Biden Tax Plan Details and What They Could Mean for Your Finances
Biden’s nearly $2 trillion social-spending and tax bill eponymously titled the “Build Back Better Bill”, passed the House in November and is currently working its way towards a vote in the Senate. Democratic leaders are facing a tough road through an evenly split Senate and a very arduous budget process, so much is still to be determined as far as what the final legislation will look like. Nonetheless, even a pared-back version of the bill could prove to be one of the biggest pieces of legislation and one of the most impactful for working people and the middle class since the Great Society and War on Poverty in the 1960s. The bill would provide a variety of environmental provisions, provide federal funding and support for education and child care, and attempt to tackle the rising costs of life-saving prescription drugs. In order to pay for it, though, many proposed tax law changes are on the table, including higher taxes on the wealthy alongside many enhancements to certain tax credits for lower- and middle-income families. In this article, we dive into some of the key Biden tax plan details and what they could mean for your finances.
A Surtax on Wealthy Americans
A big part of Biden’s tax plan is focused on forcing wealthy Americans to pay their “fair share” to help cover the costs of the planned social spending provisions. Negotiations have proved rather contentious at times in attempts to determine exactly how the additional taxes should look.
Democrats went back and forth on various proposals, including raising the top income tax rate, eliminating the discounted long-term capital gains tax rate, removing the step-up in basis on inherited property, and a “billionaires tax” on the value of unsold assets.
Ultimately, the House settled on a “surtax” on millionaires and billionaires that will begin in 2022. The additional surtax would equate to 5% of modified adjusted gross income from $10 million to $25 million (or $5 million to $12.5 million for married filing separately taxpayers). Modified adjusted gross income is simply your regular adjusted gross income minus any deduction allowed for investment interest.
What it Could Mean for Your Finances: Unless you’re earning $5 million per year or more (as a single filer or married filing separately taxpayer), or $10 million per year or more (as a married filing jointly taxpayer), this surtax will not affect you in any way.
If you are above those thresholds, however, you can expect to see an increase in your overall tax burden. As a result, make sure you are setting aside additional amounts from your earnings to cover the added surtax and work with your licensed tax professional to determine the best plan of action for managing the additional burden.
No More Mega Backdoor Roth IRA, Backdoor Roths, and Other Retirement Savings
One of the more newsworthy and prominent provisions proposed in the new bill would curb the ability of wealthy individuals to take advantage of current tax loopholes and rules around tax-advantaged retirement savings accounts.
For one, the ability to make IRA contributions would be eliminated beginning in 2029 if the total value of your IRA and defined contribution plans (e.g., 401(k), 403(b), and 457 plans) hits or exceeds $10 million, and your modified adjusted gross income exceeds:
- $400,000 for single filers;
- $425,000 for head-of-household filers; or
- $450,000 for joint filers.
Additionally, a new required minimum distribution (RMD) rule would go into effect in 2029 as well for taxpayers that meet the above criteria. Current RMD rules are only tied to age instead of wealth and Roth IRA’s, specifically, are not subject to these distribution rules under current law.
While the proposed formula for calculating the distribution amount is complex, taxpayers could generally expect to have to withdraw 50% of IRA accounts valued at more than $10 million, and 100% of Roth accounts over $20 million.
Other proposed changes in the bill would eventually completely eliminate backdoor Roth IRA conversions and mega backdoor Roth conversions. Under current rules, wealthy taxpayers that exceed the Roth IRA income limits for contributions can use backdoor Roth conversions (in IRA’s and with after-tax accounts) as a way to get money into tax-free accounts.
However, the Build Back Better bill would put an end to any after-tax contributions in 401(k) and other workplace plans and IRAs from being converted to Roth savings, regardless of income level, beginning January 1, 2022.
Secondly, pre-tax savings in IRAs and workplace retirement plans would no longer be eligible for Roth conversions if your income levels exceed those mentioned above. Those rules would take effect beginning January 1, 2032.
What it Could Mean for Your Finances: If you meet the income or wealth limits mentioned above, the new rules could have a dramatic effect on your retirement savings strategy, and now is a good time to meet with your financial planner to discuss alternative options.
One particular strategy that wealthy taxpayers might start leveraging more is permanent life insurance policies like whole life and variable universal life that have a cash value component that grows tax-deferred and can be accessed in tax-advantaged ways.
Determining what will make the most sense for you will require taking into account your entire financial picture and working closely with your trusted advisors to find the most suitable solutions.
An Expanded Surtax on Net Investment Income
For single or head-of-household taxpayers with a modified adjusted gross income over $200,000, joint filers with a modified AGI over $250,000, or married filing separately taxpayers with a modified AGI over $125,000, an additional 3.8% surtax could be levied on net investment income under the new Build Back Better bill. Net investment income includes, among other things, taxable interest, dividends, gains, passive rents, annuities, and royalties. This surtax would be in addition to the capital gains tax already in force.
Starting in 2022, the surtax would also be expanded to cover net investment income derived in the ordinary course of a trade or business for single or head-of-household filers with a modified AGI over $400,000, joint filers with a modified AGI over $500,000, or married filing separately taxpayers with a modified AGI over $250,000. This surtax would not apply to wages on which Social Security and Medicare payroll taxes are already imposed (e.g. W-2 wages paid to owners of S corporations).
What it Could Mean for Your Finances: This particular piece of the new legislation is likely to impact wide swaths of the middle class, especially business owners and real estate investors. If you fall within the criteria explained above, and you own a business and/or investment real estate, get ready to pay more taxes and start working with your licensed tax professional to help you find more ways to maximize your tax deductions, especially if you are on the cusp of the income limits. There likely won’t be any loopholes for avoiding this tax, so maximizing tax deductions may be the only way to reduce it.
Permanent Elimination of Excess Business Loss Deduction
Under current law, non-corporate business owners (e.g. limited liability companies, partnerships, sole proprietors, etc.) cannot deduct business losses exceeding $250,000 ($500,000 for joint filers) on Schedule C of Form 1040. However, losses exceeding that amount can be carried forward into later tax years.
This rule is currently set to expire in 2027, but the Build Back Better bill would be made permanent retroactively beginning with the 2021 tax year. In other words, carried forward business losses from previous tax years would not be allowed in 2021.
Going forward, the bill would also only allow excess losses to be carried forward for the next tax year and no further. The bill would also repeal the limit on excess farm losses for farmers who received certain subsidies.
What it Could Mean for Your Finances: If you are a business owner, you may have relied on excess business losses in previous tax years to mitigate your tax burden going forward in more recent years. With this potentially going away, you may need to be more strategic with how and when you realize revenue and expenses.
For example, you might accelerate or postpone certain expenses towards the end of the tax year, or you might postpone receiving payment for services rendered to the next tax year when possible, especially if you are using the cash basis method for accounting. Make sure to work closely with your licensed tax professional to determine what’s best for your tax picture going forward.
Modified SALT Deduction Cap
Under current rules, there is a $10,000 cap on the itemized deduction for state and local taxes (SALT) until the TCJA of 2017 sunsets in 2026, but the new legislation would increase the limit to $80,000 for 2021 to 2030, then go back down to $10,000 for 2031.
Since wealthier taxpayers often itemize deductions (rather than claiming the standard deduction), this change would, for the most part, provide a tax cut rather than a tax increase for wealthier taxpayers. Seeing that the new bill is largely aimed at increasing taxes on wealthier taxpayers, this is a rather odd proposal all things considered.
What it Could Mean for Your Finances: This proposed change is good news for any taxpayers that are able to benefit from itemizing deductions as opposed to claiming the standard deduction. However, this would only be applicable (and therefore beneficial) if you live in a state or city that levies a state or local income tax. If you live in a state or city that does not have state or local income taxes, this proposed rule change will not benefit nor impact you in any way, and it will otherwise be business as usual for you.
Adding Wash Sale Rules to Cryptocurrency and Other Assets
In general, if you sell an investment holding like a stock or security at a loss and, within 30 days before or after this sale, you buy a “substantially identical” stock or security, the IRS will not allow you to take a tax deduction for the realized capital loss. This is known as the “wash sale” rule and is designed to prohibit taxpayers from claiming artificial losses for the sole purpose of reducing their tax liability.
For capital losses not subject to the wash sale rule, the IRS allows a maximum tax deduction of up to $3,000 for single filers or taxpayers who are married filing jointly and $1,500 for taxpayers who are married filing separately. Additionally, any excess losses from the sale(s) can be carried forward indefinitely and deducted (according to the aforementioned limits) in future tax years.
Currently, commodities, currencies, and digital assets such as cryptocurrency do not fall under these rules, but that would change with the new legislation, and the wash sale rules would be applied. Considering that digital assets like cryptocurrencies are already in the mainstream and so many taxpayers are investing in them, it’s no surprise the Biden administration is looking to eliminate taxpayers’ ability to apply the same rules that govern stocks and other securities.
What it Could Mean for Your Finances: If you invest in commodities, currencies, and/or digital assets, you’ll need to pay extra attention to when you buy and sell holdings to avoid any wash sale restrictions. To ensure you don’t violate the wash sale rules, all you need to do after realizing a capital loss is wait at least 31 days before repurchasing a “substantially identical” position.
However, if, for whatever reason, you do violate the wash sale rules, you won’t be able to take the tax deduction on the loss, but the loss can be added to the costs basis of the newly purchased position. This means a smaller gain (and therefore a smaller tax burden), or a bigger loss (that can be deducted and carried forward according to the limits above) are both possible as a result.
Final Thoughts on the Biden Tax Plan Details
This is by no means an exhaustive list of all the proposed changes. For example, there are many tax credits that are proposed for lower-income families that were not covered in this article. Nonetheless, the point is clear: if the new Build Back Better bill passes Congress, many tax law changes are bound to happen that could impact you and many others in significant ways. If you or your loved ones have questions, need help navigating these changes, or simply want to get a better grip on your finances, we can help! Simply click here to schedule a free one-on-one consultation with one of our expert advisors to discuss!