- Work in Congress on a tax bill is progressing, but very much in flux, so a final bill might become law later this year (or not at all).
- Before you consider how this all might affect you personally, make sure to look at your whole financial picture.
- As your questions arise, you may want to meet with a financial professional to review your situation and begin or refresh your plan.
The Ways and Means Committee of the House of Representatives has unveiled a detailed proposal to raise taxes by more than $2 trillion to pay for proposed spending in bills that are also still under negotiation, which range from infrastructure projects to the expansion of the social safety net. But there's still a long way to go before a final bill hits President Biden's desk.
The legislative text contains an array of provisions, most notably increasing the top income tax bracket, the top rate for capital gains, and the top corporate tax rate. There are a myriad of other changes on tap that affect everything from retirement savings to the tax treatment of cryptocurrency losses.
The congressional outlook
Thin margins in Congress mean there's still a lot of negotiating to do, and additional changes are expected. If there is agreement, a final law might not get signed until later this year. The situation is still very fluid.
Whatever Congress finally passes is likely take effect over a varied time frame. Capital gains tax rates are proposed to take effect as of September 13, though that could change as the bill winds through Congress. Meanwhile, some changes to Roth IRAs might not take effect until after 2031, while most others would come into effect at the start of 2022.
Strategies to consider
Before you consider how this all might affect you personally, make sure to look at your whole financial picture. While you don't want taxes to drive your investment strategy, you can explore tax-smart strategies designed to help you manage, defer, and reduce taxes in conjunction with making long-term financial planning decisions. You may want to meet with a financial professional to review your situation and begin or refresh your plan.
"It's now about looking forward, often using the same tax strategies that you were employing before, but perhaps now with more attention since higher rates may make those strategies more valuable," says David Peterson, head of wealth planning at Fidelity.
Although the details of a final bill are still in flux, there are some key provisions of the House bill that you may want to keep an eye on as the legislative process plays out.
1. Individual income tax rates
The top tax rate is proposed to return to 39.6% from 37%, where it has been since the 2018 implementation of the Tax Cuts and Jobs Act. The bracket would apply to individuals earning more than $400,000 or $450,000 for married couples filing jointly.
2. Capital gains and dividends
The House bill set the target for the highest capital gains rate at 25%. It applies to those in the top tax bracket for long-term capital gains, which in 2021 covers individual filers earning more than $445,850 and married joint filers earning more than $501,600 (exclusive of the 3.8% Medicare surtax on net investment income for individual taxpayers with more than $200,000 in modified adjusted gross income (MAGI) or couples with more than $250,000 in MAGI). The draft bill contains a transition provision that applies the new 25% rate to gains realized after September 13, 2021, unless the seller had a binding contract entered into before that date. This is far less than what President Biden had proposed in his "Green Book" budget outline in spring 2021, but still more than the current 20% rate at that income level.
3. Estate and gift tax exemption
The expanded estate and gift tax exemptions of the Tax Cuts and Jobs Act were set to expire at the end of 2025, but the latest version of the House bill would revert the thresholds back to 2010 levels, indexed for inflation, and that would be effective as of the end of 2021. That would basically cut in half the current $11.7 million exemption per individual.
Tip: For more on how estate planning changes could affect you, read Your top 5 estate planning questions.
4. Surtaxes and limitations
There are several provisions that address taxation of high earners. Of note, the proposed legislation includes a 3% surtax applicable to taxpayers with modified adjusted gross income in excess of $5 million. There are also increased income limitations on a new deduction from the 2018 tax law changes, called 199A deductions, which concern pass-through income.
5. Limits on large retirement accounts
The bill adds several provisions to curb savers from amassing large balances in tax-deferred retirement plans. One restriction prohibits high earners in the new 39.6% bracket from making new contributions to a traditional IRA or Roth if the total value of an individual’s IRA and defined contribution retirement accounts generally exceeds $10 million as of the end of the prior taxable year. The proposal also increases the required minimum distributions for for individuals in the 39.6% tax bracket whose combined qualified accounts that exceed $10 million. In addition, the bill proposes to eliminate a strategy called "backdoor" Roth conversions for individuals in the 39.6% tax bracket.
6. Corporate tax
The bill moves the top corporate tax rate from 21% to 26.5%, which is less than Biden's call for 28%.
7. Expanded wash sale rules
The tax bill proposes a change to the tax treatment of an IRS provision known as the wash sale rule, where you can't take a deduction for a loss on the sale of an investment if you replaced it with the same or a "substantially identical" investment 30 days before or after the sale. This would apply to currencies, commodities, and digital assets after December 31, 2021, if the bill passes. The bill also widens the scope of the wash sale rule from just transactions of the taxpayer to the taxpayer and related parties.
As much as taxpayers will focus on what finally becomes law, it's also important to note what did not make it into the bill at this stage.
- No elimination of the step-up of basis at death, which would have had many implications on estate planning at all income levels, is included.
- No restrictions or modifications to catch-up contributions for retirement plans and IRAs made this version.
- No repeal or modification of the caps on state and local tax (SALT) deductions is included in the bill yet, but could get added as negotiations progress.
These omissions underscore the point that the tax changes being considered are still very much a work in progress, and even if they get passed into law, they may be followed in subsequent years by still additional changes. It will be important to keep an eye on how the process progresses, and to figure out how you are personally affected. It would be prudent to meet with a tax advisor and financial professional to review your situation and begin or refresh your plan.
Next steps to consider
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