On Monday, September 13, 2021, the House Way and Means Committee released a detailed proposal of the tax overhaul that President Biden promised. The legislation was designed to help pay for spending on the President’s social program. This new legislation proposal is part of his longer-term economic plan.
Essentially, the Democrats are looking for a way to generate about $3.5 trillion in revenue to offset the cost. In part, the Build Back Better program wants monthly payments to parents, universal pre-k, free community college and paid family leave.
- The new tax proposal takes aim at wealthy Americans and big corporations.
- While not as big as some had foreseen, taxes are going up for many Americans
- Retirement account investors take the brunt of the new proposal
Basics of the New Legislation Proposal
The Ways and Means committee is generally the body that introduces new tax legislation. There are other committees who are putting together other aspects of this trillion dollar package. The provisions listed in the proposal will look to be included in that spending package.
Democrats are mostly in favor of raising taxes on the rich and big corporations. However, since they only hold the slim majority of the vote in the House, they can’t afford to have any dissenters on their side. Some dems have even expressed concern over President Biden’s proposal of tax increases earlier in 2021.
The tax increases would generate about $2.1 trillion in revenue over the next decade. The plan would raise about $871 billion in new revenue after certain tax breaks. Of course, the legislation would need to pass through both the House and Senate, before continuing on to the President. The reconciliation bill would contain these new tax legislation, if and when, all proposals are agreed upon.
Below, we’ll summarize the proposed tax changes, that could affect millions of Americans. If you are a wealthy American or own a corporation, you must be aware of these potential changes. It’s important to keep in mind that these proposals are not final, yet. There will be some give and take before a final bill is formally introduced.
- The top Individual tax rate would increase from 37% to 39.6%.
- There would be an additional 3% “surcharge tax” for those earning more than $5 million.
- Increase the top capital gains rate from 20% to 25%. Note: this could be effective for all sales after September 13, 2021, unless there’s a written binding contract.
- Expand the “Net Investment Income” tax.
- Increases the holding period for carried interest from three years to five years to receive long-term capital gains treatment. Note: If you have less than $400,000 in income, the three year period is retained.
- The exclusion rate for qualified small business stock (QSBS) would be limited to 50% if you have more than $400,000 in income. The exclusion will remain 100% for those earning less.
- The unified tax credit for estates (which now stands at $24 million for joint filers) would be reduced to $5 million per individual. The expiration of the current exemption would expire at the end of 2021.
- Another estate planning provision is the valuation rules. There will be no discount when transferring non-business assets for “transfer tax purposes.”
- The corporate tax rate will be increased to 26.5%, which is lower than what has been mentioned in the past.
- No step-up in basis proposal. The 3% surcharge to those earning $5 million would eliminate the need for this legislation.
Taking all these tax proposals into account, a New York City resident could be paying 61.2% in taxes! This is when you combine all federal, state and local taxes for those earning more than $5 million. This is just one example of how the new legislation proposal can affect Americans.
In addition to the tax changes, there are many provisions in the proposal that deal with retirement accounts. This is on the heals of the reported $5 billion Roth IRA owned by Peter Thiel. The legislation would limit the amount of wealth one can hold in these tax-advantaged plans.
Here are the key points from a retirement investor’s standpoint:
- Limits contributions to a traditional or Roth IRA if your total retirement savings is over $10 million. This includes IRAs and defined benefit plans, such as 401(k) plans.
- The above limit would apply to those earning more than $400,000 or $450,000 for those who file jointly.
- New required distributions for IRAs: If you exceed $10 million in combined retirement savings in a given year, you must distribute at least 50% of the excess amount.
- If you exceed $20 million, you must withdraw from 401(k) plans and Roth IRAs first. These rules apply to those with $400,000 ($450,000 if married filing jointly) in annual income.
- The elimination of the Backdoor Roth IRA. If you are above the above-mentioned income limits, you can no longer convert to a Roth IRA. This would go into effect after 12/31/31.
- The elimination of the Mega Backdoor Roth strategy. No longer can you contribute after-tax funds into your workplace plan, or convert after-tax contributions to an IRA. This applies to everyone!
- You would be prohibited of holding assets that require accredited investor status with IRA funds. For example, you couldn’t use your IRA to invest in private placements.
- Extend the statute of limitations from three to six years on IRAs, giving the IRS more time to find asset valuation and prohibited transaction violations.
- Reduces the 50% threshold to 10% of controlling interest in an entity to be able to invest your IRA in that entity. If you own 10% of a business, you can no longer invest your IRA in that business.
- Provide the IRS with approximately $80 billion to help them with tax enforcement and update information technology.
This could be bad news, not only for the super-rich, but everyday Americans. No longer can you use retirement funds to invest in a new startup or an entity you have very little invested in. Plus, you cannot be afforded the tax-free treatment of a Roth if your investments do really well.
A Final Word
It bears repeating that this new legislation proposal is not final. Not all Democrats are on board, including chairman of the Senate Financial Committee, Ron Wyden. Obviously, this bill would not pass through both the House and Senate as is. There is some opposition already from Democrats. Senator Wyden may seek bigger changes. The tax implications are not as severe as reports have indicated. Will it be enough to satisfy all Democrats? Only time will tell!