Looks like affluent investors can relax over the holidays after all! Many of them are off the hook from the tax hikes embedded in the Biden administration’s $1.8 trillion “Build Back Better” Act. Almost 4.5 million folks making between $369,300 and $884,900 will actually pay $4,340 less in federal tax in 2022 under the tax and spending bill recently approved by the House of Representatives and now in the Senate.
Investors can still take advantage of a longstanding loophole to pass on wealth to heirs, who won’t have to pay taxes on gains in assets that accumulated before they were inherited. There’s no tax on the paper profits of millionaires and billionaires. The top ordinary federal rate of 37% remains unchanged, as does the 23.8% capital gains rate. The long-standing tax benefits of grantor trusts, a mainstay of estate planning that’s used to pass on wealth to heirs, remain in place.
So far it looks as though the average federal tax rate of those making between $500,000 and $1 million would nudge down to 27.2% next year from the current 28.1%. Almost 22 million Americans had a net worth over $1 million in 2020, and will breathe a sigh of relief for sure. But the ultra-wealthy don’t get a free pass. The bill places a $10 million cap on IRAs. Backdoor Roth conversions, where an investor can put up to $58,000 a year into a 401(k) account and convert much of the money to a tax-free Roth account, would be banned come January 1, 2022.
In addition, high earners making more than $10 million a year would pay a 5% surtax on their incomes, including wages, capital gains and dividends. Those making more than $25 million would pay an 8% levy. This “millionaires’ surtax,” although painful, is still considerably less painful than earlier proposals.
Hard hit will be people who own small businesses or participate in partnerships and receive a chunk of their profits. Investors with interests in pass-through entities who make more than $400,000 ($500,000 for couples) would pay the existing 3.8% NIIT if they don’t already. The levy, which falls on capital gains, dividends, rental income and passive income, has an identical counterpart for people who earn wages. The “levy” was expanded because many affluent business owners avoid tax by improperly casting income as profits rather than wages.
Investors who have stock in start-ups should be concerned as well, since the bill will slice the tax benefits of qualified small business stock to 50% for individuals earning more than $400,000 and for trusts and estates.
Senate Democrats are expressing confidence they can pass President Joe Biden’s Build Back Better agenda before Christmas. Actually, the bill must pass before January 15th, when the first monthly child tax credit payment of up to $300 per child would go out. The last payment under current law will be distributed December 15th. We are waiting to see if the S.A.L.T. deduction is restored and to what degree. We are also keeping our eye on a provision that creates a huge planning opportunity for some S corporations. It gives certain S corporations a two-year window to reorganize as partnerships without any negative tax impact.
Reach Out to Us: This bill, as passed by the House, is trimmed of many of the original tax provisions. The most threatening provisions were eliminated, like the increase in capital gains tax to 25%, the higher 39.6% marginal income tax rate increase, and the 26.5% top rate for corps, as well as the 3% surcharge for corporations with income above $10 million. Many clients who are high earners with income coming through a partnership might get hit. Medical and dental practices, as well as real estate investors, should begin to plan now, even though the bill is unclear on what kind of pass-through businesses would be affected. Questions can be emailed to CPA@fuoco.com or call toll free 855-542-7537.
