How Do 2021-22 Tax Law Changes Affect You?

Elijah Heath |
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How Do 2021-22 Tax Law Changes Affect You?

A recurring topic of conversation is whether the rich “pay their fair share” of taxes. As citizens and politicians attempt to define what makes up a “fair share” consider these statistics: The top 50 of all taxpayers paid 97.1% of all individual income taxes, while the bottom 50% paid the remaining 2.9% ( Tax Foundation, February 2021 https://taxfoundation.org/publications/latest-federal-income-tax-data/

Public opinion varies on the subject. Politicians may argue both sides, telling the public they agree the wealthy do not pay enough in taxes, then court wealthy donors for campaign contributions while responsible for passing the tax laws that impact them. 

High-earning individuals, such as those who run businesses that employ dozens to thousands of people and produce needed goods and services, may be among those who feel they pay more than they should. 

As the debate continues, let’s turn our focus to 2021-2022 proposed tax law changes while Congressional committees and parties try to decide who pays what in taxes and how much. 

Key Tax Proposals for 2021-2022

  • Top capital gains tax rates would jump from 20% to 25% for those above $400,000 (single filers) or $450,000 (joint filers). 
  • The top ordinary income tax rate would return to 39.6% to single filers earning $400,000 and joint filers earning $450,000. 
  • Net investment income tax of 3.8% would apply to taxpayers and business income over $400,000 (single) or $500,000 (joint), as well as trusts and estates 
  • New 3% surtax on individual income tax returns with modified adjusted gross income (MAGI) over $5 million and trusts and estates over $100,000. 
  • Those with assets over $3.5 million stand to feel the strongest impact in estate taxes. Dynasty trusts are being limited as well.
  • Corporate tax rates increased from 21% to 26.5%, in addition to most states already having corporate tax in place.

Before these changes go into effect, you must understand what they are, how they will impact you, and how you can make adjustments. Talk to your financial advisor, such as a CERTIFIED FINANCIAL PLANNER™ professional, to understand how to protect your hard-earned assets from the proposed tax law changes. 

The financial planning professionals at Health Wealth Management have been strategizing and brainstorming ways to protect their clients’ investments all year as they anticipate these changes.

Capital Gains Increases

A key proposal would reduce the advantages higher earners can receive from capital gains. It would go up from 20% to 25% for those above $400,000 (single filers) or $450,000 (joint filers). 

The increase to 25% affects both long-term capital gains and qualified dividends. For those living in a high tax state such as New York or California, this increase, along with the proposed 3.8% net investment income tax, the new 3% surtax, plus state income tax, means residents could pay over 40% tax on a large capital gain. 

There are concerning questions about these changes being retroactive to September 14, 2021. As of this writing, that means it would be too late to reverse or make any changes to avoid this tax increase. 

Elijah Heath, a CFP® professional at Heath Wealth Advisors, says retroactive taxes cause a significant problem. Financial planners and investors made financial decisions based on the laws that were in place at the time. There is no way to undo a sale that made sense before September 14, 2021, but is now going to create a tax liability the account owner was not prepared for.  

 

Ordinary Income Tax Increases 

Proposed income tax increases on ordinary income would apply to single filers over $400,000 and joint filers over $450,000. The top rate would increase from 37% to 39.6%. 

Additionally, there could be higher Medicare Taxes in certain circumstances. Residents in high tax states like New York and California could also see changes to deductions for state and local taxes (SALT). 

Your financial advisor may suggest actions such as accelerating income like bonuses if the proposed tax changes take effect in 2022. For your tax deductions, there may be options to accelerate certain income or defer deductions such as charitable contributions based on current and future limits. It makes sense to review your IRA and determine if this is a good time to convert a traditional IRA to a Roth IRA. 

Estate Tax Increases

Estate taxes, which are additional taxes due when someone dies and has an estate over a certain dollar amount, are being considered for big changes as well. The historically high amount of $11.7 million dollars (already scheduled to decrease to half that amount in 2026) that is eligible for transfer during a lifetime or at death would decrease to $3.5 million at death and only $1 million during a lifetime. 

The current flat rate of 40% in taxes would increase to as high as 65% in taxes for gifts, estates, and generation-skipping transfer above the limits mentioned in the proposal. 

Depending on your financial circumstances, a fiduciary advisor such as a CERTIFIED FINANCIAL PLANNER™ professional, can review whether gifting assets makes sense for you. Some taxpayers may want to make their gifts now before the law changes, while others may find that it won’t affect them even if the proposed tax changes are passed. 

Estate Tax Planning - Who is Affected?

Taxpayers with assets over $3.5 million (single filers) or $7 million (joint filers), and families with irrevocable trusts, would be impacted the most by certain proposed estate tax planning changes. 

One of the proposed changes would impact grantor trusts, which allow you to make a gift, removing that asset from your estate for estate tax purposes. They are also used to buy assets from your estate in an installment sale that essentially “freezes” the value of your estate.

Current tax proposals would undo the tax advantages of these trusts and would impact irrevocable life insurance and other common types of trusts. Existing trusts are grandfathered but future transactions would be limited. Families with large estates should consult their financial planner about creating a grantor trust now. 

Generation-Skipping Transfer (GST) Trusts, sometimes called Dynasty Trusts, are generally created to avoid taxes on trusts that exist for many generations. Many states allow these trusts to help avoid estate taxes as long as the funds remain in the trust.  

The tax proposal changes would end these GST trusts after 50 years, ending their ability to avoid additional estate taxes on funds that paid other taxes through the years. Existing GST trusts should be reviewed to understand their tax burdens at the end of the 50-year period, and new trusts will need to consider current and future changes in tax laws. 

Others who would be affected are small business owners and farmers, and those without estate liquidity. If you don’t currently have a trusted financial advisor to guide you through what these tax proposal changes would mean to your estate, please consider contacting someone such as a CERTIFIED FINANCIAL PLANNER™ professional today. 

Estate Taxes – Small Businesses Impacted 

One scenario: A small business owner has a business that has been passed down through generations. While they may not have a lot of cash on hand, the total value of the business (equipment, stock, land, property, etc.) means the business has a large taxable value. 

Let’s say the IRS estimated the business is worth $5 million on paper, based on the value of land, equipment, and other hard assets. When the current business owner passes away, the heirs now face an estate tax burden that could be greater than the cash available to them through the business or farm. 

They could be forced to sell the business to pay the taxes owed when the owner dies. Because of the short amount of time required to pay the taxes, the owners may not have time to find a suitable buyer to meet the requirements, forcing them to sell the business for less than it is worth. 

Corporate Tax Rate Increases

Corporate tax rates may rise under the proposed tax law changes to fund the massive infrastructure rebuild proposed by Democrats in Congress. The federal corporate tax rate would increase from 21% to 26.5%, on top of the corporate taxes most states have already. 

The proposed changes mean the top combined corporate tax would increase to 30.9%. Companies in 21 states would pay a higher corporate income tax than any other country in the world. New Jersey would have the highest combined rate at 35%. 

Many arguments show that raising corporate income tax rates reduces output, wages, and overall productivity, making the U.S. less competitive in the global economy.  

IRA Proposed Changes

Traditional IRA contributions are being overhauled as well. Under the new proposals, taxpayers could be forced to withdraw 50% of any balance over $10 million, 100% of any balance over $20 million, and pay taxes and applicable penalties on those withdrawals. These changes apply to individuals earning over $400,000 or joint filers over $450,000. 

Since 2010, taxpayers have been able to convert assets between a traditional IRA and a Roth IRA with no limits, regardless of their income level. Under the proposed changes, high-income earners would be prohibited from doing Roth IRA conversions, although the change would not take place until tax year 2032. “Back-Door” Roth conversions would essentially be ended as well, effective for tax year 2022 if the proposal passes. 

You may want to speak to your financial advisor about withdrawing funds in 2021 before income tax increases go into effect or make a major charitable gift before those limits change.

Tobacco Users Get a Tax Increase 

The Biden administration had promised there would be no new taxes on those making less than $400,000 a year. However, many consider the proposed changes to higher taxes on tobacco products as a contradiction to his promise. 

For example, dipping tobacco is set to increase by 1600%, which will likely impact lower-income communities more since many tobacco users in the U.S. earn less than $400,000. This move to tax tobacco so heavily leads to the question of whether certain groups are being unfairly targeted.

What We Can Do

Elijah Heath, a CERTIFIED FINANCIAL PLANNER™ professional, is a fiduciary with an ethical obligation to provide information, products, and services in your best interest, not what earns him the best fee or commission. 

Call us to learn more, ask questions about your specific circumstances, and determine if we are the right fit for you. Our phone number is 813-556-7171. We can also be reached by email at Elijah.Heath@LPL.com.

 

Heath Wealth Management and LPL Financial do not provide tax or legal advice or services.  This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations to any individual.