Year-End Tax Planning for New Tax Laws: Individual Taxes

President Biden and the House Ways & Means Committee have proposed a number of significant tax changes as part of the American Families Plan. If enacted, we could see some new tax laws starting as soon as 2022.

This time of year is always ideal for year-end tax planning with only a few months left to prepare for 2022. It’s a good time to review your returns and tax liabilities for this year, so you can make adjustments to better position yourself for next year’s taxes. Now, with potential tax changes looming, it’s even more important to be prepared and alter your tax plan, estate plan and overall financial plan. You can take advantage of certain tax breaks and credits while they are still available. You can plan for the new codes to protect your financial assets, reduce tax liabilities and benefit from any of these tax changes that could help you.

This will be a three-part article series. This first post will cover the individual tax change proposals you will want to know about within the American Families Plan and how they might affect your year-end tax planning for 2021. The second and third articles will cover business taxes and estate taxes, respectively.

Here are some of the most notable individual tax changes being proposed by the House Ways & Means Committee:

New Income Tax Rates

A key part of the new tax plan proposal is to return the top ordinary income tax bracket to 39.6%. It was reduced to 37% in 2018 after the Tax Cuts and Jobs Act (TCJA) was passed. The American Families Plan aims to undo this change and “permanently” reinstall the rate to 39.6% starting in 2022. In addition, the income milestones would be lowered for single and joint taxpayers to fall into this highest income tax bracket. This will impact high-income taxpayers without affecting low-to-medium tax brackets at all.

New Capital Gains Rates

A new top long-term capital gains rate of 25% is also being proposed. It would affect any capital gains earned after September 14, 2021. Unfortunately, taxpayers with large unrealized capital gains would not be able to sell their assets before the rate hike, but there is still effective tax planning you can do if you are selling in the near future.

Net Investment Income Tax (NIIT)

Profits from S corporations are currently not subject to employment taxes or the Net Investment Income Tax (NIIT). The American Families Plan would change this. Certain high-income S corporation owners exceeding a predetermined Modified Adjusted Gross Income (MAGI) threshold ($500,000 for single filers or $500,000 for joint filers) would be subject to the 3.8% NIIT.

Additional Surtax for Ultra-High-Income Taxpayers

For those taxpayers with ultra-high incomes ($5 million or more), there will be a new 3% surtax. This will only affect a small number of taxpayers at this level, but it is very significant to understand and plan for if you are at this income level.

After-Tax Conversions

Section 138311 of the proposed tax plan would prohibit conversions of after-tax dollars held in retirement accounts (both 401(k)s and other IRAs). This effectively eliminates backdoor retirement savings strategies such as the “Backdoor Roth IRA” or the “Mega-Backdoor Roth IRA” and could significantly affect how you contribute to, manage and withdraw from individual and employer-sponsored retirement accounts in the future.

New Required Minimum Distributions

The bill also proposes new required minimum distribution (RMD) amounts for individuals who have a high income and large retirement accounts (over $10 million). RMDs would also be required on Roth IRAs totaling over $20 million. Roth IRAs were not subject to RMDs in the past, so this is a major change for those with ultra-high retirement savings.

Roth IRA Contribution Limits

If an individual’s Adjusted Taxable Income (ATI) exceeds the threshold ($400,000 for single filers or $500,000 for joint filers) AND their total retirement accounts exceed $10 million, they will not be allowed to make any further IRA contributions.

Expanded Childcare Credit

The American Rescue Plan enacted earlier this year increased the Child Tax Credit from $2,000 to $3,000. The American Families Plan aims to expand it even further to $3,600 for children under the age of six. The credit is fully refundable and would be extended through 2025.

Wash Sale Rules

The new bill essentially would close a current loophole that has enabled some investors to generate realized losses to offset other gains. This is a common practice for cryptocurrency investors and is known as a “wash sale.” This particular loophole would become no more starting in 2022, so it may be time to take advantage of it while you still can.

It should come as no surprise that these tax changes are aimed primarily at higher-income taxpayers as Biden has promised. If any of these proposed tax alterations affect you, you will definitely want to adjust your financial plan and tax strategies to protect yourself and your assets. Now is the time for year-end tax planning, and it is even more critical with major tax changes are likely on the horizon for 2022.

For help with all your tax planning and financial planning needs, contact Illumination Wealth today for an introductory consultation with one of our leading advisors.