Welcome to Part 1 of our series looking at the results potential legislation and Biden's proposals may have on your tax situation. Today we are going to explore the potential impact to individuals and businesses. Stay tuned for an update on estate and gift planning in response to proposed legislation coming next week!
Who could be affected?
While these are merely proposals at this time, and no legislative changes have been passed into law, it is worth understanding potential changes and who they may affect. Stay tuned if you:
- Have income of more than $400,000
- Itemize your deductions
- Expect to realize capital gains
- Utilize an IRA or workplace retirement plan
- Own or operate a business
Let’s explore some of the potential impact.
The tax pendulum may be swinging back after the Tax Cuts and Jobs Act (TCJA) of 2017.
Proposed changes to individual income tax returns:
- Restoring the top marginal tax bracket of 39.6% (capped at 37% under the TCJA)
- Eliminating the state and local tax deduction limit of $10,000
- Limiting the option to itemize deductions to those in and under the 28% tax bracket
- Reinstating the Pease Limitation on itemized deductions for those earning more than $400,000, effectively phasing out itemized deductions for high-income individuals
- Increasing the highest tax rate on long-term capital gains and qualified dividends from 20% to the top marginal rate of 39.6% for individuals with more than $1M in income
- Expanding the Net Investment Income Tax to include all income exceeding $400,000 not otherwise subject to FICA or self-employment tax
- Recategorizing carried interest income, currently taxed at capital gains tax rates of 15% or 20%, to be treated as wage income subject to employment taxes and the top tax rate of 39.6%. Certain family partnerships would be exempt from this provision.
Changes to Social Security taxes:
FICA taxes are comprised of two parts: OASDI (Social Security) tax of 6.2% and Medicare tax of 1.45%. Both an individual and their employer is each responsible for paying a total of 7.65% tax. Self-employed individuals are responsible for paying the entire liability. In 2021, only the first $142,800 of earnings are subject to Social Security tax.
While not included in any specific proposal, President Biden has shown support for applying an additional 12.4% OASDI tax to wages exceeding $400,000. Similar to today, the additional liability would be shared by the individual and employer.
Changes to IRAs and workplace retirement plans:
Currently, Required Minimum Distribution rules for traditional IRAs and employer-sponsored plans require distributions to begin by April 1st in the year after an individual reaches age 72. A new proposal outlines a delayed schedule for RMDs, allowing money to continue to grow on a tax-advantaged basis. The new schedule would be:
- If an individual reaches age 72 after 12/31/2021, RMDs would begin after reaching age 73
- If an individual reaches age 73 after 12/31/2028, RMDs would begin after reaching age 74
- If an individual reaches age 74 after 12/31/2031, RMDs would begin after reaching age 75
The proposal also increases the contribution limits for individuals aged 62 and above.
Businesses and Business Owners
High-net-worth individuals are not the only targets of proposed legislation. Tax situations could change dramatically for businesses and their owners as well. Here are a few provisions under consideration:
- Repealing the Qualified Business Income Deduction for individuals with income over $400,000
- Raising the corporate income tax rate from 21% to at least 25%
- Eliminating the tax exemption for the first 10% return on foreign assets subject to the Global Intangible Low Tax Income (GILTI) and raising the minimum GILTI tax to 21%
- Establishing a 15% tax on financial statement profits for companies with more than $2B in otherwise untaxed book income
Proposed changes to capital gains taxes could also have ramifications for businesses. Proceeds from the sale of a business or business interest could see a doubling in tax depending on the specifics. Family members who inherit a business or business interest would also see an increase in tax liability if the step-up provisions were eliminated.
Enforcement of Tax Laws
Enforcement of tax laws has been on the decline, but this may be about to change. Proposals under consideration include restoring recent funding cuts, which would replenishing resources for the IRS to resume enforcement activity. This would likely result in additional tax audits and penalties.
To streamline selection for audit and examinations, proposed legislation also increases the reporting requirements on financial institutions, requiring reporting on earnings from investments and business activity similar to current wage reporting.
These are not small changes under consideration. Many may result in hefty tax bills and come with large ramifications for future planning. There are things you can do now to get ahead of the more likely changes, since many would be effective upon passing with little to no grace period.
- Review your portfolio and build potential tax policy changes into your investment strategy. Consider selling appreciated assets to lock in gains before any rate increases. Our Wealth Management team can provide a complete portfolio review and advise on a plan of action.
- Plan your income and deductions. Accelerate income into 2021, including Roth IRA conversions and realizing gains in an Intentionally Defective Grantor Trust (IDGT). Defer deductions and capital losses to minimize the impact of increased tax rates. Reach out to your M&S Tax Advisor to review your current and expected tax situations.
While some of the proposed provisions are more likely to become law than others, there is one thing we can be sure of – change is coming. We fully expect Congress to move on tax legislation, and we will be following the situation closely. As always, it is our priority to keep you informed. In the meantime we strongly urge you to reach out to our team to ensure adequate time for planning opportunities.