How Biden's Tax Proposals Could Affect You
What to do now, and what to prepare for.
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Earlier this year, there were discussions of increasing the top individual income tax rate on ordinary income from 37.0% to 39.6%--the rate before former President Donald Trump's tax cuts. What's more, for households earning more than $1 million per year, the Biden administration proposed taxing long-term capital gains and dividends at a higher top ordinary income tax rate of 39.6%, almost double the current top tax rate of 20.0%. Since then, we've seen the House Ways and Means Committee release a set of provisions along with President Joe Biden's Build Back Better plan. The president's plan calls for $1.75 trillion in spending on a wide variety of social programs that would impact childcare, healthcare, higher education, climate change, and more. Notably, the proposal contains several tax law changes, such as increased income tax rates, as well as changes to capital gains tax rates and backdoor Roth contributions, which have fallen to the bottom of the priority list for now.
It's tough to say which of the proposed tax law changes will go the distance and be enacted into law or which will be tossed aside. Additional tax provisions also could be added later. For now, nothing is set in stone. However, financial advisors and taxpayers will want to stay up to date on the president's tax proposals so you're prepared if and when they make it through the legislative process. To get started, let's dive into some of the proposals and what they could mean for you.
As it currently stands, individuals who itemize deductions can claim a maximum of $10,000 for state and local income and property taxes paid in a given year. Proposed changes would raise the state and local tax, or SALT, deduction cap from $10,000 to $80,000 and extend this cap through 2030. The $80,000 SALT cap amount would also apply to the 2021 tax year. In 2031, the SALT deduction cap would be reset to $10,000. This could require some adept planning, depending on the timing of this being enacted into law.
Up until this point, the "wash sale" rule has not applied to cryptoasset transactions because the tax code says that wash sales only apply to shares of stock or securities, neither of which crypto falls under. This loophole has allowed individuals holding crypto to sell their assets, realize the losses, and quickly repurchase the asset at lower prices. However, new legislation will subject crypto transactions to the wash sale rule. That said, if you currently own cryptoassets at a loss, consider selling them before year-end. You can then repurchase the assets immediately afterward and claim the loss on your taxes for 2021. As with all tax planning, it's in your best interest to work with a certified public accountant and have excellent recordkeeping.
Last month's version of the Build Back Better plan would put a stop to "backdoor" Roth IRA contributions beginning in 2022. This popular tactic allows individuals to avoid the Roth IRA contribution limits by making nondeductible contributions to a traditional IRA and then transferring those contributions to a Roth IRA later. This provision is aimed at mega-backdoor conversions as well. Just in case the term sounds unfamiliar, if you're making aftertax contributions to your 401(k) and converting the contributions to a Roth account, either within the 401(k) or in an IRA, you're making a mega-backdoor Roth contribution. In the long run, both strategies let retirement savers take advantage of tax-deferred growth during their accumulation years as well as tax-free withdrawals during retirement. Significant replanning will be needed if this becomes law.
Roth conversions allow you to move money from a pretax IRA or 401(k) into a Roth IRA or Roth 401(k). Of course, you'll have to pay ordinary income tax on the conversion amount in the process. Nonetheless, Roth conversions are a useful strategy if there is a year where you have low income and, subsequently, a low tax rate. However, starting in 2032, previous versions of the proposed plan would eliminate all Roth conversions, particularly if your income exceeds the applicable threshold of $400,000 for single filers or $450,000 for married couples filing jointly. Fortunately, even if this proposal gets signed into law, you'll have 10 years to address and plan for it.
With the exception of cryptoassets, none of the above changes has been discussed in depth in the most recent proposal. Although the debate is likely to continue for some time, the general consensus is that any new laws will pass before year-end. Lastly, while it is prudent to be aware of tax changes, they are not the only factor in decision-making, as holistic financial planning is focused on your goals and priorities.
Samuel Deane is a financial advisor and CEO of Deane Wealth Management, an independent investment advisory firm for millennials in technology. He specializes in comprehensive financial planning, equity compensation, and tax planning. The views expressed in this article do not necessarily reflect the views of Morningstar.