Anticipated tax proposals have finally been released in legislative form on September 13, 2021. As of early October, these proposals have yet to be finalized in Congress as the sausage is being made. Thankfully the changes are not as bad as many had feared, but there are many changes that may impact your financial and tax planning.
For many families, the most significant benefit will be the extension of the child tax credit through 2025. The child tax credit was increased for tax year 2021 from $2,000 per qualifying child up to $3,000 per qualifying child aged six and older and $3,600 per child under the age of six. The credit starts to phase out at $150,000 of income for those married filing jointly, although a smaller $500 credit may be available for those up to $400,000.
Another change will benefit families without workplace insurance and retirees before Medicare eligibility at age 65, allowing increased healthcare tax credits. The new legislation would make permanent the “affordability percentages” used to determine the Health Insurance Premium Tax Credit. This provision allows households with incomes greater than 400% of the Federal Poverty Level to qualify for Premium Tax Credits if their healthcare premiums exceed 8.5% of income, also known as the “expected contribution.”
Suppose you are married, both age 60, retired, and have $100,000 of income on your tax return. Your expected contribution is $8,500. This makes your tax credit an incredible $9,670 in 2021.
As expected, taxpayers with taxable incomes under $400,000 single and $450,000 married filing jointly (MFJ) were largely spared a tax increase. However, taxpayers with incomes above those levels will see a tax increase.
The top marginal tax rate will increase from 37% up to 39.6%. In addition, this top bracket will start at taxable income above $400,000 single and $450,000 MFJ, down from $536,000 single and $628,000 MFJ. Thus taxpayers with taxable income in these ranges will have their marginal tax rate increase from 35% up to 39.6%.
In addition, the long-term capital gains rates increase from 20% up to 25% starting at these same $400,000 single and $450,000 MFJ thresholds.
A few other notable changes in the bill include eliminating the conversion of after-tax amounts in IRAs and 401ks. This will eliminate both the backdoor Roth conversion and the mega backdoor Roth conversion strategies. These provisions allowed taxpayers to make nondeductible (after-tax) contributions and convert the funds to a Roth IRA.
In addition, all Roth conversions for taxpayers in the top tax bracket will be eliminated beginning in 2032.
Finally, IRAs will be prohibited from owning any security with income, asset, or licensing requirements. This negatively impacts accredited investors who desire to use private placement investments in IRAs.
There were several reforms to estate tax law, with the most notable being a 50% reduction in the estate and gift tax exclusion. The new exclusion amount is expected to be about $6 million in 2022 after inflation adjustments.
Didn’t Make It
There were several changes many thought would be in the bill that are not. Capital gains rates for taxpayers with income over $1 million were expected to the top ordinary-income rate of 39.6%. Instead, long-term capital gains tax rates are capped at 25%. Additionally, the elimination of capital gains at death was not in the proposal. Thus gains will continue to be stepped up at death.
Social Security payroll taxes were expected to be imposed on wages over $400K. Currently, these payroll taxes stop with wages above $142,800. It was believed they would be re-imposed once wage income goes above $400K as part of a Social Security solvency fix, but this is not in the plan.
Many in high tax states were hoping the state and local tax (SALT) deduction caps were going to be removed. This provision caps the amount of these taxes that can be deducted to $10K. For now, this cap looks to remain in place.
Many of the tax proposals were not surprises. If at all surprised, it tended to be positive.
Remember that good tax planning starts with taking a multi-year, forward-looking approach. For 2021 and the next few years, you can still have taxable income of about $330,000 and only pay a 24% tax rate. This is quite a deal compared to 2017, when the 25% rate began at about $75,000 of income and may prove to be quite a deal when we look back down the road. There is still time to act and create a tax-smart retirement plan.