On Monday of last week, the House Democrats advanced a tax bill known as the “American Families Plan.” The bill’s goal is to find the revenue needed to fund Biden’s $3.5T spending agenda for climate change, education, health care and other priorities. While the current version of the bill is far from final, key components of the bill are likely to become law. Below I summarize some of its major components and lay out some planning implications. We will continue to monitor developments closely as there are likely some moves our clients might consider taking before the end of the year.
“American Families Plan” – Key Provisions
- Income Tax – The bill proposes increasing the top marginal income tax rate from 37% to 39.6%. But the bigger deal is that the bracket ranges are changing a lot at the top. For example, the top tax bracket for a couple filing jointly and earning between $418k-628K is currently 35%. Under this bill, the 35% bracket shrinks to $418.8k-$450k, the 37% bracket disappears, and anyone over $450k will pay 39.6%.
- Income Surtax – New 3% surtax on individuals and married couples on all income in excess of $5M.
- Capital Gains Tax – Top capital gains rate would increase to 28.8%, from 23.8% for married joint filers with taxable income above $450,000 and single filers above $400,000, retroactive to September 13, 2021.
- Corporate Tax – Plan would raise the corporate tax rate to 26.5% from 21%. Smaller companies (less than $10 million of revenue) would get graduated tax brackets with lower rates.
- Roth Conversions – Prohibits all Roth conversions for taxpayers in the highest ordinary income tax bracket starting 10 years from now
- Backdoor Roth Conversions – Prohibits Roth conversions of after-tax funds in retirement accounts for all taxpayers starting January 1, 2022.
- Large Retirement Accounts – I have yet to read a clear explanation but the bill appears to prohibit further contributions and imposes an immediate RMD (irrespective of the owner’s age) on retirement accounts once the combined total of the retirement accounts reach $10M for owners who have taxable income greater than $400k (single filer) and $450k (joint filers). For accounts totaling between $10M-$20M, the RMD will equal 50% of the amount over $10M each year. For owners with accounts totaling over $20M and who have some Roth assets, they will also be required to distribute 50% of the excess over $10M, but must first distribute the lesser of the total Roth dollars or the amount necessary to bring the total retirement account balances down to $20M.
- Wash Sales – Makes cryptocurrency and other digital assets subject to the wash sale rules.
- Estate Tax Threshold – Reduces the estate tax exemption by 50% starting next year so a couple’s limit would be $11.7M, not $23.4M.
- Grantor Trusts – Attempts to eliminate the estate tax benefits (current loopholes) around certain grantor trusts. In essence, the bill is trying to eliminate the benefits associated with GRATS, SLATS, ILITS, etc.
- Tax Credits – Makes permanent a bunch of now-temporary tax credits, the largest being the child tax credit.
Most of these provisions will really only affect the ultra-wealthy with the notable exception that the change in the income tax brackets and rates will be felt most by folks in the $400-500k income range who will see themselves move from the current 35% bracket to the new 39.6% bracket, as higher earners were already in the 37% bracket will see only a 2.6% increase to 39.6%.
The other provision I am watching carefully is the proposed prohibition on after-tax Roth conversions as this can potentially affect many savers, not just the ultra-wealthy.
But by and large, the bill sticks to Biden’s commitment not to raise taxes on individuals who make less than $400k.
What’s Not in the Bill?
Equally interesting is what didn’t show up in the bill. Here there were few surprises.
- Fixing the Carried Interest Loophole – Biden’s proposal to kill the carried interest loophole by increasing the top cap gains rate to 39.6% for those earning more than $1.0M is nowhere to be seen.
- Elimination the Step-Up in Basis on Death – I’m curious why this one didn’t get included as it has been pointed out in the press that its presence is a key tool the ultra-wealthy use to reduce their taxes.
- Elimination of the SALT Cap – Presumably this cap was not lifted because it is largely only binding on wealthy folks.
- Wealth Tax – The only surtax in the bill is on income, not wealth, in part because of the operational challenges associated with quantifying the latter.
There are a few things that jump out – the more obvious one is that if you have been contributing after-tax dollars to one or more of your retirement accounts, you should think about converting those contributions to Roths before the end of the year.
Other than that, if you think you are going to fall in the new higher tax bracket next year, then you might try to pull in some of that income in 2021, and/or defer tax deductions until 2022. This is always easier said than done but one way to defer deductions would be to delay any charitable giving you anticipate doing between now and year end until 2022.
Finally, if you are sitting on cryptocurrency losses, I’d harvest those losses before the end of the year.
The bill is a watered-down version of what President Biden wanted but still goes a fair distance in fixing some of the more egregious loopholes that have favored the rich. We’ll see what sticks and what doesn’t in the next weeks and will be reporting out as we learn more.