Lately most of the talk in Congress has been about infrastructure bills and pandemic-related measures. Soon government revenue and taxes will come to the forefront. During last year’s campaigns, a wide variety of tax increases and tax changes were proposed. A number of these changes are likely to be considered and voted on by Congress this year. Understanding the changes that are possible will make it easier to take action if any of these provisions become law.
Higher Individual Income Tax Rates
One of President Biden’s key proposals is to raise the top individual tax rate from 37% to 39.6%. This change would impact individuals with taxable income over $452,700 and married couples with income over $509,300. Households earning more than one million dollars would also pay long-term capital gains taxes at the same rate. Self-employed individuals and small business owners would pay additional taxes on business income. Income from pass-through entities, like S corporations and partnerships, would be subject to either self-employment tax at 15.3%, or the Affordable Care Act’s net investment income tax of 3.8%. Corporate taxpayers would see an increase in their tax rate from 21% to 28%.
Taken together, these proposals mean it is very likely tax rates will be higher next year. Pulling forward income into the current year and postponing deductions could help if taxes are set to rise. Some investors may choose to sell assets and trigger capital gains now, ahead of the increase in rates. The “wash sale rules” only apply to losses, not gains, so this strategy would work even if you sold stocks and bought them back the next day.
Retirement Plan Deductions Are Safe – For Now
During the presidential campaign, President Biden proposed reducing the tax benefits of saving in retirement plans. Fortunately, these changes did not make it into this year’s budget proposal. The campaign proposal would replace deductions for retirement plan savings with a flat credit. This plan would penalize high income earners by giving them a credit worth less than the taxes they paid on their contribution to the plan. If these changes are included in future legislation, most high-income earners would be better off making Roth contributions. Small businesses should consider adding a Roth option to 401k plans this year, so that it is available if these proposals make it into law.
Higher Estate and Gift Taxes
Senator Van Hollen (D-Md) has introduced legislation to impose capital gains taxes on inherited assets and gifts. Individuals would have a $1 million exclusion for capital gains, and an additional exclusion of $500,000 for a personal residence. This proposal would be retroactive to the beginning of 2021, which makes planning more complicated. If passed, this law will significantly change the tax planning strategy for appreciating assets. Rather than holding them until death, to get the “tax free” step-up in basis, it may make more sense to transfer assets sooner rather than later.
It’s too early to know what tax changes will make it into the final law. Even with the most severe changes, strategies like capital gain harvesting, Roth contributions, and transfer tax planning will still help save on taxes. Every planning technique has risks, and tax planning is just one part of a well-rounded financial plan. Thinking through the possible changes and gathering ideas on what to do if they happen will make it easier to take action when tax laws change.
Matthew A Treskovich | CFA, CPA/PFS, CITP, CMA, CFP®, AEP®, MBA, CLU, ChFC
Chief Investment Officer