In many of our personal lives, December can be quite hectic. The calendar and to-do list fill up quickly with holiday parties, shopping, gift wrapping, and arranging time with family. To add to the stress, all these tasks and obligations are compressed into a shortened timeframe. The old axiom of the “hustle and bustle” of the holiday season is certainly appropriate.
In recent years, Uncle Sam has exacerbated the stress level for this time of year with last-minute changes to tax laws and regulations. Recall that on December 20th, 2019, Congress passed the SECURE Act, which among other things made big changes to IRA rules, including required minimum distributions (RMDs) and inherited IRA distribution requirements. That provided a frenzied ten days to digest, recommend, and implement changes before year-end! Very Grinch-like if you ask me.
Then came the bevy of Covid-related regulatory and tax changes (CARES Act, March 27th, 2020, Infrastructure Investment and Jobs Act, November 15th, 2021). Congress is at it again with the Build Back Better Act, passed by the House of Representatives on November 19th. This still needs to pass the Senate where it will likely undergo meaningful changes before it gets sent back to the House, and then on to final signature by President Biden. But some of the key proposed provisions for personal income taxpayers include:
- Starting Jan. 1, 2022, the legislation would prohibit the use of the mega-backdoor Roth conversions.
- Starting Jan. 1, 2022, the bill would also eliminate backdoor Roth conversions of after-tax contributions.
- Starting in 2032, the legislation would prevent single people earning more than $400,000 a year and married couples with incomes above $450,000 from converting pretax retirement-account money to Roth accounts (aka “Roth Conversion”).
- The plan would raise the $10,000 cap on the state and local deduction to $80,000, retroactive to include the tax year 2021. It would extend that higher cap through 2030, beyond the current cap’s scheduled expiration after 2025, with the cap falling back to $10,000 in 2031.
- High-income business owners would face a 3.8% tax on active business income. This provision would apply to those with modified adjusted gross income (MAGI) exceeding $400,000 ($500,000 for couples) and is effective for taxable years beginning after December 31, 2021.
In addition, what is NOT in the bill is almost as newsworthy. Left on the proverbial “cutting floor” of the House chamber and excluded from the bill were some major proposed changes including:
- Elimination of the step-up in basis on assets held longer than one year
- An increase in tax rates from current levels
- Reduction in the starting point for the highest tax bracket to $400,000 (MFJ at 37% starts at $647,850 in 2022)
- Reduction in estate tax exemption (which sunsets at the end of 2025 anyway) from the current level of $11.7 million for a married couple
How Will Possible Tax Changes Affect Me?
With the SECURE Act (2019) limiting the deduction of taxes paid (real estate, state, and local) to only $10,000 for a married filing jointly return, many taxpayers in high-tax states lost a large tax deduction and were resigned to taking the standard deduction ($25,100 for married filing jointly).
But if the House bill becomes law and is retroactive to 2021, many taxpayers may end up itemizing again in 2021 if the SALT limitation (state and local taxes) is raised to the proposed level of $80,000. This would also mean their charitable contributions and some out-of-pocket medical expenses (above the 7.5% of AGI threshold) would now become deductible instead of falling under the higher standard deduction amount. It’s likely this $80,000 cap will be adjusted down and/or phased out at higher incomes to avoid disproportionally benefitting higher earners. That said, it’s probably still worth keeping track of those expenses again as many high earners may end having a SMALLER tax liability in 2021 (through 2030) than they originally projected!
The Federal government doesn’t do us any favors when it comes to their frenzied changes right before year-end. The best we can do is to stay vigilant on monitoring the developments out of Washington D.C. and stay informed. The changing tax laws can affect different taxpayers in different ways, depending on their personal situation. This is why we keep a sharp eye on the news and dig into the proposed changes so we can work with clients to minimize taxes, leaving more for the people and causes you care about! If you have questions about how these potential changes may affect you, reach out to one of our wealth advisors at Johnson.