Tax Law Changes Coming
Among the most heavily discussed Democratic proposals is the increase in income tax rates, raising tax rates on ordinary income to 39.6% for individuals. The new rate would apply to married individuals who file jointly with taxable income over $450,000, to heads of households with taxable income over $425,000, to unmarried individuals with taxable income over $400,000, to married individuals filing separate returns with taxable income over $225,000, and to trusts and estates with taxable income over $12,500, as adjusted for inflation in future tax years.
Beyond the increase in tax rates, the rate brackets would also be modified with individuals on the upper end of the 32% and 35% rate brackets at risk of a potential tax rate increase as a result.
Individuals should also consider that they may have to pay more in income taxes due to the limitations on the 20% Section 199A Qualified Business deduction, a 3% surcharge on ultra-high earners, and the 3.8% Net Investment Income Tax that will now apply to active business income for high earners. There is a lot of math to run through before you will have an answer as to what your real effective income tax rate will be (the answer is, higher). It could be worse as the federal income tax rates were 70% in the 1970's, and have previously been as high as 90%.
The following should be helpful:
Top Individual Rates
The current top individual rate is 37%. The proposal is to raise that to 39.6% effective January 1, 2022.
C-Corporations are currently taxed at a flat 21%. A graduated rate is proposed, 18% on the first $400,000, 21% on income up to $5 Million, and a 26.5% rate on income in excess of $10,000,000. These rates are still significantly lower than what the corporate tax rates were before the 2017 tax cuts.
Capital Gains taxes would be raised immediately from 20% to 25% for transactions originating after September 13, 2021.
Irrevocable 'Grantor Trusts'
Currently irrevocable 'Grantor Trusts' typically are not included in a grantor's estate (and transfers are not subject to sales tax). Future trusts and future transfers would be included in the 'deemed owner's estate' and would be subject to sales tax.
Roth IRA Contributions
Roth IRA contributions can currently be made irrespective of the owner's account balance. Effective January 1, 2022, high income earners would be prohibited from contributing past $10 Million.
Net Investment Income
The definition of 'Net Investment Income' for the 3.8% Net Investment Income Tax under Code Section 1411 would be broadened to include any income derived in the ordinary course of business for single filers with more than $400,000 in taxable income ($500K for joint filers) effective January 1, 2022. Currently the 3.8% tax generally applies only to passive investment income (interest, dividends, gain on the sale of stock, etc.). This could impact filers who have S-Corp status for business ventures which may encourage S-Corporations to covert to C-Corporations!
The Net Investment Income Tax would also apply to trust and estate income beginning at $13,050 of net taxable income in 2021 (inflation adjusted). Most trusts and estates that have ownership of profitable businesses or ownership interests in profitable entities that are taxed as partnerships would be subject to the 3.8% tax except to the extent that the income received is paid out to beneficiaries.
New 3% Surcharge on High Income Individuals
A new 3% surcharge on high income individuals, and trusts and estates beginning January 1, 2022 would apply to individual taxpayers to the extent they have Adjusted Gross Income in excess of $5 Million ($2.5 Million if married filing separately) and on trust and estate income exceeding $100,000 per trust or estate. This proposed surcharge would apply to AGI in excess of the threshold. AGI includes ordinary and capital gains, and is not decreased by charitable deductions (or any other itemized deduction). The result would impose this tax for most taxpayers when a business or other large asset is sold for a gain.
The 199A Deduction
The 199A deduction for qualified business income would be limited to $500,000 for joint returns, $400,000 for individual returns, $250,000 for a married individual filing a separate return, and $10,000 for a trust or estate.
Limits on Contributions to IRA (or Roth) Accounts
No additional contributions to IRA (or Roth) accounts would be allowed if the combined balance is greater than $10 Million and the account holder has taxable income over $400,000 or if the account is jointly held by a married couple with taxable income exceeding $450,000.
IRAs would no longer be allowed to invest in entities in which the IRA owner has a 10% or greater ownership interest (presently 50%), or if the IRA owner is an officer. This will be considered an IRA requirement rather than a prohibited transaction, which means that if the IRA invests even a small part of its holdings in such a business the entire IRA would be disqualified resulting in loss of creditor protection status and having taxes apply as if the IRA was liquidated.
The IRS would receive approximately $80 Billion to enforce the tax law and presumably audit many more taxpayers.
Planning to Plan?
What actually will be passed is likely to change. Organize your information and be prepared to get properly positioned once changes are passed (IF THEY ARE)!
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