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Tax Consequence Of Biden’s Tax Plan

Income Tax Rates

For tax years beginning after 2021, the top ordinary income tax rate for individual taxable income will rise to 39.6 percent, which will start at a lower threshold amount.

  • Single $400,000.
  • Married Filing Jointly $450,000.
  • Married Filing Separately $225,000.
  • Head of Household $425,000.
  • Estates and trusts $12,500.

If you reach the age of 72 years in 2021, your first RMD should be taken before December 31, 2021, to avoid bunching two years of RMDs into 2022 and accelerating income into the lower tax-rate year.

The highest tax rates apply to estates and trusts earning over $12,500 per year. Nevertheless, this is a mere fraction of the income at which the highest rates apply to individuals who may be beneficiaries.

Solutions

  • It still makes sense to defer income and accelerate deductions if you earn less than these projected tax levels (for 2021 year-end planning). If you expect to be subject to the higher rates in 2022, it might be advisable to reverse this strategy.
  • Reverse income tax planning is another approach. The suggestion is that high-income taxpayers accelerate income into 2021. For example, cash-basis taxpayers can send invoices and collect payment before the end of the year.
  • Consider a Roth IRA conversion in 2021. It is advisable to do a back-door Roth IRA contribution and conversion before December 31, 2021. Please take note: For seniors on Medicare, their modified adjusted gross income in 2021 will determine whether and to what extent there is a surcharge on Part B and Part D.
  • Request your employer to pre-pay an upcoming 2022 bonus in 2021.
  • Defer business deductions like equipment and furniture acquisitions to 2022, while cash-basis taxpayers should consider deferring expense payments until 2022.
  • Required Minimum Distributions (RMDs) from retirement plans and IRAs are effective for 2021. If you have reached your starting date or are a beneficiary, who needs to take RMDs, do so in 2021.
  • For 2021, consider accelerating your income while the rates are low. Complex non-grantor trusts pay their own income tax. Distributions carry income out to the beneficiaries who are taxed at a lower rate.

A case in point

Accumulation trusts created after the Secure Act changed the rules by eliminating stretch-IRA motivated some taxpayers to make funds payable to protect their plan assets. However, if all the plan assets are distributed after ten years following the plan holder’s death, those funds will likely hit the new highest rate.

Income Tax Surcharge

Under the BBBA, the modified adjusted gross income of individuals, estates, and trusts above specific amounts will pay an additional three percent in taxes. Modified adjusted gross income = adjusted gross income – the deduction for investment interest.

  • The extra three percent would be effective for tax years that begin after 2021.
  • For single filers, heads of households, and joint filers, the threshold amount is $5 million.
  • For married taxpayers filing separately, it is $5 million.
  • For estates and trusts, it is $100,000.
  • The $100,000 threshold for trusts and estates will push trust income to a 42.6 percent tax rate before adding state and local taxes.

Solution

  • Some taxpayers changed their beneficiaries to trusts after the Secure Act eliminated the stretch IRA. Under the Secure Act, you must pay out the entire balance at the end of year ten following the plan holder’s death. The resultant tax rate will now be 42.6 percent on all plan balances.
  • If the funds were distributed to a beneficiary, the marginal tax bracket would be only 22 percent.
  • Naming trusts as beneficiaries require precaution: consider the protection provided by a trust versus the individual beneficiary’s possible lower income tax rate.

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Capital Gain Rates

Current Law

Graduated rates apply to a person’s long-term capital gains and qualified dividends and depend on the amount of taxable income.

At breakpoints adjusted annually for inflation, the rate goes up from zero percent to fifteen percent, to twenty percent, and so on.

Biden’s Law

Graduated rates apply to a person’s long-term capital gains and qualified dividends and depend on the amount of taxable income.

Taking effect for tax years that end after September 13, 2021:

  • A 25 percent rate replaces the top 20 percent rate.
  • In addition, the breakpoint where the 25 percent rate begins is lowered to align with the income amounts applicable for the new 39.6 percent ordinary income bracket.

The low-end breakpoints remain the same.

TRANSITION RULE for tax years that include September 13, 2021:

  • It makes the 20 percent rate applicable for sales and exchanges before and the 25 percent rate applicable for sales and exchanges after September 13, 2021.

Solution

  • Use an instalment sale for property sales to spread the gain over many years and bring the taxpayer’s taxable income down to 15 or 20 percent rather than 25 percent.

Net Investment Income Tax

Under Biden’s BBBA, the scope of net investment income (NII) tax expands to apply to all business income. As a result, effective for tax years beginning after 2021 and excluding income where FICA is already imposed, the following taxpayers that materially, participate in the trade or business will no longer be exempt from the 3.8 percent tax:

  • S corporation shareholders
  • Limited Partners
  • LLC members

S corporation structures and a strategy to pay distributions from the pass-through entity instead of a high salary becomes moot. Once enacted, this will require a complete strategy reassessment.

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Code Sec. 199A Qualified Business Income Deduction

Current Law

Between 2017 and 2026, taxpayers can deduct 20 percent of the qualified business income from an S corporation, partnership, or sole proprietorship.

The regulations excluded income earned by certain enterprises, including law, medicine, and others.

Biden’s Law

The proposed law puts a cap on the deduction amount and significantly limits Code Sec.199A deductions for wealthy taxpayers, effective for tax years beginning after 2021.

The proposed legislation caps trust at $10,000. This is a deal-breaker – it will eliminate trust-owned real estate and trust-owned qualifying businesses from participation. In addition, it will be challenging to evaluate gifts to trusts that include rental real estate or business interests that qualify for the Code Sec. 199A deduction for qualified business income.

Retirement Plans

IRA Restrictions for High-Balance Plans

High-Income Taxpayer

  • A taxpayer subject to the new 39.6 percent tax rate or the 25-percent rate on long-term capital gains.

BBBA targets high-income taxpayers

  • In the crosshairs are high-income taxpayers with $10 million retirement plan balances, effective for tax years beginning after December 31, 2021.

Contributions

The BBBA prohibits these individuals from contributing to a Roth or traditional IRA for any tax year if the total value of the individual’s IRA and defined contribution retirement account exceeded $10 million at the end of the previous year.

  • 401(k), 403(b), and 475(b) balances are included.
  • Amounts rolled over, including payments received upon death, divorce, or separation, are not subject to this limit.

RMDs

High-income individuals with aggregate vested balances between $10 and $20 million will face RMDs that increased to 50 percent.

  • The total RMD amount can still come from any IRA or employer plan
  • The excess amount above $20 million – must be distributed from Roth IRAs and Roth designated accounts into defined contribution plans up to the lesser of:
    • The sum needed to bring the balance in all the accounts down to $20 million
    • The aggregate balance of the Roth IRAs and designated Roth accounts in defined contribution plans.

After distributing the excess required under the 100 percent distribution rule, the taxpayer can select the accounts from which to distribute to satisfy the 50 percent distribution rule. Effective for tax years beginning after December 31, 2021

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