A cauldron of tax changes is brewing in the legislature, but the pot’s still being stirred.
If passed, the $3.5 trillion Build Back Better Act—which may end up being closer to $2 trillion—would have a significant impact on tax rates, Roth IRA strategies, and common estate planning techniques, including gifts to trusts.
As proposed legislation only, many changes are likely before any rules are enacted.
That said, taxpayers may wish to consider certain moves now to help offset what Congress dishes up later.
Leverage Today’s Generous Estate and Gift Tax Exemption
A primary concern to clients with taxable estates is the Act’s lowering of the estate, gift, and generation-skipping transfer exemptions.
As proposed, effective January 1, 2022, the federal estate and gift tax exemption would fall from $11.7 million per individual to approximately $6 million.
The current exemption was set to expire after December 31, 2025. The proposal would simply accelerate this sunset date.
Individuals might consider establishing trusts in 2021, rather than waiting to 2022, to capture the larger $11.7 million exemption before Congress ratifies new changes under the Act.
Maximize Today’s Lower Individual Income Tax Rates
Under the proposed Act, the top individual marginal tax rate on income earned in 2022 would increase from 37% to 39.6% for those with taxable income over $400,000 (or $450,000 for those filing jointly).
The highest tax brackets would also be substantially compressed, meaning taxpayers would hit higher tax rates at much lower income levels.
Depending on filing status, those earning $400,000 to $450,000 could see the largest average increase in tax liability, from 35% to 39.6%.
Taxpayers with income over $5 million and trusts with income over $2.5 million could also see a 3% tax surcharge on modified adjusted gross income.
Where possible, those who might be impacted could accelerate income into 2021 at current lower tax rates and delay deductions to future years when higher tax rates would make deductions more impactful.
And Don’t Forget Proposed Changes to Capital Gains, Roth Conversions, and IRA Contributions
Among other proposed changes under the Build Back Better Act are modifications to the capital gains rate and limitations on Roth conversions and retirement plan contributions.
The top capital gains rate is anticipated to increase from 20% to 25% effective September 13, 2021, the date of the provision’s introduction.
Regarding Roth conversions, present law allows taxpayers to convert a traditional IRA to a Roth IRA without limitation. Under the proposed Act, this would no longer be possible for taxpayers with adjusted taxable income greater than $400,000 (or $450,000 for joint filers).
What to do now? Individuals who expect to find themselves in the top tax bracket for the foreseeable future may consider Roth conversions this year to take advantage of lower rates.
Breathe a Sigh of Relief
Compared with tax law changes proposed earlier this year under the American Families Plan, the proposed Build Back Better Act contains a few respites from what might have been.
Under the Build Back Better Act, there is no forced realization of capital gains and no repeal of the step-up in basis rule—used to calculate tax liabilities on inheritance assets—at death. This means heirs will be spared large tax bills that likely would have forced liquidations of stocks, businesses, real estate, and other potentially more illiquid assets to cover the liability.
For those earning more than $1 million, the tax rate for long-term capital gains was expected to be as high as 39.6% under the American Families Plan. The rate of 25% is a notable reprieve.
A Portfolio Built for Times Like These
While it can be tempting to follow along in real time, keep in mind proposed changes under the Build Back Better Act remain speculative and change by the day.
Most of the proposed legislation either increases tax rates, lowers income thresholds, or eliminates planning strategies. The good news? If enacted, these changes may simply make Vista’s current approach more important.
Whether it’s favoring tax-friendly investments, holding higher-taxed assets in tax-deferred accounts, or strategically harvesting available losses, our approach already seeks to maximize the share of return that ends up in your pocket.
You can expect us to reach out to you should passed legislation impact our advice. In the meantime, please reach out to your Vista team with any questions or concerns.
We’re here to help.