The Low-down on the Latest Federal House Ways and Means Committee’s Tax Proposals - Alaska Permanent Capital Management

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The Low-down on the Latest Federal House Ways and Means Committee’s Tax Proposals

It has been a rollercoaster of a year for many reasons, the constantly changing tax proposals notwithstanding. Because APCM Wealth Management for Individuals (AWMI) advisors specialize in advanced financial planning strategies, which includes optimized tax bracket management, we have been along for the ride as we work to understand how all the congressional tax proposals might impact our clients. Congress has been working on legislation related to a $3.5 trillion spending package aimed toward advancing a variety of the Biden administration’s social and economic policies via a budget reconciliation this fall.  Specific tax provisions associated with the proposed legislation have changed a few times, keeping us on our toes.

Most recently, on September 13th, the U.S. House Ways and Means Committee released an extensive summary of its tax proposals aimed toward funding the reconciliation package. While the legislation is far from final as it makes its way through the procedural gauntlet, we think it is prudent to summarize some of the main provisions we believe could impact our clients in the event we might be able to implement strategies ahead of enactment. We are planners, after all.

Proposed Changes

  • Changes to Tax Treatment of Rollovers to Roth IRAs, beginning 1/1/2022

    Under current law, individuals are subject to income limitations for making direct Roth IRA contributions (i.e., single filers making over $125,000 are subject to a contribution phase out until $140,000, at which point contributions are completely disallowed). Starting in 2010, similar income limitations no longer applied to Roth conversions, making the “back-door” Roth IRA strategy very advantageous for high income individuals looking for additional preferential retirement savings vehicles. The idea is that an individual who is ineligible for direct Roth IRA and deductible traditional IRA contributions is allowed to make a non-deductible IRA contribution and immediately convert the balance to their Roth IRA, making all future growth tax-free.

    An individual may not be doing a “back-door” Roth IRA strategy, but instead may be looking to do Roth conversions of pre-tax balances if there is an advantageous tax arbitrage opportunity. We have been helping several clients with this analysis, and we are finding that Roth conversions are especially beneficial under the current Tax Cuts and Jobs Act tax rates.

    The House Ways and Means Committee proposals aim to close the “back-door” Roth strategy AND any Roth conversion for single filers or married individuals filing separately (MFS) with taxable income over $400,000, married taxpayers filing jointly (MFJ) with taxable income over $450,000, and heads of household with taxable income over $425,000. Additionally, the provision “prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level.”
  • Increase of Top Marginal Individual Income Tax Rate to 39.6%, effective beginning 1/1/2022 for taxable income over:
    • $450,000 for married individuals filing jointly
    • $425,000 for heads of households
    • $400,000 for individuals filing single
    • $225,000 for married individuals filing separately
    • $12,500 for estates and trusts 

This provision effectively eliminates the existing 35% and 37% brackets and moves from the 32% bracket directly to 39.6%.

  • Increase in Top Capital Gains Rate to 25%, effective as of the date of introduction of the Act – 9/13/2021!
    The current top long-term capital gains rates are 0%, 15% and 20% (based on taxable income and depends on filing status). This proposal aims to eliminate the 20% bracket and introduce a 25% bracket.
  • Limitation on Maximum Allowable Qualified Business Income (QBI) Deduction, effective beginning 1/1/2022 to:
    • $500,000 for married individuals filing jointly
    • $400,000 for individuals filing single
    • $250,000 for married individuals filing separately
    • $10,000 for estates and trusts

This provision would impose an absolute limit on the total deduction allowable for taxpayers with passthrough business income.

  • Limitations on Excess Business Losses of Noncorporate Taxpayers, effective 1/1/2022
    This provision would permanently disallow net business losses (business deductions in excess of business income) for noncorporate taxpayers, and instead it allows excess business losses to be carried forward to the next taxable year to offset income.
  • Surcharge on High Income Individuals, Trusts, and Estates, effective 1/1/2022
    This provision would impose a 3% tax/surcharge on modified adjusted gross income (MAGI) in excess of $5,000,000 (MFJ) / $2,500,000 (MFS).
  • Changes to Lifetime Gift/Estate Tax Exemption
    The current per-person gift/estate tax exemption, also known as the unified tax credit, is $11.7 million (adjusted annually for inflation) until the Tax Cuts and Jobs Act provision expires at the end of 2025. The House Ways & Means Committee proposal would cut the exemption to the 2010 level of $5 million per person (adjusted for inflation). Gifts and estates in excess of the exemption are subject to a 40% tax rate.
  • Changes to Tax Rules on Grantor Trusts
    Grantor trusts as they exist currently can be used to push assets out of a decedent’s taxable estate while retaining the ability to control the trusts closely. The new provision would pull grantor trusts into the estate, applicable only to future trusts and transfers. This will have significant impacts on irrevocable life insurance trusts (ILITS) because oftentimes contributions are required to pay the premiums on the life insurance policy.
  • Contribution Limit for Individual Retirement Plans of High-Income Taxpayers with Large Account Balances, effective 1/1/2022

    If combined IRA and defined contribution account balances as of the prior taxable year exceed $10 million, contributions to Roth or traditional IRAs will be prohibited for taxpayers with income in excess of:
    • $450,000 for married individuals filing jointly
    • $425,000 for heads of households
    • $400,000 for individuals filing single or for married individuals filing separately
  • Increase in Required Minimum Distributions (RMDs) for High-Income Taxpayers with Large Retirement Account Balances

    For taxpayers with combined traditional IRA, Roth IRA, and defined contribution account balances in excess of $10 million at the end of a taxable year, minimum distributions amounting to 50% of the excess would be required.

Possible Planning Strategies

  • Accelerating income / deferring losses
    • Including capital gain harvesting / capital loss deferral (depends on whether the 9/13/2021 date sticks)
  • Executing larger Roth conversions
  • Implementing non-deductible IRA contribution/Roth conversion strategy prior to 12/31/2021 versus waiting until the tax filing deadline of 4/15/2022 to make a contribution for the prior year since this strategy would be eliminated at the end of this year
  • Coordinating with your estate planning attorney on possible necessary changes to trust provisions/structure

This is not an exhaustive list, as there are a number of additional tax provisions; this list merely includes those provisions we believe are especially important to highlight for our clients. We aim to be as proactive as possible (which is a bit difficult when we don’t yet have a final bill to operate from), so if you believe any of these situations apply to you, please be sure to reach out to your financial advisor, CPA, and/or estate planning attorney to plan ahead.

Meghan Carson, CPA, CFP®
Financial Advisor

10/11/21

https://waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/documents/SubtitleISxS.pdf

 

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