There are many changes proposed in the new tax code. We broke them down to highlight what could potentially impact you and your family.
The step-up in cost basis rule when passing assets to the next generation remains intact!
This means if you have positions with a low cost basis—which is often the case if you bought a security many years ago—tax liability on the gain will be wiped out when inherited by the next generation. No capital gains tax will be owed.
This change was a big worry of ours as it would have negatively impacted almost all of our clients.
The 0% capital gains tax rate remains for single earners up to $40,400 and those Married Filing Jointly (MFJ) up to $80,800. The rate is then 15% on income up to $400,000 (single) and $450,000 (MFJ).
The Child Tax Credit is extended through 2025 at $250 per month for children between the ages of 6-17 and $300 for children younger than 6. The Childcare Credit is made permanent in the bill; so, childcare-related expenses are deductible up to $8,000 for one child and $16,000 for multiple children. Once again, your income matters as these benefits begin to phase-out at the $125,000 adjusted gross income (AGI) level.
The estate tax exemption drops sharply from $23,400,000 per couple to $11,700,000. For single-filers, the exemption falls from $11,700,000 to $5,850,000.
The upshot: We can take action now. You can gift or transfer assets before year-end and explore other advanced strategies with your attorney, CPA, and financial planner if this reduction of the exemption might impact you. If the proposal becomes law next year, certain asset transfers and business discounts to advanced trusts will be treated as taxable events.
Acting soon is highly advisable.
The backdoor Roth IRA could be a relic of the past. The new law, as currently written, effectively prohibits so-called “backdoor” Roth IRA contributions. While prior-year IRA contributions are permitted through tax-day, you might have until December 31 to complete a backdoor Roth contribution for 2021. The lesser-known mega-backdoor Roth contribution is also nixed in the proposal.
Note: if you have NON-deductible contributions to your IRA or 401k, this means the deadline to convert to a Roth is year-end. It’s a complex situation, so be sure to coordinate with your accountant. Your CPA can advise if form 8606 has been filed or not.
While this is not very common, it is important if it applies to you.
Income tax rates for high earners will be on the rise (see graphic below). Once again, $450,000 for MFJ and $400,000 for single-filers are the income levels to know. The tax rate on income above those levels increases from 37% to 39.6%. While not a seismic shift higher, lawmakers also narrow the 35% bracket and eliminate the 37% bracket.
Those in the $400,000 to $700,000 income range would feel the most impact on a percentage basis. There aren’t many things we can do about this change. It could make sense, however, to accelerate income into 2021 if possible.
Current vs. Proposed Income Tax Brackets
(Sources: Michael Kitces and Jeffrey Levine)
The top capital gains tax rate increases from 20% (plus a 3.8% surtax) to 25% (plus a 3.8% surtax) effective retroactive to September 13, 2021. (Once again—we must caveat—IF the current proposal becomes law.)
Due to the retroactive nature of this change, you can’t simply sell appreciated securities now in the hopes of capturing a lower tax rate. On the bright side, the proposed rate is dramatically better than the original 39.6% figure. The new rate would apply to income-earners of at least $400,000 (single) and $450,000 (MFJ).
Small business taxes also go up. S corps would face an additional 3.8% tax on income above $400,000 (single) and $500,000 (MFJ). This change effectively increases the top bracket from 37% to 43.4%, factoring in the 37% bracket moving to 39.6%
Less Likely to Impact Most Families
A new 3% tax on modified adjusted gross income over $5,000,000.
Certain trust income above $100,000 is also hit with the 3% tax.
Roth IRA and Traditional IRA contributions would be prohibited at the $400,000 (single) and $500,000 (MFJ) AGI thresholds.
New Required Minimum Distribution (RMDs) are required if your income hits the $400,000 (single) or $450,000 (MFJ) level, AND your retirement accounts are over $10 million.
For retirement accounts between $10 million and $20 million, the owner must distribute 50% of the excess (and more if over $20 million).
There are new prohibitions against investing in certain types of investments.
Finally, new tax-loss harvesting or “wash sale” rules are proposed for cryptocurrency, commodities, and foreign exchange trading to align with those of traditional investments.
Items to Keep In Mind
While the proposed rules have not yet been passed, there is a reasonable chance they will.
If you believe any of these tax code modifications will negatively impact your family, you should consider taking action now. There is still time to take advantage of today’s favorable tax rules before next year’s stricter (and potentially costlier) laws are effective.
The tax code is changing quickly. And more rules could be on the horizon so be sure you understand how changes specifically impact you from your own professional advisors.
The above points are just a handful of the important changes. This overview should at least get you thinking about meeting with your attorney, tax accountant, or financial planner to identify what steps to take to protect your family’s income and assets.
Thank you for taking a look. If you would like to talk, please reach out to us!
-Your Team at ISC Financial Advisors