Preparing for Pending Tax Changes

Dec. 6, 2021

Income Taxes and the Build Back Better Act

On November 19, the U.S. House of Representatives passed an updated version of the Build Back Better (BBB) Act. It will now be considered by the U.S. Senate where its fate is uncertain.

If passed, the bill goes into effect on January 1, 2022 creating a tight deadline to adjust to new changes. The following noteworthy proposals warrant attention today:

  • Elimination of Back-Door Roth Conversions
  • Creation of Surcharge on High-Net-Worth Individuals and Families
  • Raise the State and Local Tax (SALT) Deduction

To proactively prepare, here is a breakdown of these three key changes in today’s version, actionable planning ideas to consider before year end, and the status of the bill.

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Elimination of “Back-Door” Roth Conversions

The back-door approach to Roth IRA funding that emerged under current law is now in jeopardy if the BBB Act is passed in current form. With this pressing timeline, individuals interested in making Roth conversions should explore taking advantage of the following approach.

Current law restricts higher income earners from contributing to Roth IRAs, only allowing after-tax contributions for taxpayers with incomes below $140,000 for single filers and $208,000 for married couples filing jointly. Instead, they can take the following steps:

  1. Make a nondeductible (after-tax) contribution of up to $6,000 ($7,000 if age 50 and older in 2021) directly to a traditional IRA
  2. Then convert the contributed funds to a Roth IRA, paying little-to-no additional taxes on the nondeductible amount converted

Similarly, highly paid employees with 401K retirement accounts can elect the same approach but with more substantial pre-tax contribution limits $58,000 ($64,500 if age 50 and older in 2021) and convert these amounts into a so-called mega-backdoor Roth IRA after paying the tax on the converted amounts.

Creation of Surcharge on High-Net-Worth Individuals and Families

High-net-worth individuals and families should anticipate a new surcharge tax:

  1. 5% surcharge tax on modified adjusted gross income (MAGI) that is in excess of $10 million dollars
  2. Additional 3% surcharge tax for those with MAGI in excess of $25 million

Where it may apply, for example, is where proceeds from a sale of a business exceed $25 million. Such proceeds would be subject to the additional 8% surtax. Note that the surtax is in addition to ordinary income and capital gains tax rates.

Prepare accordingly, to the extent possible, by completing the sale of a business before year-end. As an alternative, consider an installment sale of the business to minimize or avoid the potential new surtax.

Raise the State and Local Tax (SALT) Deduction

The state and local tax deduction limit (or cap) is slated to be raised to $80,000 from 2021 through 2030.

Raising the SALT cap will allow individuals and families to deduct more of the state and local taxes they pay from their federal taxes. Taxpayers can use the deduction when they file their 2021 Federal tax returns if the bill passes in its current form.

For wealthier taxpayers who live in higher tax states, this temporary change will allow them the opportunity to group (or bunch) together itemized deductions before the higher SALT cap expires.

The SALT cap would restore to the current amount of $10,000 effective January 1, 2031.

The Status of the Bill

As noted, the bill is currently with the US Senate. Democratic lawmakers would like to get the bill to President Biden’s desk before year-end, but to do so, compromise will be needed. There remain competing priorities between the moderate and progressive wings of the Senate’s Democratic Caucus. Senators Manchin, Sinema, Sanders, and Schumer all need to agree to avoid a Republican filibuster and pass it as part of the budget reconciliation process.

The Build Back Better Act has experienced many changes since it was introduced in late September, and it’s likely that more changes are on the way. It’s also possible the bill may not make it to President Biden’s desk for his signature. 

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The information in this article is not intended as legal or tax advice. Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation.

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