When I was a young kid, there were many activities that I was reluctant to try. I think my reluctance to try new activities stemmed from fear of the unknown. Fortunately, my parents strongly encouraged me to try various activities, and I generally discovered that my initial worries were unwarranted. I am not sure if my parent’s initial encouragement is why I enjoy many activities today, so many that I am embarrassed to name them all. One takeaway from my upbringing includes an underlying belief that things are usually not as scary as I initially believed.
The reason for bringing up fears of the unknown is directly related to some potential tax law changes currently being debated in Washington. I have had many questions from clients who are nervous regarding how the potential tax law changes may negatively impact them. It appears to me that many of the initial claims about significant tax law changes have been softened over the past few months. However, there could still be negative tax implications involved for many of our clients if the proposed changes get enacted into law. Some of the significant provisions being discussed include:
- Raising the top federal tax rate from 37% to 39.6%,
- Levying a 3% surtax on income higher than $5 million for single and joint filers,
- Raising the tax on dividends and the long-term capital gains tax rate for assets held over one year to 25% (up from 20%) for individuals earning more than $400,000 and for couples that earn over $450,000,
- Placing new limits on those who have large retirement account balances
- Establishing new limits on Qualified Business Income (QBI) deduction for pass-through firms.
These proposals are a long way from becoming law but are winding their way through Congress. The Senate may have its own set of proposals, which would require both legislative bodies to forge a compromise before a tax bill lands on the President’s desk.
Moreover, a sharply divided Senate seems likely to pare $3.5 trillion in proposed spending, assuming legislators in the House compromise on new outlays. If new spending is reduced, smaller tax hikes could follow.
While a wait-and-see approach may serve some folks well, we understand that planning for any changes reduces the odds of an unwanted surprise, so I will do my best to provide you with some general guidelines.
If proposed changes are enacted, a couple filing jointly with $600,000 of taxable income will see their top rate rise from 37% to 39.6% next year. An additional possibility includes a 3% surtax on individuals earning over $5 million, which would raise the top tax rate to 42.6%. This change would hit very few taxpayers—but be aware that the sale of a business or large asset could push you above the threshold.
A higher rate on dividends and long-term capital gains tax rate are being considered.
As proposed, if a capital gain is realized on or after September 14, 2021, individuals earning more than $400,000 and couples earning over $450,000 will pay a top rate of 25%. The same would hold true with dividends.
There will be new RMD requirements for individuals with high income and large retirement accounts, regardless of age.
If you exceed $400,000 and $450,000 in income for single and joint filers, respectively, AND retirement accounts total over $10 million, you will be subject to RMDs beginning in 2022 regardless of your age. You will also be prohibited from making IRA contributions. However, the restriction on contributions does not apply to employer-sponsored plans such as 401ks, SEP IRAs, or SIMPLE IRAs. If your income is above the $400,000 and $450,000 limits and retirement accounts exceed $20 million (including a Roth IRA), you would be required to distribute funds from your Roth IRA.
New limits on QBI deduction.
If you are self-employed, the House proposal limits the deduction to $500,000 for joint returns and $400,000 for individual returns. Once you have exceeded the cap, additional amounts will be disregarded.
Left on the cutting room floor
Lawmakers in the House have not proposed taxing unrealized capital gains at death, as the President had initially proposed. Also, the step-up in basis for inherited assets is NOT in the current House proposal. But one proposal being floated is to reduce the estate and gift tax exemption to $5 million. Tax reform in 2017 raised the limit to $11.7 million for individuals and $23.4 million for couples.
Presently, several provisions are being negotiated. These potential changes will not be as significant as initially discussed, but they will certainly significantly impact those deemed “wealthy” by the government. We will continue to monitor the changing tax landscape, and we will adjust our planning strategies for affected clients once we have clarity on what the future holds. Enjoy what is left of those fall colors!
Sources and further reading
- Capital Gains and Capital Pains in the House Tax Proposal
- Will Taxes Rise for the Wealthy?
- Democrats Want to Raise Taxes. Here’s Your To-Do List
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.