Will Tax Law Changes Increase Your Taxes?
Will you be paying more in taxes next year? Let’s ask the question in another way. Since politicians have taken aim at high earners: are taxes going to rise for the wealthiest taxpayers?
Clients usually ask, “How will this affect me?” or “Will I be ensnared by Congress’ definition of wealthy?”
If proposed changes in the tax code that passed a House committee are enacted into law, those that are wealthy, as defined by lawmakers, will likely see their taxes rise.
Some of the main issues that might concern those with higher incomes include:
- Raising the top federal tax rate from 37% to 39.6%
- Levying a 3% surtax on income higher than $5 million for single and joint filers
- Raising the tax on dividends and the long-term capital gains tax rate for assets held over one year to 25% (up from 20%) for individuals earning more than $400,000 and for couples that earn over $450,000
- Placing new limits on those who have large retirement account balances
These proposals are a long way from becoming law but are winding their way through Congress. The Senate may have its own set of proposals, which would require both legislative bodies to forge a compromise before a tax bill lands on the President’s desk.
The proposed increase in the top tax rate and the surcharge on income over $5 million. A couple filing jointly that has $600,000 of taxable income will see their top rate rise from 35% to 39.6% next year, if proposed changes are enacted (4.6 percentage points, or a $6,900 increase in taxes on $150,000 of income).
However, there are ways to minimize the tax sting next year.
Consider shifting 2022 income into tax year 2021, which would be subject to today’s lower rate. Consider looking for ways to defer expenses and deductions that you might normally incur in 2021 and push them into 2022.
Maximize contributions to tax-deferred savings and retirement accounts. If you itemize deductions on your returns, charitable contributions will reduce your taxable income.
In addition, municipal bonds, which are exempt from federal income tax, will become more attractive if a higher marginal tax rate is enacted.
The proposed 3% surtax on individuals earning over $5 million would effectively raise the top tax rate to 42.6%. This would hit very few taxpayers but be aware that the sale of a business or large asset could push you above the threshold.
Please note that the surcharge is separate from today’s 3.8% tax on net investment income.
A higher rate on dividends and long-term capital gains tax rate is being considered. As proposed, if a capital gain is realized on or after September 14, 2021, individuals earning more than $400,000 and couples earning over $450,000 will pay a top rate of 25%. The same would hold true with dividends.
Left on the Cutting Room Floor
Lawmakers in the House have not proposed taxing unrealized capital gains at death, as had initially been proposed by the President. Also, it looks like we’ll still get a step-up in basis for inherited assets. That has also been up for debate.
But one proposal being floated is to reduce the estate and gift tax exemption to $5 million. Tax reform in 2017 raised the limit to $11.7 million of individuals and $23.4 million for couples.
These are some of the major provisions. They may or may not be enacted into law. If they are enacted, there are also rumblings they might make the laws retroactive to parts of 2021.
We understand that taxes play a role in overall returns, but so do many variables. Your financial plan should ultimately drive investment decisions, not tax laws. Do not let the tail wag the dog. In other words, be careful not to let taxes solely dictate your investment decisions.
We are providing general guidelines. We understand that your situation is unique, and we would be happy to entertain any questions and tailor our recommendations to your individual needs.