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  • Writer's pictureJohn A. White

What You Need to Know as an Individual Taxpayer

The world of taxation is ever-evolving, and it's crucial for individual taxpayers to stay informed about proposed changes that may impact their financial planning. In this comprehensive guide, we'll explore some of the key tax law changes that are currently being proposed and provide insights on how they may affect you. From income tax rate increases to adjustments in capital gains tax and the expansion of the Net Investment Income Tax, we'll cover it all. So, let's dive in and understand what you need to know to navigate the potential changes in the tax landscape.



Income Tax Rate Increases and Rate Bracket Adjustments

One of the most significant proposed changes is the increase in income tax rates. Under the new proposal, the top individual tax rate for ordinary income would be 39.6%. This higher rate would apply to married individuals filing jointly with taxable income over $450,000, heads of household with taxable income over $425,000, unmarried individuals with taxable income over $400,000, married individuals filing separately with taxable income over $225,000, and trusts and estates with taxable income over $12,500. It's important to note that these changes would only be applicable to taxable years beginning after December 31, 2021.


Additionally, the rate brackets would be adjusted, potentially resulting in a tax rate increase for individuals falling within the upper end of the 32% and 35% rate brackets. These proposed changes highlight the importance of considering income acceleration strategies, maximizing pre-tax contributions to retirement plans, and exploring opportunities for Roth IRA conversions before the new tax rates come into effect.


Capital Gains Tax Rate Increase

Another significant proposed change is the increase in the maximum capital gains tax rate. Currently, the maximum tax rate for capital gains is 20%. However, under the new proposal, this rate would be raised to 25%. The increased rate would apply to sales occurring on or after September 13, 2021, and would also impact Qualified Dividends. It's worth noting that gains from sales made before September 13, 2021, would still be taxed at the existing 20% rate, provided they were reported under the installment method or originated from transactions entered into under binding written contracts before that date.

The potential increase in the capital gains tax rate emphasizes the importance of carefully managing investment decisions and considering strategies such as tax-loss harvesting to offset capital gains with capital losses.


Expansion of the Net Investment Income Tax

The proposed tax law changes also include an expansion of the Net Investment Income Tax (NIIT). Under the current law, the NIIT applies to passive investment income such as interest, dividends, and capital gains. However, the proposed changes aim to expand the definition of net investment income to include any income derived in the ordinary course of business for single filers with taxable income exceeding $400,000 and joint filers exceeding $500,000, effective from January 1, 2022. This expansion has implications for high earners, as it would subject a broader range of income to the 3.8% NIIT.


For individuals with trusts and estates, it's important to note that the NIIT applies to these entities once their income exceeds $13,050 in 2021, with the threshold increasing slightly each year. Therefore, trusts and estates that have ownership of profitable businesses or ownership interests in profitable entities taxed as partnerships may be subject to the NIIT unless the income is distributed to beneficiaries. Considering the potential impact of the expanded NIIT, it becomes crucial to evaluate distribution strategies and assess the overall tax efficiency of trust and estate structures.


The Introduction of a 3% Surcharge on High-Income Individuals, Trusts, and Estates

Under the proposed tax law changes, a new 3% surcharge would be introduced for high-income individuals, trusts, and estates. Effective from January 1, 2022, the surcharge would apply to individual taxpayers with Adjusted Gross Income (AGI) exceeding $5,000,000 ($2,500,000 for married taxpayers filing separately) and trust and estate income exceeding $100,000 per entity.


It's important to understand that this surcharge would apply to AGI in excess of the applicable threshold, which includes both ordinary income and capital gains. This means that individuals, trusts, and estates falling within the high-income category would face an additional tax burden on their overall income. Careful planning becomes crucial to manage AGI and potentially mitigate the impact of the 3% surcharge through strategies such as installment sales or utilizing charitable remainder trusts.


Impact on Small Businesses

Small businesses would also experience changes under the proposed tax laws. The current flat corporate income tax rate of 21% for C corporations would be adjusted to an 18% tax rate on net income up to $400,000, a 21% tax rate on net income up to $5,000,000, and a 26% tax rate on net income exceeding $5,000,000. This adjustment aims to strike a balance between corporate tax rates before the 2017 tax cuts and the current lower rates.

For high-income individuals who claim the 20% deduction for qualified business income (Section 199A deduction), the proposed changes introduce a maximum deduction limit of $500,000 for joint returns, $400,000 for individual returns, $250,000 for married individuals filing separately, and $10,000 for trusts and estates. Additionally, excess business losses for non-corporate taxpayers would be permanently removed.


These changes highlight the importance of carefully evaluating business structures, considering potential conversions from S corporations to C corporations, and exploring tax-efficient strategies to optimize business income and deductions.


Proposed Changes to Retirement Accounts

The proposed tax law changes also address retirement accounts, specifically targeting high-value individual retirement accounts (IRAs) and pension holders. Individuals with combined Roth and traditional IRA and retirement plan accounts exceeding $10 million as of the end of a taxable year may be restricted from making further contributions if their taxable income exceeds $400,000 (or $450,000 for married taxpayers filing jointly). Furthermore, these large account holders would be required to make minimum distributions based on the excess amount over the $10 million limit.


Additionally, the proposed changes aim to eliminate the "backdoor Roth" technique for high earners, which allowed indirect funding of Roth IRAs. These changes underscore the need for careful retirement planning, considering the potential limitations on contributions and exploring alternative wealth preservation strategies outside of traditional retirement accounts.


Implications for Charitable Giving

Charitable giving remains relatively untouched by the proposed tax law changes, except for certain grantor charitable lead annuity trusts. In fact, with the potential increase in income tax brackets, charitable donations may become even more attractive, as they can potentially lead to larger tax deductions. Establishing a family foundation or utilizing charitable remainder trusts may be beneficial for those who anticipate being high earners in the future.

Charitable giving strategies can help individuals achieve their philanthropic goals while potentially optimizing their tax situation. However, it's important to consult with a financial advisor or tax professional to ensure that charitable giving aligns with broader financial objectives.


Miscellaneous Changes and Considerations

Beyond the major proposed tax law changes mentioned above, there are several other noteworthy provisions that individuals should be aware of:

  1. The exclusion on the sale of Section 1202 Qualified Small Business Stock would be limited to 50% of the gain for taxpayers with AGI exceeding $400,000, subject to specific conditions and timing.

  2. Cryptocurrencies, such as Bitcoin and Ethereum, would be subject to constructive and wash sale rules starting from January 1, 2022. Taxpayers should carefully consider the implications of these rules when managing their cryptocurrency investments.

  3. IRAs would no longer be permitted to invest in entities in which the IRA owner has a 10% or greater ownership interest, or if the IRA owner is an officer. This change aims to prevent prohibited transactions and maintain the tax advantages of IRAs.

  4. The IRS is expected to receive increased funding to enforce tax laws and conduct audits, which may lead to more scrutiny and potential tax assessments for taxpayers.

  5. The employer tax credit for wages paid during family and medical leave would expire in 2023.

  6. S-Corporations that elected S-Corp status prior to May 13, 1996, would be allowed to convert tax-free to a partnership within two years following the passage of the proposed tax law. This conversion offers greater flexibility in terms of income distribution and allocation.

It's essential to keep in mind that these proposed tax law changes are subject to review and potential amendments as they progress through the legislative process. Seeking advice from tax professionals and financial advisors becomes crucial to navigate and plan for the potential impact of these changes effectively.


Planning for the Future

As we await the finalization of tax law changes, it's important to plan ahead and consider various strategies to optimize your financial situation. Here are some examples of planning moves to consider:

  1. Complete your estate plan as soon as possible to ensure it aligns with the proposed changes.

  2. Explore opportunities for charitable giving, especially if you have large IRAs, to take advantage of the existing deduction rules.

  3. Evaluate the potential benefits of accelerating income into 2021 to take advantage of the current tax rates.

  4. Consider tax-efficient investment strategies, such as tax-loss harvesting, to manage capital gains and losses effectively.

  5. Review your retirement planning and explore alternative wealth preservation strategies outside of traditional retirement accounts.

  6. Consult with tax professionals and financial advisors to ensure that your financial plans align with the proposed tax law changes.

While planning is crucial, it's important to remain flexible and adaptable as tax laws evolve. Working with trusted professionals can provide valuable guidance in navigating the complexities of the tax landscape and making informed decisions.


Conclusion

Proposed tax law changes have the potential to significantly impact individual taxpayers. From income tax rate increases to adjustments in capital gains tax and the expansion of the Net Investment Income Tax, it's essential to stay informed and proactively plan for the future. By understanding the potential implications and exploring tax-efficient strategies, individuals can navigate these changes while optimizing their overall financial position. Remember to consult with tax professionals and financial advisors to ensure a tailored approach that aligns with your specific circumstances and objectives.


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