What should taxpayers anticipate given the change of leadership in Washington? Is there action you should take today to avoid paying higher taxes in the future? Here are five key items to help you, your tax professional, and your Kovitz advisor think through how to manage your tax bill, both in light of current law and potential changes in the not-so-distant future. Notably, none of these items represent action you should take now as a result of last year’s election outcomes, as it remains to be seen what policies will be implemented by President Biden and the (narrowly) Democratic-controlled Congress that may impact your tax return.
1. "Gotcha!": Some Historical Context on Retroactive Tax Laws
Individuals are calendar year taxpayers. So, what if a tax bill is signed into law later this year that is retroactive to this tax year (2021)? While a retroactive tax law bill is certainly a possibility, it is impossible to plan around a hypothetical. So, at this point, we simply point to historical context: since the 90’s, retroactive tax law changes have more often than not been favorable to taxpayers.
Here are three examples of bills that were retroactively effective in the year they were signed:
- The Economic Growth and Tax Relief Reconciliation Act of 2001, which generally reduced ordinary income tax rates.
- The Taxpayer Relief Act of 1997 reduced the maximum capital gains rate.
- The Omnibus Budget Reconciliation Act of 1993 included tax rate increases that were retroactive for calendar year 1993. At the time, Democrats held a sizable majority in Congress.
2. Possible Tax Law Changes
Below are a few income tax policy proposals made either by Biden’s campaign or by Democratic Congressional leadership, some that may reduce your tax bill, and some that may increase it:
First-Time Homebuyer Credit. Do you have a young adult in your family who is looking to purchase their first home this year? If so, this would be an incentive for them. President Biden has indicated interest in reintroducing the first-time homebuyer credit, potentially up to $15,000 payable at the time of home purchase, as opposed to after the return is filed.
SALT Deduction. Also on the table is a repeal of the $10,000 cap on the state and local tax, or SALT, deduction. If you reside in Chicago, New York, Los Angeles, or another relatively high state income tax location, and itemize deductions, a repeal could equate to tax savings on your federal income tax return.
Capital gains taxes., President Biden has indicated he would a) consider eliminating the step-up in cost basis on inherited assets and b) require those making over $1 million of income to pay ordinary income rates on capital gains. The basis step-up has proven to be popular with taxpayers however, and repealing it would impose complex enforcement challenges on the IRS. To be clear, we are not saying this will not happen, just that attempts to repeal stepped-up basis have proven to be unpopular historically.
We can’t predict exactly what will happen this year, especially with the slim majority in the Senate, but we will look for specific guidance as talks progress with another round of pandemic relief and as bills are introduced in Congress. So, more to follow!
3. Lower IRA Required Minimum Distributions are Coming in 2022
The Treasury Department recently updated the life expectancy tables used for Required Minimum Distributions (RMDs) on IRAs. The new requirement impacts everyone who will be required to make these distributions, beginning in 2022. The life expectancy tables were changed because folks are living longer, on average. Thus, the new tables will result in lower RMD payments than before. To be clear, you can still take out more if you would like, but you will be required to take out less, meaning less in taxes!
For example, the factor for an individual age 72 was 25.6, but it will now be adjusted to 27.4 in 2022. Let’s say you have a balance of $100,000 in your IRA are turn 72 in 2022, your RMD for will be $3,650 ($100,000 / 27.4) instead of $3,906 (100,000 / 25.6).
If you already take RMDs contact your Kovitz advisor to explain the difference between what your RMD payment is currently and how the new factors will alter your IRA distribution payments beginning in 2022.
4. Maximizing Roth Retirement Contributions
Effective income tax rates (the rate you actually pay as calculated by dividing your total income tax paid by your AGI) are relatively low, even for the highest earners, compared to historical averages since the 1950’s. This is to say, most taxpayers are paying the same or less federal tax now as a percentage of their income than they have in the past. However, high-income earners are set to revert to slightly higher tax brackets at the end of 2025 (potentially increasing their effective tax rate), unless Congress takes action otherwise, for example, President Biden has indicated he would support reverting to the higher tax brackets before 2025.
Those in a higher income tax bracket today who believe they might be in a lower bracket in the future may not want to contribute to a Roth IRA or a Roth 401(k) and pay taxes at their current rate. However, with historically low rates, now is as good a time as any to pay the taxes on retirement contributions. Remember, Roth IRAs not only grow tax-free, withdrawals are tax-free.
What’s the right move for you? Speak with your Kovitz advisor about contributing to a Roth IRA, converting traditional IRA savings into tax-free Roth IRA savings and/or contributing to a Roth 401(k), if offered by your employer.
5. Wealth Transfer Taxes:
At this time, if no action is taken by Congress, the current estate tax exemption of $11.7 million per person will revert to half that amount at the end of 2025. President Biden has indicated he plans to reduce the current estate tax exemption to somewhere near $3.5 million. However, there is also a chance that nothing will change, and Congress will simply roll forward the existing exemption amount, indexed for inflation.
Currently, only individuals who are likely to die with more than $11.7 million and married couples with twice that amount are concerned with estate and gift tax avoidance at the federal level. However, if you are single and have a net worth of $5 million or if you and your spouse have a net worth of greater than $10 million, estate tax could become much more relevant to you in the not-so-distant future.
For example, you might consider various estate tax avoidance techniques, such as annual exclusion gifts, the direct payment of tuition and medical expenses or more complex techniques like grantor retained annuity trusts or a dynasty trust.
If you concerned how your assets will flow through your estate plans under the current federal tax laws, or would like a better understanding of how changes to wealth transfer taxes might affect you and your heirs, speak with your Kovitz advisor so you can see the extent to which estate, gift and generation skipping tax
Contact Kovitz to discuss any questions you may have regarding potential tax changes.
Kovitz and its advisors do not provide tax advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax advice. You should consult your own tax advisors before engaging in any transaction.