Saturday, October 23, 2021

Eleven Changes in House Tax Proposal May Affect Your Clients

They may need to sell off some IRA holdings and take other steps, says advisor who read the entire 881-page text.

John Gehri
John Gehri

The U.S. House of Representative’s Ways and Means Committee rolled out a new 881-page tax proposal in mid-September and I read through the full text. It covered a number of topics that will likely be relevant to our clients and yours.  What struck me the most was some of the areas that were included as well as those that were not.

The full text of the bill is available here.

Child Tax Care Credit, pages 358 – 423

The proposal seeks to extend the program through December 2025. It includes an inflation adjustment identical to the calculation used for IRA accounts and phase out ranges similar to the 2021 credits.  Modified adjusted gross income (MAGI) of less than $150,000 for a joint return and MAGI less than $112,500 for a head of household or single return will result in the full credit amount; these credits phase out at $400,000 for joint, $300,000 for head of household and $200,000 for single.

This section of the bill also includes a penalty period in which the credit can’t be claimed of ten years for fraud and two years for reckless disregard if this credit is claimed in error.  Here is an article Monica Dwyer and I wrote for more about this topic: Child Tax Credit May Cause Client Confusion.

Corporate Tax Reforms, pages 525 – 630

The top proposed rate is 26.5% for amounts in excess of $5,000,000 in taxable income but the proposal includes a 3% surcharge on amounts in excess of $10,000,000 in taxable income. This provision has the potential to slow down hiring as business owners will see their profits decline.

Wash Sale Updates, pages 630 – 636

This new proposal contains a significant expansion of the rules on wash sales, which involve the purchase and sale of a security at a loss and then buying a substantially similar security in the next 30 days. Unlike the current rules, the proposed rules will not include just the taxpayer but also the spouse (even if a joint return is not filed) and all dependents along with corporations, partnerships, trusts, estates, et. al over which any of these persons have control.  This proposal also includes all IRA accounts, Health Savings Accounts, 529 accounts (either as the participant or the beneficiary), annuities and 457 deferred compensation arrangements.

This is a really big deal because complying with the intent of the rules will increase the time required to compile the records needed to determine if a wash sale is present. The new proposed changing are also likely to cause reporting issues for families that don’t ordinarily share this type of information. These proposed rules will also for the first time include cryptocurrencies and it will make them subject to the same rules as other securities.

Individual Income Tax Rates, pages 636 – 641

The highest proposed rate is set to increase to 39.6% for couples over $450,000 of taxable income and singles in excess of $400,000 of taxable income. This would be an increase from the 37% rate currently in place. The proposal doesn’t specify the full breakout of all the brackets.

Capital Gains Tax Rates, pages 641 – 646

The capital gains rate is set to increase from 20% to 25% for those in the 39.6% tax bracket.  For a client with $200,000 of long-term capital gains this will mean an additional $10,000 in capital gains taxes.

Estate Taxes, page 654

The proposal would decrease from $11,700,000 to $5,000,000 the amount of assets that can be passed to a non-spouse as an inheritance without triggering the estate tax.  The issue of portability in which the surviving spouse can utilize the unused exemption of the first to pass was not addressed.  This topic may require a client to update his or her estate plan.

Retirement Plans, pages 665 – 686

The sum of all accounts will be limited to $10,000,000 per person in any year when taxable income exceeds $400,000 for a single taxpayer, $425,000 for a head of household or $450,000 for a joint return.  Any person in this position will be prevented from making additional annual contributions to any plan.  This person will also be required to withdraw 50% of the excess amount from the plans.  If the balance exceeds $20,000,000, the excess removal must first be done with money from Roth accounts.  Workplace plans in excess of $2,500,000 will also be required to file an informational return with the IRS akin to the 5498 reporting for IRA accounts.  Deferrals to Roth 401(k) plans will no longer be permitted.

Roth Conversions, pages 686 – 689

In a huge shift, only taxable amounts will be permitted to be converted. This will eliminate both the back door Roth IRA as well as Mega Roth 401(k) strategies.  No Roth conversions will be permitted in a year in which the taxable income of a taxpayer exceeds $400,000 for a single taxpayer, $425,000 for a head of household or $450,000 for a joint return. Families that wish to use a back door Roth IRA and Mega Roth 401(k) strategies would have to do this by December 31, 2021 Clients would be well advised to look at this now as this may be the last year to use these strategies.

Limitations: IRA Investments, pages 689 – 698

Account owners would no longer be permitted to place or have funds in vehicles that are permissible only for accredited investors such as primate placements and hedge funds.  Funds that are currently invested in this manner must be removed from the offending vehicles by December 31, 2023.  Failure to do so will cause the full balance of the account to be deemed distributed to the taxpayer under IRC 4975 and subject to penalties that can be equal to the amount of the prohibited investment.

While the bill doesn’t require that IRA funds be limited to publicly traded stocks, bonds and mutual funds, the proposal would for all practical purposes force taxpayers to only invest in things that are traded on public exchanges.  Anything that requires being a high-net-worth investor would be banned in an IRA. The text would also prohibit using entities like an LLC which the IRA owns to make the investments since the IRA owner would own more than 10% of the entity.

Those who have one of these disallowed investments would either need to sell (if that is even possible) or take a tax reportable distribution that will most likely also be subject to penalties. Those with these investments may wish to speak to the sponsors sooner rather than later. These investments are often illiquid and may have very limited options to sell the position. These limitations would certainly reduce investment choice for those who have been primarily investing through retirement plans.

Tobacco, pages 714 – 723

As part of the funding mechanism, the federal taxes on the products listed in this section are scheduled to increase. This includes small and large cigarettes, small and large cigars, smokeless and pipe tobacco, as well as other products. Many of these products are set to see a doubling of the tax due in 2022.

Prescription Drug Prices, pages 759 – 825

The government will set the price of widely used drugs and will force drug manufacturers to sell them at the listed prices.  Failure to comply will result in financial penalties along with excise taxes for the manufacturers.  While this may result in savings for consumers, it may come at the cost of reduced research and development in the long term and fewer choices for treatments in the near term due to availability.  Take the time to review your health plan and discuss treatment options with your providers if this is a concern (and encourage clients to do the same).

Step-Up In Basis – Not Included

 One item of note that was not included in this bill was the removal of the step-up in basis at death.  This was widely anticipated and would have meant that although assets are included as part of a taxable estate heirs would retain the original basis of the property and pay gains upon the sale or other disposition.

As we look to year-end planning and Congress works the bill through the legislative process, these topics will serve as discussion points with clients. These provisions presenting opportunities for some and challenges for others.  We should all be honored that our clients are relying on us to provide the guidance they need to navigate this as part of achieving their goals.  Let’s make it happen.

John M. Gehri, CFP, ChFC is an advisor with Harvest Financial Advisors in the Cincinnati/West Chester, Ohio area. John may be reached at john@harvestadvisors.com.

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