This is a new installment in an ongoing series where Marc Bautis, Wealth Manager and Founder of Bautis Financial, comments on hot topics in the financial industry.
A couple of weeks back the U.S. Congress pushed ahead with a mammoth $3.5 Trillion Spending Plan called the Build Back Better Plan. A passage deadline of September 27th was set, and now we’re in for politicking back and forth from the two parties. With a big price tag on the projects in the plan comes the question: How will it be funded? If your immediate thought is higher taxes, you’re correct. On Monday, the House Ways and Means committee published their 800 page tax proposal. Here is an 18 page summary.
While there could be many changes to the original tax proposal before (and if) it becomes law, it’s a good time to see what’s inside of the proposed bill.
One of my favorite resources for tax information is Jeffrey Levine, a CPA for Buckingham Partners. His Monday night tweet storm analysis of the proposal gives some great (and entertaining) insight into it.
On Wednesday, Jeff followed up with a detailed analysis of the changes and potential planning opportunities in the Kitces Nerd’s Eye View Blog.
From the planning side, here are a couple of areas I think will impact people the most. To reiterate, nothing has been passed, so it makes sense to evaluate and analyze, but be careful about making any planning decisions based on proposals.
Corporate and Individual Tax Rates
The House proposal would take steps to reverse most of the 2017 Republican tax cuts, but probably didn’t go as far as President Biden initially hoped.
Corporate tax rates would jump to 26.5%, after the GOP slashed it to 21% from 35%.
In 2017, the top individual tax bracket was cut to 37%. Under the new proposal the rate would be restored to 39.6%
Changes to Capital Gains Tax Rates
Earlier in the year there was talk that capital gains tax rates would increase to the same level as ordinary income rates. Luckily, the proposal has capital gains tax rates increasing from the top current rate of 20% to 25% if your income is $400,000 if you file single, and $450,000 if you are married and file jointly.
Most changes to the tax code are set to take place at some point in the future, usually January 1st. The capital gains tax rate change would go into effect immediately — not immediately after the bill is passed, immediately after the proposal was released. So any assets sold prior to September 14th, 2021 would fall under the current table below. Any assets sold September 14th or later would fall under the proposed column in the table.
New 3% Surtax for Ultra-High Income Taxpayers
Section 138026 of the proposal would create a new 3% surtax on ultra-high-income taxpayers.
The government likes surtaxes: See the Medicare Investment Surtax. That’s because surtaxes are harder to avoid using deductions. Also, it’s an “out” in a way, where the government can say, “ We only increased the top tax bracket from 37% to 39.6% and not 42.6%.”
This surtax would impact people earning over $5 million annually. While individual taxpayers would rarely be subject to the surtax, there may be instances where the sale of a large piece of property or business would trigger it. Contrarily, trusts are subject to this surtax if trust income generates over $100,000 of income.
Elimination of the Backdoor Roth IRA
We’re big proponents of backdoor Roth IRAs. This is a strategy that’s popular with “regular” taxpayers, not just the high income earners that the bill is targeting. Five years ago, we wrote a blog post about how to take advantage of backdoor Roth IRAs.
SECURE Act 2.0
The tax proposal is not the only piece of financial legislation that’s currently up for discussion. We could also see an update to the SECURE Act, a legislation passed in late 2019 that made sweeping changes to people’s retirement.
There were changes to required minimum distributions (RMDs), stretch IRAs and rules on IRA contributions. Although the SECURE Act is only a couple of years old, Congress is already considering what many are calling SECURE Act 2.0. There’s no guarantee of passage, but as it winds its way through Congress it has widespread bipartisan support and both the Senate and the House have drafted similar bills.
While we’re talking about legislative changes and tax proposals, now is a good time to look into what’s being proposed.
Easing the RMD Bite, Again
People do not like to be told what to do — whether that’s forcing people to take money from their retirement accounts in the form of required minimum distributions or to take a vaccine.
Currently, an RMD from a traditional IRA isn’t required until 72. SECURE Act 2.0 would raise the RMD to 73, beginning in 2022, 74 in 2029 and 75 in 2032.
Taking your first distribution from a tax-deferred retirement account will depend on many factors, but if the funds are not needed, it is usually a good idea to defer withdrawals until required.
By delaying a withdrawal, the investments maintain their tax-exempt status. Or, if you need cash before RMDs are required, you decide how much to withdraw. You are not bound by an arbitrary rule.
A More Favorable Catch-Up Provision.
If Secure Act 2.0 is passed into law, employees 50 and older can make extra catch-up contributions to a 401(k) or similar plan. The limit for 2021 is $6,500, which is indexed to inflation.
As proposed, Secure 2.0 maintains the catch-up limits for those aged 50 but increases the annual catch-up provision to $10,000 for participants ages 62-64. The new limit begins in 2023. This new maximum is indexed to inflation.
However, all catch-up contributions must be placed in a Roth IRA, which would disallow a tax deduction. Starting in 2022, all catch-up contributions must be made into a Roth IRA.
Presumably, it’s a way for the government to capture revenue. Nonetheless, Roth IRAs are not subject to RMD and withdrawals are exempt from federal income taxes.
Student Loan Matching
SECURE Act 2.0 would permit employers to make matching contributions to their 401(k) plans tied to the employee’s student loan payments. The goal: Encourage younger employees to save for retirement.
It would also help employers pass nondiscrimination tests that prevent plans from favoring higher income employers.
While we recognize this provision will probably complicate the administration of a 401(k) plan, we applaud the proposal simply because we know that the sooner one begins saving for retirement, the sooner one may enjoy the power of compounded returns. As we always counsel, it’s never too early to start saving.
The proposed changes discussed are the more important components of the proposed act, in our view. But we also wanted to briefly mention some of the additional provisions.
SECURE Act 2.0 Would Also:
- Allow Roth contributions to SEP and SIMPLE plans.
- Accelerate part-time workers’ participation in 401(k) plans.
- Extend some of the features of 401(k) plans to 403(b) retirement plans.
- Require the Treasury secretary to increase awareness of the Retirement Savings Contributions Credit (also known as the saver’s credit), which is available to low- and moderate-income workers.
- Eliminate some impediments to offering lifetime income annuities as a retirement plan investment option.
It would also place limits on employers who attempt to capture excess plan payments from a participant.
Like the tax proposal discussed above, the SECURE Act 2.0 may pass as proposed, changes could be made or the bill could run into unforeseen obstacles that prevent it from being enacted into law.
As we have already said, the review is a high-level peek at what is being proposed. Any advice we may provide will be tailored to your individual circumstances.
We suspect changes to the proposed law will probably be made, but odds favor passage.