The latest tax legislation released by the House Ways and Means Committee on September 13th includes several impactful tax proposals, deviating substantially on some issues from the American Families Plan released by the Biden administration in April. This legislation creates several potential implications for an extremely small subset of the population such as ultra-high net worth families, taxpayers with more than $5 million of annual income, or individuals who have built IRAs in excess of $10 million.
Rather than cover all the details of the legislation or the strategies that only apply to a very narrow subset of the population, we highlight five immediate planning strategies that would have broader reach if the legislation passes. Of course, there is still a lot of political jockeying to be had and hills to be climbed before any of this becomes law so it would be wise to treat the following as actionable suggestions if the legislation passes in its current form.
1) High income earners should accelerate income into 2021.
This becomes relevant for married taxpayers (married filing jointly – MFJ) with taxable income above $450,000 and single taxpayers with taxable income above $400,000. For example, a single taxpayer with $400,000 of taxable income in 2021 will pay 35% federal tax on an additional dollar of income in 2021 versus 39.6% on an additional dollar of income in 2022 – assuming the current legislation passes. In the event it does become law, business owners or other individuals who can accelerate the recognition of income (excluding capital gains) into 2021 at the lower tax rates would be advised to do so.
2) High income earners should defer discretionary deductions to 2022.
Married taxpayers with income in excess of $450,000 and single taxpayers with income in excess of $400,000 who expect that income to be relatively consistent in 2022 would be well-served to defer discretionary deductions (i.e., charitable contributions)1 to 2022 if the current legislation become law. Such deductions become more valuable in 2022 under the latest legislation – saving as much as 4.6% for every dollar of deductions next year versus this year. It is also worth noting that any changes to the “SALT” deduction – which were not part of the original legislation but seem likely to be added – would further increase the advantage of deferring deductions to 2022 for many taxpayers.
3) Anyone with after-tax dollars in a 401k plan or an IRA needs to consider a Roth conversion before year-end.
The new legislation – if enacted – would prohibit the conversion of after-tax dollars to a Roth account after December 31, 2021. This means that anyone who has after-tax contributions in an IRA or 401k would have until year-end to convert those dollars to a Roth account. Should they? In the case of individuals with after-tax dollars in a 401k, the answer is an emphatic yes – provided the employer allows in-service distributions. In the case of individuals with after-tax dollars in an IRA, the answer depends on a number of variables with the most important variable being the amount of after-tax dollars relative to the total value of IRA assets.
4) Anyone who planned to do a backdoor Roth contribution for 2021 should get it done before year-end.
This December 2020 post outlined ten predictions for the next decade with one being the termination of backdoor Roth contributions (prediction #8). Unfortunately, one of those predictions may come true in the first year if the recent legislation passes and any conversions of after-tax dollars are no longer permitted. As a result, anyone who was planning to wait until early 2022 to make backdoor Roth contributions for the 2021 tax year (normally a deadline of April 15) should go ahead and complete the full backdoor Roth process (contribution and conversion) before year-end. There is no harm to making the backdoor contribution this calendar year whereas procrastinating until early 2022 could result in a lost opportunity.
5) Harvest capital losses – but maybe not until 2022.
Because the legislation release date (September 13) is the specific line of demarcation for the new, higher capital gains tax rate of 25%, there is no benefit for most taxpayers2 to recognize gains before year-end in hopes of avoiding higher rates next year.3 That said, a higher capital gains tax rate increases the value of tax loss harvesting for high income taxpayers as the offsetting losses would now provide greater tax benefit.4
But before anyone starts harvesting capital losses (assuming the legislation passes), it is worth evaluating whether such losses will be more valuable in 2021 or 2022. It really boils down to whether the losses would offset gains/income from 2021 or from future gains/income. If the losses would be offsetting capital gains realized before September 13th, 2021, then it may actually be better to defer realizing those losses until 2022 when they will be more valuable.
Closing Comments
Again, all of these recommendations are based on a piece of legislation that still has many hills in front of it. If you are a Golden Bell client, you can rest assured that we are actively monitoring the legislation and that we will reach out to you (if not already) about any of these strategies that require action or evaluation for your unique situation. In the meantime, do not hesitate to contact us if you have any questions about the legislation or the strategies summarized above.
- Other deductions such as the mortgage interest deduction would also be more valuable in 2022 but tends to be less discretionary
- Notably, there might be an advantage for ultra-high earners with more than $5 million of annual income to recognize gains in 2021 to avoid the new 3% surtax in 2022.
- The new 25% tax rate would apply for capital gains realized after September 13th for married taxpayers with income >$450,000 and single taxpayers with income >$400,000.
- Either as a $3,000 offset to the higher ordinary income rates or as an offset to realized capital gains that would otherwise be taxed at 25%.