Did you know that today’s tax rates are some of the lowest Americans have ever experienced since the federal tax code was first adopted in 1913? Too bad they won’t stay that way, at least if President Joe Biden has any influence on what he has in store for us and the U.S.
Although we are already up to our eyeballs in debt, President Biden has proposed a $2.3 trillion “infrastructure” plan known as the American Jobs Plan. The plan would last for eight years and would be paid back, at least in theory, over 15 years. The proposal includes:
- $447 billion to modernize our transportation infrastructure. It would fix 20,000 miles of roads and repair 10,000 bridges, and upgrade public transit, airports, water transit and ports
- $400 billion to help in-home care for the aging and those with disabilities
- $350 billion to retrofit and build more affordable housing as well as constructing and upgrading public schools
- $300 billion to assist the manufacturing industry and small businesses
- $180 billion for research and development
- $174 billion to encourage the manufacture and purchase of more electric vehicles
- $111 billion to enhance our water infrastructure including the elimination of lead pipes from water supplies
- $100 billion to expand broadband internet to rural areas
- $100 billion to modernize the electric grid and make it less susceptible to blackouts
How do all these projects get paid? You guessed it . . . by raising taxes. Although the specifics of the plan are hazy and much negotiation will likely be needed before a bill is signed into law, it is better to be forewarned and learn about the issues now. Planning ahead? . . . “Imagine That™”!
Corporate Tax Increases Are First on the Agenda
As early as January 2022, corporate tax rates could increase from 21% to 28%. U.S. based companies could also be faced with an increase in the tax rate to 21% for any international corporate income they earn.
A 15% minimum tax has also been proposed to be levied on what is called “book income” that large corporations have to report to investors as opposed to what they show on their tax return, which is generally much lower. Biden’s plan would also make it harder for U.S. companies to merge or acquire a foreign business to avoid paying these tax hikes.
Tax Increases for Individuals are Not Too Far Behind
In addition to the $2.3 trillion plan for infrastructure, President Biden will soon be coming out with another spending proposal called the American Families Plan and the total of both plans is estimated to be around $4 trillion. The second proposal will be funded by changes in tax laws for individuals and will address “human infrastructure,” whatever that means. Although there will certainly be lots of deliberation in Congress before anything becomes approved into law, some of the possible changes in the tax law which may take place are as follows:
- Increasing the tax rate for families/individuals making over $400k to 39.6%. Currently, the top federal tax rate is 37%. It is unclear whether the tax increase will be for families or individuals making over $400k, but if you are in this situation, consider using strategies to reduce your income
- Strategies: Fully fund your retirement plans, open a profit sharing or defined benefit pension plan, make charitable donations, convert investments to a more long-term capital gains focus, and bunch deductions into the same tax year to get the most bang for your buck
- Getting rid of 1031 tax-deferred exchanges for real estate
- Strategies: 1031 tax-deferred exchanges are difficult to complete because you need to find replacement property within 45 days of the sale of the first property and the replacement property must be purchased within 180 days. Even if the 1031 exchange goes away, there are as many as ten other strategies that can be used to defer or eliminate taxes on the sale of appreciated real estate. Please contact me if you are in this situation and we can discuss your situation
- Eliminating the step-up in basis at death and possibly creating a taxable event when heirs receive assets. Currently, those who inherit assets may pay little in capital gains tax because they pay tax only on the difference between the value on the date of death and the value when they sell the asset. This provision may be the least likely proposal to garner enough support to be included in a bill, but it still is a possibility
- Strategies: If this provision should become law, use active efforts to bring down the gains in an investment portfolio. This can be accomplished by rebalancing your investments at least annually (and even more often if the market experiences turbulence), transferring low-basis investments to lower income family members, making gifts, and providing donations to charities
- Deductions to IRAs, 401(k)s and similar accounts may be replaced with a 26% credit. The thinking here is this proposal would make funding retirement accounts more attractive to lower income investors by offering a tax credit verses a tax deduction
- Strategies: Affluent investors should consider funding after-tax accounts, such as a Roth IRA or Roth 401(k), because investors would otherwise not receive the full deduction of their retirement contributions
- Increasing the long-term capital gains tax to 39.6% on gains of $1 million or more. The current Federal long-term capital gains rate is 20% and there is a 3.8% Medicare tax
- Strategies: To avoid paying the 39.6% tax, plus the 3.8% Medicare tax, look at deferring income or reducing income by gifting appreciated assets to charity, using a technique called “tax-loss harvesting,” funding retirement plans, increasing business deductions, and accelerating deductions where possible
- Reducing the federal estate tax exemption to as low as $7 million for couples ($3.5 million for individuals). Currently, couples can have $23.4 million and individuals $11.7 million before facing federal estate taxation. The consensus is that if the estate tax exemption is reduced and you have something done before the law is passed, you will be “grandfathered in” and not affected by the new law
- Strategies: If you do not have estate documents drafted and your estate is larger than the $7 million/$3.5 million exemption amount, consider hiring an estate planning attorney to have something drafted before the law is passed. As well, for some of our higher net worth clients, they are funding trusts to the highest level possible now to remove assets from future estate taxes
- Increasing the federal estate tax to 45%. Currently, the rate is 40%
- Strategies: See above regarding the federal estate tax exemption
- Reducing the federal gift tax to $2 million for couples ($1 million for individuals)
- Strategies: Gift more than $1 million before the law is passed to avoid the tax. Especially for parents who have children or others they wish to help purchase a home, using this technique before the law changes will be extremely helpful. Combine this with the first-time home buyer credit to be discussed below
- Several estate planning tools will no longer be available. If this provision is adopted, you will not be able to fund or have assets sold to an Irrevocable Trust which can be disregarded for income tax purposes. In most circumstances, you will not be able to use what is called a Grantor Retained Annuity Trust (GRAT) to transfer assets at a potential discount. Further, valuation adjustment techniques overall would not be allowed
- Strategies: Arrangements made before the law is in place should be okay and will be considered “grandfathered in,” if they are not added to or altered after the law is passed. Consider the potential benefit of a GRAT before the law is passed. As well, gifting assets into a trust with a valuation adjustment to “compress” valuations may also make good sense depending upon the size of your estate
- The maximum amount of itemized deductions will be capped at 28% for those earning over $400k. It is unclear whether the tax increase will be for families or individuals making over $400k
- Strategies: You may need to stagger gifts and donations to charities to make sure your deductions are under 28% of your income, as well as other itemized deductions like property taxes, home mortgage interest, etc.
Tax Credits are also Being Proposed for Certain Classes of People
Tax credits are more beneficial than a tax deduction because it is an amount of money the taxpayer can directly subtract from the taxes owed to the government. Deductions, on the other hand, merely reduce the amount of taxable income. Here are three proposed tax credits that are being considered:
- The Earned Income Tax Credit (EITC) will be expanded to workers age 65 and older who do not have children living at home. Currently, those age 65 and older cannot claim this credit. EITC is designed to help low- and moderate-income workers receive a tax break by reducing the amount of income taxes they pay
- Strategy: If you are in this situation, help your children find another suitable place to live so you can receive the EITC
- The Child and Dependent Care Tax Credit will be increased to $8k for one child and $16k for two or more children. Currently, the credit for children under age 13 is up to $4,000 for one child or $8,000 for two or more children
- Strategy: This tax credit only applies for out-of-pocket expenses for childcare while you are working or looking for employment. If you are working from home due to the coronavirus, you will need to hire someone to take care of your children while you are working if you want to receive this credit
- A first-time home buyer tax credit of $15k. Currently there is no credit for first-time home purchasers but there is interest in restoring this credit previously available
- Strategy: If you are a first-time home buyer, you may want to delay the purchase of a home to see if this credit is enacted into law. If so, you will then be able to take advantage of the credit when you buy your first home. Interestingly, the credit would be paid when you purchase a home rather than waiting until you file your tax return in the following year
Conclusion: Steps can be Taken to Minimize the Possible Tax Increases
We do not know which of the above provisions will be adopted into law. But with President Biden’s goal of spending $4 trillion on his two proposals, we know the money has to come from somewhere. And that somewhere is from taxes, which will need to be increased to pay for all this spending by our federal government.
It is better to be forewarned and learn about the issues now, rather than be ignorant of the impending changes. If you would like to discuss any of these tax issues, or any other concerns you may have, we offer a 20-minute free consultation. . . “Imagine That™”!
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Written by R. J. Kelly – April 2021
Image credit: unknown author, Canva, one design use license