Quarterly Tax Updates – November 2021
The House narrowly passed the centerpiece of President Biden’s domestic agenda on Friday, approving $2.2 trillion in spending over the next decade – the aims to finance more than half of it from tax reforms aimed at wealthy Americans. The plan would raise revenue by levying a tax surcharge on those making more than $10 million a year, raising taxes for some high-income earners and strengthening IRS tax enforcements.
Individual Tax Rates Increase:
House Democrats have proposed a top marginal income tax rate of 39.6% for individuals, part of a sweeping change to the tax code to fund climate investments and an expansion of the U.S. safety net.
That rate, an increase from the current 37% levy for the wealthiest taxpayers, would kick in for single individuals with taxable income over $400,000 and for married couples at $450,000.
This increase has been removed in the latest release of the Build Back Better Framework, thus leaving the top tax rate for the 2021 tax year at 37%.
Millionaire and Billionaire Surtax:
Although the plan currently would not increase the individual tax rates, the plan would impose a new surcharge on the top 0.02% of Americans, according to the White House.
There would be a 5% surtax on modified adjusted gross income of more than $10 million, and an additional 3% (or, a total 8% surtax) on income of more than $25 million.
Thus, someone with income between $10 million and $25 million would pay the ordinary 37 percent income tax rate for wages and salary plus the 5% surtax, for a combined rate of 42%.
And because the tax is imposed on AGI, rather than taxable income, taxpayers would not be allowed to subtract the standard deduction or more likely for this crowd, itemized deductions from income subject to the surtax.
The surtax is estimated to raise $230 billion over 10 years and would go into effect 1/1/2022.
Capital Gains Rates Increase:
House Democrats also proposed raising the top tax rate on capital gains and qualified dividends to 28.8%.
The top federal rate would be 25% on long-term capital gains, which is an increase from the existing 20%. (Long-term capital gains are incurred on appreciated assets sold after more than one year of ownership.) Added to an existing 3.8% surtax on net investment income and the total tax bite would be 28.8%.
The new rate would apply to stock and other asset sales that occur after Sept. 13, 2021; the date House Democrats introduced the tax portions of their legislation.
Similar to the individual tax rate increase, this increase has also been removed in the latest release of the Build Back Better Framework, thus leaving the top rate for the 2021 tax year at 20%.
However, due to the Millionaire and Billionaire Surtax mentioned earlier, Long-Term Capital Gains and most dividends would be taxed at 20 percent plus the 3.8 percent net investment income tax plus the 5 percent surtax (for those with AGI above $10 million) for a combined rate of 28.8 percent.
Retirement Account Law Changes:
The November 3 version of the Build Back Better Framework has resurrected retirement law changes that will curb high balance accounts and popular wealth building strategies including backdoor Roth IRAs and after-tax 401(k) contributions.
There’s also a new $2.5 million retirement account reporting mandate, presumably to help the Internal Revenue Service with compliance. The changes are generally progressive and will hit the wealthiest taxpayers, in order to pay for the social and climate change bill.
The legislation is in flux, but the fact that these provisions were in, then out, then in again, suggests that anything could happen.
The new rules would apply broadly to workplace retirement accounts like 401(k)s and 403(b)s as well as Individual Retirement Accounts (IRAs) and deferred compensation plans. Here are details pulled from the full November 3 text.
Contribution Limits on Large Accounts:
There would be new contribution limits, essentially prohibiting new retirement account contributions for a taxpayer whose aggregate retirement account balances exceeded $10 million in the prior tax year.
It would apply to married couples with taxable income over $450,000 (over $400,000 for singles). There are exceptions for SEP-IRAs, SIMPLE IRAs, and rollovers. But deferred compensation plans are caught up in the new rules.
Also, there are more complicated rules for those whose accounts exceed $20 million. The effective date: December 31, 2028.
New Distribution Rules for Large Accounts:
These same folks would have to take a special minimum withdrawal (50% of the amount over $10 million) from their retirement account in the year following any year the aggregate balance exceeded $10 million. That’s including deferred compensation. Again, there are more complicated rules for those whose accounts exceed $20 million. Effective date: December 31, 2028.
Backdoor Roth Conversions:
The proposal eliminates backdoor Roth IRAs by limiting rollovers and conversions to taxable amounts. In a backdoor Roth, a taxpayer who earns too much to contribute directly to a Roth IRA can now make non-deductible contributions to an IRA and then convert it to a Roth IRA immediately owing no tax, essentially moving the money through the backdoor to a tax-free environment.
The effective date for the crackdown would be after December 31, 2021.
Backdoor Mega Roth’s (After-tax 401(k) Contributions:
The proposal prohibits all employee after-tax contributions in 401(k)s, after December 31, 2021. It also prohibits taxpayers from converting existing after-tax IRA amounts to Roth, also after December 31, 2021.
Both the backdoor Roth’s and backdoor Mega Roth provisions are regardless of income level. Typically, workers start making after-tax contributions, if their employer offers this, once they’ve maxed out their pre-tax and/or Roth salary deferrals.
Roth Conversions:
The proposal eliminates Roth conversions for high-income taxpayers—singles with taxable income over $400,000 and married taxpayers filing jointly with taxable income over $450,000—starting after December 31, 2031.
Information Reporting:
The proposed information reporting requirement says that plan administrators—like Fidelity or whoever runs the day-to-day of your workplace retirement account—must report annually to the IRS a list of account holders, or their beneficiaries, with retirement account balances of at least $2.5 million.
The information report will also include what portion of the account is in the Roth bucket, if any, as opposed to the pre-tax bucket. Effective date: December 31, 2028.
Why would the IRS need to know this? Presumably Congress is trying to get a better handle on how many large tax-favored retirement accounts are out there.
The danger: Once Congress sees how many $2.5 million accounts are out there, the definition of an outsized account potentially could be reduced from $10 million.
Former President Barack Obama had proposed a cap on retirement account contributions once total accounts reached the $3.4 million, based on a formula of how much annual income could be generated.
State and Local Tax (SALT) Deduction:
Another addition in the framework is the easing of limits on the state and local tax deduction, known as SALT.
Back in 2017, Republicans passed the $10,000 SALT deduction cap as part of their tax law, as a way to help offset the cost of tax cuts elsewhere in the bill. The cap is currently scheduled to expire after 2025.
The most recent version of the House’s bill would raise the cap from $10,000 to $80,000, holding it at that level through 2030. The cap would then revert back to $10,000 for 2031.
But note that House Democrats are developing a proposal that takes a different approach, keeping the cap at $10,000 and making it permanent, but including an exemption from the limit for taxpayers with income under a level between $400,000 and $550,000.
Business Income Tax Proposals:
There are two provisions in the framework related to business income.
One would apply a 3.8% Medicare surtax to all income from pass-through businesses and another would limit a tax break on business losses for the wealthy. The reforms would raise $250 billion and $170 billion, respectively, over a decade, according to estimates.
Currently, the owners of most pass-through businesses are subject to a 3.8% self-employment tax or net investment income tax. (Such businesses, like sole proprietorships and partnerships, pass their earnings to owners’ individual tax returns.)
However, some profits (namely, those of S corporations) aren’t subject to the 3.8% net investment income tax, which was created by the Affordable Care Act to fund Medicare expansion. The proposal would close this loophole for wealthy business owners.
It would apply to single taxpayers with more than $400,000 in taxable income or married couples filing a joint return with more than $500,000 in taxable income.
The second proposal is also somewhat vague on business losses. But the House tax proposal last month, which contained a similar measure, may offer a clue; it would permanently disallow excess business losses (meaning, net tax deductions that exceed their business income).
This applies to businesses that aren’t structured as a corporation. Both provisions would kick in after Dec. 31.
Additional Items not in the Framework:
No change to Section 199A deduction.
No change to lifetime estate and gift tax exemption amount. It will be $12,060,000 in 2022.
No changes to grantor trust rules.
No changes to 1031 exchange rules.
New 2022 IRS Income Tax Brackets and Phaseouts:
On Nov. 10, 2021, the IRS announced inflation adjustments for 2022 affecting standard deductions, tax brackets, and more. The changes—effective when you file in 2023—are the result of higher inflation in 2021. These adjustments, which apply to more than 60 tax provisions, are made annually by the IRS to avoid bracket creep or the pushing of taxpayers into higher tax brackets due to inflation.
The tax items for tax year 2022 of greatest interest to most taxpayers include the following dollar amounts:
Standard Deduction:
The standard deduction for married couples filing jointly for tax year 2022 rises to $25,900 up $800 from the prior year. For single taxpayers and married individuals filing separately, the standard deduction rises to $12,950 for 2022, up $400, and for heads of households, the standard deduction will be $19,400 for tax year 2022, up $600.
Tax Brackets:
Marginal Rates: For tax year 2022, the top tax rate remains 37% for individual single taxpayers with incomes greater than $539,900 ($647,850 for married couples filing jointly).
The other rates are:
35%, for incomes over $215,950 ($431,900 for married couples filing jointly);
32% for incomes over $170,050 ($340,100 for married couples filing jointly);
24% for incomes over $89,075 ($178,150 for married couples filing jointly);
22% for incomes over $41,775 ($83,550 for married couples filing jointly);
12% for incomes over $10,275 ($20,550 for married couples filing jointly).
The lowest rate is 10% for incomes of single individuals with incomes of $10,275 or less ($20,550 for married couples filing jointly).
Itemized Deduction:
For 2022, as in 2021, 2020, 2019 and 2018, there is no limitation on itemized deductions, as that limitation was eliminated by the Tax Cuts and Jobs Act.
Alternative Minimum Tax (AMT):
The Alternative Minimum Tax exemption amount for tax year 2022 is $75,900 and begins to phase out at $539,900 ($118,100 for married couples filing jointly for whom the exemption begins to phase out at $1,079,800). The 2021 exemption amount was $73,600 and began to phase out at $523,600 ($114,600 for married couples filing jointly for whom the exemption began to phase out at $1,047,200).
Earned Income Tax Credit:
The tax year 2022 maximum Earned Income Tax Credit amount is $6,935 for qualifying taxpayers who have three or more qualifying children, up from $6,728 for tax year 2021. The revenue procedure contains a table providing maximum EITC amount for other categories, income thresholds and phase-outs.
Health Flexible Spending Accounts:
For the taxable years beginning in 2022, the dollar limitation for employee salary reductions for contributions to health flexible spending arrangements increases to $2,850. For cafeteria plans that permit the carryover of unused amounts, the maximum carryover amount is $570, an increase of $20 from taxable years beginning in 2021.
Estate and Gift Tax Exemption:
Estates of decedents who die during 2022 have a basic exclusion amount of $12,060,000, up from a total of $11,700,000 for estates of decedents who died in 2021.
The annual exclusion for gifts increases to $16,000 for calendar year 2022, up from $15,000 for calendar year 2021.
401(k) Contribution Limits:
The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan is increased to $20,500, up from $19,500.
IRA Contribution Limits:
The income ranges for determining eligibility to make deductible contributions to traditional Individual Retirement Arrangements (IRAs), to contribute to Roth IRAs, and to claim the Saver's Credit all increased for 2022.
Taxpayers can deduct contributions to a traditional IRA if they meet certain conditions. If during the year either the taxpayer or the taxpayer's spouse was covered by a retirement plan at work, the deduction may be reduced, or phased out, until it is eliminated, depending on filing status and income. (If neither the taxpayer nor the spouse is covered by a retirement plan at work, the phase-outs of the deduction do not apply.) Here are the phase-out ranges for 2022:
For single taxpayers covered by a workplace retirement plan, the phase-out range is increased to $68,000 to $78,000, up from $66,000 to $76,000.
For married couples filing jointly, if the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is increased to $109,000 to $129,000, up from $105,000 to $125,000.
For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the phase-out range is increased to $204,000 to $214,000, up from $198,000 to $208,000.
For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
Roth IRA Contribution Limits:
The income phase-out range for taxpayers making contributions to a Roth IRA is increased to $129,000 to $144,000 for singles and heads of household, up from $125,000 to $140,000.
For married couples filing jointly, the income phase-out range is increased to $204,000 to $214,000, up from $198,000 to $208,000.
The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
SIMPLE IRA Contribution Limits:
The amount individuals can contribute to their SIMPLE retirement accounts is increased to $14,000, up from $13,500.
Acknowledgements and Contacts
This publication was prepared by AWM Capital Tax LLC. If you may have any questions regarding any of the topics discussed above, please feel free to reach out to our team for additional assistance:
Robert D. McConchie
Partner
AWM Capital Tax LLC
Robert@awmcapitaltax.com
Jay A. Santana
Senior Tax Manager
AWM Capital Tax LLC
JSantana@awmcapitaltax.com