Get Ready for Tax Changes – They’re Coming Soon!
Congress is working on various tax proposals that could be voted on soon. The following discusses some of the proposed tax law changes. However, we do expect additional changes to occur as the proposals move through Congress. Therefore, we recommend not undertaking now any irreversible actions (e.g., sales, gifts) that you would not be doing absent these new tax proposals. By November we hope to have more clarity on these topics and some tax strategy actions could be warranted before year-end.
One proposed change relates to individual tax rates for high-income earners. The proposal is to increase the current rate of 37% to 39.6% for individuals making over $400,000 or $450,000 for married filing jointly. There is also an additional 3-percentage-point surtax for individuals and couples with an AGI above $5 million. Lower tax brackets appear to be left as they currently stand.
Another tax proposal is to raise the long-term capital gains and qualified dividend tax rates from the current 20% maximum rate to 25%. Adding the existing investment income tax and the surtax means the effective federal capital gain tax rate could be as high as 31.8%. If this tax proposal passes, it would be effective as of Monday, September 13th, 2021. This change only affects those with taxable incomes above $445,850 or $501,600 for those filing single and married filing jointly, respectively. For lower taxable incomes, the 15% or lower capital gain tax rates remain as they are now.
Another tax proposal relates to the estate tax exemption. The estate tax exemption increase that was put into effect in 2017, set to expire at the end of 2025, would now expire December 31st of this year. This would lower the estate exemption amount from $11.7 million to about $6 million per person. The elimination of cost basis step-up at death appears not to be a part of these latest tax proposals.
“Back-door” Roth IRA conversions of after-tax IRA contributions would be eliminated. Other Roth IRA conversions would be limited, but not for 10 years, so they can still make sense to do in order to reduce future taxable income and estate taxes at the cost of some income taxes at the time of the Roth IRA conversion.
Starting next year, IRA accounts would no longer be eligible to own hedge funds, private equity or other investments that require the owner to have a minimum level of income or net worth (e.g., assets that can only be owned by an Accredited Investor). IRAs would have two years to eliminate these investments currently owned. This may cause problems for some long-lived truly illiquid investments, unless Congress decides to add in a grandfathering provision for assets currently owned.
Business income tax changes have been proposed. The plan would raise the corporate tax rate from 21% to 26.5%. Smaller corporations would enjoy tax brackets with lower rates. This proposal would change the current flat rates to a graduated rate structure. Companies would face an 18% rate on income up to $400,000, 21% on income up to $5 million and a 26.5% rate on any income above that. The benefits of the graduated rate would phase out for firms earning more than $10 million a year. The proposal would also reduce a tax break for businesses that pay their taxes on their owners’ individual tax returns, such as partnerships and S corporations. This would change the 2017 tax law and put caps on deductions for these companies. The plan would limit the deduction at $500,000 for joint filers, $400,000 for individuals and $250,000 for a married person filing a separate return. The proposal would also impose a 3.8% tax on those entities. Currently, a tax at that rate applies to wages of high-income individuals and to passive income, but active business profits are exempt. Companies would also face new limits on interest deductions.
Highly profitable businesses that earn most of their income in the U.S. could see a reduction in net profits by 15% or more. However, we would expect price declines in publicly trades stocks to be much less than this due to a smaller effect on cash flows. Also, many of these firms do have large non-U.S. operations and we expect that firms will undertake new tax strategies to reduce the impact of U.S. tax law changes to businesses.
If you have concerns about how these new tax changes may affect you, please reach out to us at contactus@wescapgroup.com or at (818)563-5170.