In the latest tax plan news, the House Ways and Means Committee released its $3.5 trillion tax proposal on Sept. 13, 2021. This bill has gone through substantial negotiation, meaning its final form, if it passes into law, is likely to remain similar to this version, though, of course changes may occur.1
This bill requires a 51% vote to pass, through the U.S. Congress’ budget reconciliation process. Expert commentator Jeff Levine gives the bill an approximately 85% chance of becoming law.2
For us, the bill is notable for some proposed changes that it does not include. There is:
- No loss in step up in basis (i.e., no loss in the erasure of unrecognized capital gains at death).
- No 39.6% tax on capital gains for those with over $1 million of income.
- No loss of most Roth conversions until 2032, and then only for those with income over $400,000 single and $450,000 married.
In addition, many aspects of tax and estate planning law are untouched by the bill. This includes the $15,000 annual exclusion on gifts and the general income tax structure.
A key planning consideration for many clients will continue to be analyzing tax rates over the coming years. We will be looking for lower tax years to accelerate income and considering the timing of sale of gain property. Below we’ve listed what we believe are key considerations for our clientele.
If you think the changes below will affect you, please consult your CPA, your estate planning attorney, and your wealth manager.
Tax rate change
A top federal income tax rate increase might affect our working clients, especially those with dual incomes. For people with incomes over $400,000 single and $450,000 married, the tax rate increases from a range of 35%-37% to 39.6%.1
Strategies to deal with this increase include:
- Reducing income through retirement and deferred compensation plan contributions
- Bunching stock option exercise into certain years
- Potentially matching charitable giving to higher tax years.
Those affected should consider also accelerating income into 2021, including potentially exercising stock options and possibly implementing a Roth conversion.
Speaking of Roth conversions, the “Back Door Roth IRA,” will end on Jan. 1, 2022.1 This strategy allowed people with higher income to fund a Roth IRA. The final conversion from traditional IRA/401(k) to a Roth IRA must be made by the end of 2021.
S Corp surtax
For our self-employed clients, there is a new 3.8% phased-in surtax. The surtax affects S Corporation owners with income over $400,000 single and $500,000 married. This surtax could spike their tax rate above the highest stated rate of 39.6% to over 43%.1
Many self-employed clients have high flexibility in setting up tax-deferred retirement plans to help reduce current income. Options include 401(k) profit-sharing plans and cash value pension plans.
They often also have some flexibility in accelerating or deferring income, including potentially accelerating income into 2021. Note that this planning is complicated by another provision, which caps the qualified business income deduction for those with income over $400,000 single and $500,000 married.1 Year-end tax planning with your accountant and financial advisor will be key in 2021 and likely going forward.
Capital gains tax
For most of our clients, the current federal capital gains tax rate is 15% to 20%. Those making over $400,000 single and $450,000 married will be subject to a new top long-term capital gains rate of 25%.
For clients who normally have income under these levels, income can spike due to the sale of a building, business or a large block of appreciated securities. Staggering the recognition of capital gain on financial securities can be a good strategy to avoid a spike year.
Accelerating capital gains to 2021 won’t work. This is one area where the new rules start on Sept. 13, 2021, unless a binding sale is in place.1
Trust tax planning is important today, and that will continue. The 25% tax rate on capital gains applies at $100,000 of trust income.1 Bunching recognition of gains into one already high-income year, while “running” other years at a lower capital gain recognition rate may make sense. Of course, we should partner with your CPA to run the numbers to identify strategies.
A significant change under the law reduces the federal estate tax exclusion amount. The current exclusion ($11.7 million) will be cut in half and then adjusted for inflation, for a future exclusion of approximately $6 million.1 Married couples can double the exclusion with proper planning.
Charitable gifts at death reduce your estate tax, as do lifetime gifts of up to $15,000 per recipient.
It is key to note that making a large gift in 2021 may not be helpful, unless that gift either is very large (at or more than the current exclusion amount) or uses more complex strategies such as a defective grantor trust, QPRT, GRAT, etc.
Alan Grassman explains the exclusion in detail along with other estate planning changes. Please consult your attorney or wealth manager immediately if you have any concerns about the exclusion.
As always, please let us know your questions and comments about this and future tax plan news. We view tax reduction planning as key to wealth stewardship.
Laura is a Senior Wealth Manager and the Founder of LWP. She has a master’s degree in tax and is an excellent listener. While she is a sophisticated financial planner with experience in complex issues, her priority is ensuring a financial plan works for people.