Unless you’ve been living under a rock (or just completely avoid the news, in which case let me know your secrets), you are aware that 2021 has ushered in a new presidential administration. And as is the case with any incoming administration, changes to the tax code sits close to the top of the list in priority.
In this post, I’ve outlined some of the proposed changes to the tax code along with some examples of how the change may affect taxpayers. Of course, this list is not exhaustive, but highlights the key changes to the individual taxpayer. It should also be noted that nothing has yet to be signed into law and many alterations to these changes are to be expected moving forward.
Flat Retirement Contribution Credit of 26%
Currently, for every dollar you contribute to a 401k/employer plan today, you save taxes at your marginal tax rate. So if you are in the 32% tax bracket, if you contributed $15,000 you would save ~$4800 in taxes.
The proposed changes institute a flat 26% credit, so in the above example this would mean a tax savings of $3900, or about $800 in additional tax liability.
For higher income earners, this may mean it could become more beneficial to contribute to your Roth options within your retirement plan, while for lower income earners the pre-tax option may become more advantageous. It could be a reversal in previous thinking about how to best save within your employer plan.
Tax Increase for Income Over $400,000
The Biden administration has proposed a tax increase back to pre-TCJA levels for those earning greater than $400,000. All those earning less than $400,000 will have the same brackets as they did after the 2017 TCJA. Below is a chart of the current and proposed tax brackets.
Expand Social Security Tax for income above $400,000.
For 2020, income is only subject to FICA tax on the first $137,000 of income. The proposed changes adds additional FICA taxes on income above $400,000, creating a ‘tax donut hole.’ So all income $137,000 and below would be subject to FICA taxes, income between $137,000 and $400,000 would not be subject to any additional FICA, but all income over $400,000 would be added and subject to FICA taxes. This is visually depicted below.
Cap the Itemized Deduction Tax Benefit at 28%
If you itemize deductions today you are doing so at your current marginal rate. For example, if you are in the 35% tax bracket and have $30,000 of itemized deductions, the tax value of this deduction is $10,500 ($30,000 * 0.35). The proposed changes would limit the deduction to 28%, meaning in the previous example the tax value of the itemized deductions would now be $8,400 ($30,000 * 0.28), or a $2,100 increase in taxes.
Elimination of Long-Term Capital Gains treatment for Income over $1M
Currently, when you sell an investment/property/asset that has been held for more than 1 year for a gain, the maximum you can expect to pay on this gain is 20% (not including net investment income tax of 3.8%). The proposed changes would make those with income over $1M pay ordinary income tax rates as opposed to long-term capital gains rates.
So in effect, if your income is over $1M that would put you in the highest tax bracket, which is proposed to change to 39.6%. If you were to sell an asset for a gain in this scenario, your expected tax liability would almost double from 20% to 39.6%. There are still a few unanswered questions (such as would the full amount of gain be taxed at ordinary income or just the amount over $1M), but this change can certainly affect tax strategies if you plan on selling an asset, property, or business.
Elimination of the Step-Up in Basis Upon Death
If someone owns an asset, say a property, with a cost basis of $100,000 and a value of $500,000, they have a gain of $400,000 which they would pay tax on if they sold. If you were to inherit this asset upon their death, current provisions allow for a ‘step-up’ in basis, meaning your new cost basis in the property in $500,000, thus meaning you would owe no tax. The proposed changes work to eliminate this provision, and instead would keep the cost basis at $100,000, meaning whenever you sold the property your gain would be much higher.
There many things to think through with this change, as many inherited assets are illiquid and it can also be quite difficult to obtain cost basis information, particularly for assets that have been transferred of held for many years.
If you have questions about how these changes may affect your situation, we encourage you to visit us at FivePoints Financial Planning or schedule a complimentary phone call to see how our services can benefit you.
Andrew Langdon, CFP®, EA, MBA is a fiduciary fee-only financial planner who specializes in serving veterinarians in their pursuit of practice ownership.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Andrew Langdon, and all rights are reserved. Read the full Disclaimer.
