The Senate approved a bipartisan, $1 trillion infrastructure bill. Now comes the hard part. It goes to the House of Representatives, where it faces an uphill battle: House Democrats have proposed a separate $3.5 trillion in new social spending and tax hikes via the reconciliation process. The debates get louder with contentious politics at both ends and moderates in between. And regardless of your politics, investors are asking how to make smart financial decisions in very uncertain times and to avoid doing something foolish.
This article discusses why these bills are important and possible actions investors can take related to tax planning.
Debt and Taxes
The new $3.5 trillion budget bill contains many provisions that didn’t make the final Senate version, including provisions for child care, education, health care, and climate change. The budget blueprint is half-financed by debt; federal debt is envisioned to rise to $33.5 trillion in fiscal 2024 and to more than $45 trillion in 2031.
The other half is funded primarily by tax hikes— on corporations, especially those with foreign operations, and high-income earners (individuals making more than $400,000/year)— and additional sources of funds, including IRS tax enforcement, healthcare savings, and a new fee on carbon polluters. Some of the discussed tax increases include:
- Estate taxes: Current estate tax exclusion is $11.7 million, and President Biden proposes to roll it back to 2009 amounts ($3.5 million). The ability to do a step-up in basis upon death is eliminated. Example: Say you inherit your parents’ home worth $600,000. The current law says you can sell and have no gain because your basis is $600,000. The proposed law says your parents’ cost basis of $150,000 carries over to you, and thus you might have $450,000 of capital gains when you sell.
- Income tax: Individuals’ highest income tax rate is expected to be restored to 39.6% (currently 37%). For individuals with income over $1 million, long-term capital gains are currently taxed at a lower, preferential rate of 20%, but would instead be taxed at an ordinary 39.6%. And pay attention to both the tax rates and permitted deductions; they can offset each other or magnify the shift.
Planning Tips to Discuss with Your Financial Advisors
My business partner, Kirstin Griffin, generally advises clients to make financial planning decisions based on current conditions, whether they be tax rules or getting hit by the proverbial bus tomorrow. Also, there can be a big difference between what is debated, then approved, then clarified with tax regulations. Nevertheless, here are some planning considerations to discuss with your advisors including your CPA or enrolled agent.
- Accelerate income where possible. Tax deductions become more valuable when brackets increase.
- Review equity compensation structures if payroll taxes increase by 12.4% (equally split by employee and employer) for taxpayers earning more than $400,000 in wages.
- Gift more, or sooner, to charities or family members.
- Earn more. Whether it be wages or investment returns, it’s what you pocket after taxes that matters.
- If you have assets that could sell now at a lesser capital gains tax rate, consider selling them now. Don’t wait until you have a bigger capital gains tax hit.
- Moderation may make sense. If Rothing makes sense, consider partial Roth IRA conversions where you fill your current tax bracket without jumping into the next (avoid bracket creep), and think twice if you’re considering paying your kids’ tax bills (which is what occurs when kids inherit your residual Roth IRA).
Taxes can be frustrating, and tax planning can be challenging. Control what you can and adjust as the rules change. May you have sage advice and secure your future wisely.