Earlier in the year, President Biden proposed the Families Act, giving us a hint into what changes may be in store should a bill be passed. Now, however, Democrats on the House Ways and Means Committee have released their official tax proposals, providing much more insight into what the potential changes could entail and more importantly, how they might affect your financial plan.
Here are some of the key parts of that proposal.
1. Increased Tax Rates
As promised—and in keeping with the Biden Administration’s original proposed American Families Plan—the bill would include several tax increases, including those centered around the oft-mentioned $400,000 income mark:
- First, the Bill lowers the amount of income needed to qualify for the top tax bracket to $400,000 for individuals and $450,000 for married couples.
- On top of that, it proposes to reinstate the 39.6% top marginal tax rate, which was recently lowered 37% by the 2017 Tax Cuts and Jobs Act.
- The legislation also increases the top capital gains rate to 25%.
- And finally, it will apply a 3% surtax for ultra-high earners with over $5 million of income.
The Bottom Line: Putting aside the tax increases for corporations, individuals in the $400,000–$500,000 income range will perhaps see the most significant effect from these proposed changes, as their jump in tax percentage will be the highest. However, the fact remains that all those in the top tax bracket will feel the new taxes to some extent. Nonetheless, it may help to work with your advisor to better understand exactly how the changes will affect you and update your financial plan accordingly.
2. Closing Perceived “Loopholes”
Within the plan, an emphasis was also placed on closing perceived “loopholes” in the tax system. Notably, these include several changes to Traditional and Roth Investment Retirement Accounts (IRAs).
Changes to Roth Include:
- Prohibiting Roth conversions of after-tax funds in retirement accounts;
- After-tax 401(k) contributions will no longer be able to be converted to Roth, effective 2022; and
- Prohibiting all Roth conversions for those in the top income tax bracket.
Traditional IRAs will see two new rules for high-income taxpayers with more than $10 million of aggregated retirement account assets, including:
- A prohibition on making new IRA contributions;
- A new Required Minimum Distribution of 50% of the combined balances above $10 million and 100% of combined balances above $20M; and
- Income associated with “carried interests” would be taxable at the ordinary income tax rate rather than the current law, which is set to the more preferred capital gains rate of 20 percent.
The bottom line: With several changes to the law around retirement accounts, a shift in strategy may be needed to keep some of your retirement investments optimized. It is important you speak with your financial advisor about how these changes may affect your financial plan and what your plan should be moving forward.
3. Estate Law Changes
The proposed bill also contains significant tax changes to estate law. A few notables include:
- A 50% reduction in the estate and gift tax exemption. This reduction, however, will also coincide with an increase to the special valuation reduction for real property used in family farms and businesses from $750,000 to $11.7 million.
- Intentionally Defective Grantor Trusts (IDGTs) are now included in their grantors’ estates.
Grantor trusts would be included in the estate, including some Irrevocable Life Insurance Trusts (ILITs), Spousal Lifetime Access Trusts (SLATs) and Intentionally Defective Grantor Trusts (IDGTs).
- Any sale between an individual and their own grantor trust will be treated as the equivalent of a third-party sale, and any transfers out of a grantor trust will be considered a taxable gift.
The Bottom Line: As with the changes to retirement accounts, these new estate laws may prompt some changes to your current financial or estate plan. Be sure to reach out to your financial advisor to see what those changes might be.