (RMDs) on IRAs over $10 million (starts at $400,000 for single filers and $450,000 for married filing jointly); a 50% RMD would apply to IRA accounts on the excess amounts between $10 million and $20 million and 100% of the amount over $20 million; Roth IRAs over $20 million are not exempt

Effective Date: January 1, 2022

Potential Action: If your pre-tax retirement accounts will potentially be subject to these new RMDs, you may want to look at Roth conversions (if allowed) before they reach these thresholds to help spread out some of the income.  You may also want to consider asset location strategies, such as placing assets less likely to appreciate (bonds) in your IRA accounts and stocks with lower dividend income in your brokerage accounts, if possible.

High Net Worth Individuals and Families

Proposal: Estate tax exemption reverting back to $5 million per individual, indexed for inflation ($10 million for married couples); with the inflation adjustment, this will likely be around $6 million per individual and $12 million for married couples

Effective Date: January 1, 2022

Potential Action: Meet with your estate planning attorney if you’re going to be impacted by the lower exemption amounts.  Considerations for reducing your taxable estate include Roth conversions (since paying the taxes now will lower your overall estate), executing gifts before December 31st, and others.

What notable provisions did it not include that were previously discussed?

• Long-term capital gains were not increased to the same as ordinary income rates.
• There was no loss of the step-up in cost basis at death.

Remember that none of these potential strategies should be considered without first looking at your overall financial and tax situation with your tax advisor.  If you’re already one of our valued clients, you can rest assured that we’re currently reviewing your situation and will reach out if any actions should be considered before the end of the year.

Please note there may be changes to these proposals before (or if) they become law.