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Tax Policy Update and Year-End Strategies to Consider - Podcast

| October 13, 2021
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In today's episode Nicholas Olesen, CFP®, CPWA® recaps the latest on tax proposals, how they could change your taxes and savings strategies,  and what actions you should consider before the end of the year. 

As you have probably already heard, there are tax increases coming and they are far reaching. A few of the highlights we cover in the show:

  • Increase the top marginal income tax rate to 39.6% for individuals earning more than $400,000, joint filers above $450,000, and head of household filers above $425,000. This is a HUGE change, as it decreases where the top bracket starts from $600,000 down to $450,000 for joint filers. For those with income over $450,000 you will see a sharp increase.
  • Raise the top long-term capital gains rate from 20% to 25% for those same folks (add in 3.8% NIIT and it’s actually 28.8%)
  • Add a 3% tax on incomes of over $5 million.
  • Add a 3% tax to partnerships and certain businesses, along with removing the QBI deduction. This is another HUGE change for many we serve.
  • Eliminate Roth IRA Conversions for higher income earners
  • Prohibits ALL employee after-tax contributions and prohibits after-tax IRA contributions no matter the income level, which is a great strategy we covered here: Back-Door Roth IRA

You can find a transcript below.

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Please send us feedback and any topic or questions you would like us to cover.  Email us at: nolesen@kathmere.com 

Transcript from today’s show:

Hi, thanks for joining us on. My name is Nicholas Olesen, Director of Private Wealth here at Kathmere Capital. As we have kind of talked about the last few episodes, it feels like we're going to touch on taxes again. And back in the early summer, we had the, the Senate come out with a proposal on their taxes and we just received a few weeks back the house ways and means committee putting together this language around this tax increase and what that'll look like.


Now we'd been waiting to put together this episode in hopes that they would actually come out with a full plan and bill that we could then actually dive into and talk, talk through. Unfortunately, they're still negotiating still talking about it, but it is important. You know, we are entering the fourth quarter of 2021.

And so it's important for you to think about these without just a few days or a few weeks to go to a plan for that. Let's dive right in. We're going to break this up into kind of two different sections here or, or maybe a few. One is going to be on the individual side, you know, both true taxes for your, for individuals.

We're going to look at the transfer taxes, I E estate or gift taxes. We're going to look at this interesting language that they put in on an irrevocable, grantor trust, which is something that we use for clients. And I thought it'd be interesting to touch on here. And then we're going to wrap it up by talking about the retirement plan side, IRA side, and corporate.

So let's start off on the individual side. This one is going to be the one that probably affects more people than the other. As you probably saw, you know, again, this came out about a month ago. Now we're just touching on it here, though. They have increased or, or propose to increase the marginal tax rate, the highest tax rate to 39.6% for a married filing.

And that's for those with incomes over four 50. Now this is a huge shift. This was originally six or as of today, 600,000 in income is what it takes to reach the top marginal bracket there. Now, moving that all the way down. 450 and increasing the rate to 39.6. So we're seeing a really, very large increase for those individuals that make over 450,000, but a drastic difference for those that make over 600, because all of a sudden now 150,000 of your income is taxed 4.6% more than it was. So a really big change, the proposal that they put in there as the effective date of the end of this calendar year. So as I, as I talked to with a client of ours just before I jumped on this podcast, If you can show income this year, please show it because next year you're going to actually get hurt quite a bit.

The other thing that they did is they added another tax code section to impose a search tax equal to 3% of [00:03:00] your modified, adjusted current income. If your income exceeds 5 million. So again, this is a very small part of the population, but they're really trying to target those high earners. High-income wagers with this extra, additional 3% tax on top of it.

And then the one that, that affects a lot of our clients and a lot of individuals is their increase in the long-term capital gains rate. So for those high income earners that we have, your income is. You are, your taxes are going up on your income, but they're also trying to capture this on the long-term capital gains rate.

They're reversing what happened in 2017 tax cut. And they're going back to a 25% long-term capital gains tax rate. And again, don't forget the net income investment income tax, that 3.8%. That is on top of that. And so that'll get you up to a 28 points. Now again, if you have, you know, income, that's over 5 million, they're adding that 3% on top of it.

So it actually gets to the 31.8% for those high income earners with investment income. So, this is a big one, and this is, this is also the tricky part in that they released this and said it's effective today. So as of September 13th in the language originally, I don't think this is going to actually stick, but as of September 13th, these new rates apply now have a really hard time believing, you know, they have gotten away with this in the past before, but they did it early, early in the year and just said effective January 1st that starts.

It's going to be very interesting to see how they navigate this, if you will, or if they actually do add this on the other thing that they did is, is they expanded and this is this this one hit, this one, had a lot of our client's heart. And this is if this goes through, and this is a frustrating one is they are attacking a 3.8% net investment income for trade or business tax.

If your income is over 400,000 as an individual or 500,000 as a joint. And that's also tacking on for states and trusts. Now what's really interesting and, and going to be tricky and how they navigate this is that net investment income tax. Again, here at what it's called, it's called net investment income tax it's 3.8%. That should be on investment. But they're actually going through it and they're tacking on to partnership income for a business distribution, things along those lines. So that's really hard. We're seeing almost a 4% increase in individuals tax for those high income earners, tack that on top of the fact that they've already increased it from 37 to 39.6, it means that you are seeing a number of our clients have a 5% or an 8% increase on their effective taxes for their income.

So some things to consider, you know, if you can, and this is why I wanted to put this out beginning of the quarter versus waiting until they actually pass. This is you might want to accelerate your ordinary taxable. Not capital gain tax income specifically, but in 2021, if you can increase your taxes, your income showing if you're a business and you can accelerate your income to show this year, you really want to do that because if you're in that [00:06:00] higher bracket, you're getting.

The other side of it is you might want to defer any deductions until 2022. Again, we talked to a client just last week and said, Hey, I know that you guys are charitable. I know you have a lot of things you're doing in the business, and you want to have those expenses show up this year because you want a lower tax bill this year.

But with the expectations, the taxes are higher, we expect and we re we would recommend. The other thing that we are looking at on the trust and estate side of things is distribute income to beneficiaries now and do it for beneficiaries that are lower marginal tax brackets in the future. So if you can, somehow in, in the way that those trusts can be, if you can distribute some income, start doing that now, before they start getting her.

Now as far as capital gains, you know, they do need to be sold. You can borrow against them instead of selling it to forget this capital gains issue. There are a lot of accounts that we could do that for, for clients. If they need. The other thing that we're looking at on the deferred comp side is we are looking at a lot of different qualified plans and non-qualified different compensation plans starting in 2022, you know, new plans coming on for these businesses that have really high wages and high earners, and they want to make sure they can defer that income into maybe the future when the taxes will be lower or their personal taxes.

And the last one is really cash value, life insurance. It might be a means to accumulate wealth. That's really tax efficient with these higher tax rates on this investment income. So those might become a more interesting if you will, or more applicable for those that have the means to really save into them well, and, you know, good health and all that.

Now let's, let's transition into this, you know, gifting and a state tax. One thing that we knew was probably coming as this kind of was a surprise to nobody was that they are going back and reverting the gift and estate lifetime gift and estate tax exclusions back to the 2010 levels.

But, but inflating it for inflation. So the lifetime exclusion amount will be reduced down to 6.03 million in 2022. Okay. All that I'm talking about today are the proposals. We'll see if they come through this one, though. I would be surprised if this does not. When we look at that, you know, one thing that we recommend and you need to work with an attorney, you need to look at these.

So these are not direct recommendations for anybody, but things to consider are making large gifts to beneficiaries or a trust for their benefit and allocate an increased estate and gift tax exclusion amount before 2021. So that you can remove this while we still have the lifetime exemption. That is about double what it's going to be in 2020.

One strategy that we recommend looking into and talking to a good estate attorney about is having one spouse. Again, if a married couple have one spouse use their full lifetime exemption at under today's law and have the other one, not so interesting. One that that's how. Then you might want to consider if you're in that situation now to touch on an interesting trust or a trust that we've looked at and use for some clients.

And so therefore we expect others have probably looked at it or seen it or used it. Isn't you revokable grant tortured. This new proposal actually adds another [00:09:00] tax code section. That's going to include the deceased individuals, grossest state, any portion of that went to an irrevocable grantor trust for which they were deemed an owner for tax reasons.

They're going to treat that distribution that it actually was a gift and they're therefore treated that when they passed away, it gets included. Back into their estate. Typically if you do it right, these are excluded from it. But they're trying to pull these back in and so you really need to be very careful the way that you're using grant or trust and, and the ownership or how that applies to you.

And then when you're looking at of the amount and dates of enactment are, are going to be really important. So, you know, creating them and contributing to them before this goes into an act enactment really would be. Beneficial. If you haven't looked at it, if you're in that situation really recommend looking at that.

Cause that's, that's a big shift. That's a, that's a big one that we have that's out there that you might want to establish and fun and max out these trusts until they, because in the future, unfortunately it looks like they're going to pull these back into. All right now let's transition to retirement plans and IRA accounts, individual retirement accounts, you know, up one of the things that you might've read about as an individual named Peter teal had a very large, a insanely large Roth IRA because he was able to transfer shares when he started and was a founder in PayPal into his Roth IRA and show that he owned it in the Roth IRA. And then that obviously, you know, that company has done incredibly well from, you know, being worth pennies, to being worth billions of dollars. When you look at it, that is, you know, one of the interesting tax ways of getting money into a Roth IRA or an IRA it has to be a whole lot of qualification.

So it was just really worked out well for him. Most, most individuals do not, but because of that and because of the press, I think that it, it. You saw them add this line that says that they want to prohibit future contributions to a Roth IRA or traditional IRA. If an individual has an IRA or defined contribution retirement accounts that add up to $10 million as of the end of the previous county.

Now this limitation applies to those with income that's over 400,000 or four 50. And that's going to start next year. It's interesting because most people probably wouldn't be able to contribute if they have an IRA north of that, or a 401k north of that. But we do have clients who have just been able to put money in, had money that's in there, how to business that was in a retirement plan and have grown to those numbers.

And so they would not be able to do anything more with that type of. The other thing that really is going to be this kind of going after to make these go away is they're imposing a new account balance based, retired, required, minimum distribution. So we all probably know about the RMD required minimum distribution.

Once you reach age 72, but this is going after those that have income that exceeds that four 50 for married, and you have a 401k plan or [00:12:00] retirement plan of any sorts that are over $10 million at the end of the year. A minimum required distribution is going to be equal to 50% of the amount that exceeds 10 million.

So let's, let's run the numbers on this because it's mind blowing if away, if you will, if you have $449,000 as a married couple, that. You can have a $20 million IRA account and do nothing. But the day that you have $451,000 that shows up in a calendar year and your account is over $10 million or your retirement accounts are over $10 million.

They're going to require you take 50% over that 10 million out. And it counts towards that. So let's hypothetically say somebody has a $20 million IRA account as of today. And next year they're going to have four over $450,000 in income. That means they're going to have to show $10 million in income for the year.

They can't pass that on. They can't use the 10 year window to get that money out. And it is an aggregate. That's actually one of the things that we were looking at the code, and it does say the aggregate balance of your retirement plan. Is included, whether it's a Roth IRA or traditional IRA, you have to take it out.

And, and you it's counted in that $10 million number. So it's really going to be interesting. The other thing for those that have, you know, really, really large balances, if you have balances that exceed 20 million. They're going to require that that comes out of the Roth IRA as well. So they don't allow you to use those that's effective at the end of next year, or I'm sorry, at the end of this year, starting next year.

Here's one that really frustrates me. It's gotta be honest with you. They're taken away the backdoor Roth IRA strategy for those that have income that's over 400 or 450. So again, this this number you're going to hear a lot. I'm going to talk about this 450 as a married couple or 400 as an individual.

They're going to take it away. You cannot. They're they're prohibiting Roth conversions from both IRA. So an IRA to a Roth IRA and also, and this is a really big one. An employer sponsored plan can not go and do a backdoor Roth. This is a strategy we use consistently all the time. It's one of the best things, in my opinion for those that have high wages or have high earners or can save above and beyond the traditional 401k a number at 19,500, if you can put in more money into it, you can then put after tax dollars, converted to a Roth, and you've gotten your quote unquote backdoor, Roth IRA, and those distributions and transfers and contracts.

Starting next year can not happen anymore. Now, the one glimmer of hope of this is that they are talking about them not taking this away until 2031. So that's, that is a long time from now. However, they have put this in that they are prohibiting all employee after tax contributions to qualified plans and IRAs from being converted to a Roth [00:15:00] IRA, regardless of income level, starting in 2022, January 1st, 2022, that stops.

So you can do backdoor Roth strategies no matter your income level up until 2031, however they're taking. And that is again, an income based takeaway, but there can there, regardless of your income level, they're not allowing you to put money in after tax to a qualified plan or an.

I just, I just don't get it. Like why, why, why are we not allowing people to do this? If you can save more and you can use the Roth IRA, why not allow you to put more in, through, you know, putting an after tax to a, an IRA and converting it to a Roth. It just, it really is really frustrating. So for those of you that have it, and again, this is exactly why I'm putting this podcast out now versus waiting until this bill actually.

If you have dollars, you can convert and you're at certain income thresholds or you're in a lower bracket than you think you're going to be. Or, or you just want to take advantage of this review, your income strategies, review all the options you have put as much after tax money into your 401k this year, as you can put as much after tax money into your IRAs, as you can convert any traditional and defined contribution plan accounts to a Roth before 2031, I know that gives you 10 years, but make sure you're doing all of those.

And if you can, if you, if you have a very large retirement plan, start taking them distributions out before they start digging down the road. All right. That's, I'm going to get off my frustration horse right here. Let's then talk about the, the, the corporate and business side. So what they're looking to do, and again, proposed as everything I've talked about so far today is.

They're looking on the corporate business side to replace this flat corporate tax rate structure with a graduated structure consisting of an 18% on the first 400,000 of income, 21, up to 5 million and then 26.5 for income thereafter for businesses. Now the benefit of the graduated phase out of corporations, making more than 10 million to 20 million basically gets you to 26.5.

So there's really no difference there. This is beginning January 1st. That's a pretty substantial difference. One of the things that we look at that did make a huge difference, if you will that, that I think affects a lot of individuals is they want to limit the 19 a the IRS code 19. The one that does affect a lot of people.

And again, similar to the backdoor Roth conversion and taking this away. Just this one's a little interesting that I don't really understand is they want to limit the 1 99, a qualified business income to their. And they want to limit it to a maximum of 500,000 in the case of a joint return, 400 for individual two 50, for those filing jointly and 10,000 for a trust.

So they're taking it away. Look that if you have more income than that, they're taking it away, be ready for it. That is uh, Generous qualified business income deduction that you get today, and that is going to go away in 2022. So look, there was a lot that I just went through in there. We're going to try to put some notes together just to, to button this [00:18:00] up and keep it a little cleaner for those of you that like to just read through it or see it.

Hopefully we'll have that out by the time this releases, if you do have questions, though, if you do want to talk about your situation and review what this means for you and have some projections run and talk about strategies that you should do by the end of the quarter or moving. Look, a lot of the strategies that we have for clients are talking about in 2022 and beyond, this is what we're doing.

It's not always just based on this calendar. Please reach out. We'd love to talk to you. We'd love to help you with that. I hope you found this beneficial. Once we do get an actual proposal together, we will put out a I'm sorry. Once we do get an actual. Put together, we will put a summary together. We will put that out for you guys, but I just wanted to put this out today.

Cause I thought this was it kind of had gone on too long and it looks like they're punting this down the road for a final bill until the very last minute. And that does not give you a lot of time to plan. So I hope this was. We'd love to talk. If you have any questions, thanks so much for your time.

Take care. 

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