In all, $2.9 trillion in tax hikes are being proposed to offset Biden’s $3.5 trillion budget bill.
Dreamstime
If you make big money or you smoke, chances are good that you’re not going to like the tax package that Congress is set to vote on before the end of the month.
Democrats, led by President Joe Biden, are clear about where they stand—higher taxes for top earners: A 3% surtax on income above $5 million, changes to individual retirement account rules, a cut in the qualified small-business stock exemption, and the elimination of an estate-planning tool would be the biggest changes.
And there’s more: The word’s still out on increasing the deduction cap for state and local property and income taxes. Plus, a few of the measures—a higher capital-gains tax— could go into effect retroactively. Most, though, would apply to 2022 income.
The changes essentially align with Biden’s campaign promise to raise taxes only on the rich, although House Democrats want to hike the federal tax on cigarettes, which now stands at $1.01 a pack, and other nicotine products. A 2019 government study showed that 21% of adults with an annual household income of less than $35,000 smoked cigarettes, compared with 7% of those earning more than $100,000.
In all, $2.9 trillion in tax hikes are being proposed to offset Biden’s $3.5 trillion budget bill, which includes new and broader spending on child care, healthcare, education, and clean energy.
Remember, though, nothing is set in stone yet. Revisions could still be coming. Here’s where things stand now:
Double income whammy
If you file single and make more than $400,000, or if you file as a couple earning more than $450,000, your income-tax rate is notched up to 39.6% from 37%.
The second hit would be a 3% surtax on modified adjusted gross income over $5 million. Modified AGI is your adjusted gross income minus deductions for investment interest income.
Capital-gains pain
The top capital-gains tax rate is bumped to 25% from 20%. Tack on the 3.8% tax on investment income that went into effect under President Barack Obama, and investors are looking at a 28.8% tax on gains.
If passed, the increase would apply to all transactions completed after Sept. 13, 2021, Tara Thompson Popernik, director of research for the wealth strategies group at Bernstein Private Wealth Management, told Barron’s.
“This change is not dramatic, but it will become effective immediately—retroactively,” she said. “The reason they wrote it this way is to prevent a year-end selloff.”
IRA crackdown
Get ready for tighter rules for IRAs, including:
•Those with total assets in IRAs of $10 million or more wouldn’t be able to make more contributions.
•So-called backdoor Roth conversions—used by the wealthy—would be banned. Wealthy taxpayers generally can’t contribute to a Roth IRA, which aren’t taxed, because of income cutoffs of $140,000 for singles and $208,000 for couples, but they can—and do—fund a regular IRA and immediately convert it to a Roth.
•Accredited investors—those with $1 million or more in investment assets—would need to get rid of their so-called qualified investments, private debt and private equity. They would have two years to make the transition.
“They will have to do something with those investments or face the possibility that their IRA is disqualified as an IRA,” Popernik said, adding that this would be a problem for accredited investors with new investments because lockup periods are generally longer than two years.
“We really need more clarification on this,” she told Barron’s.
Estate tax squeezes
Expect the taxman’s grip to tighten on estate taxes.
Proposed is a cut in the per-person estate tax exemption to roughly $6 million from $11.7 million. For married couples, the exemption drops to just above $12 million from $23.4 million.
Also on the chopping block are grantor trusts, which the ultrawealthy use to transfer their assets to their heirs. These tax shelters would become part of the estate again, and subject to taxes.
LLCs and the like, get ready
Another double whammy: This one would hit pass-through entities—LLCs, S corporations, and partnerships.
Owners of these businesses would have to pay Obama’s 3.8% investment income tax on active income—their salaries. Now the levy applies only to passive income, which is defined as any revenue—rent is an example—that is earned without involvement in the business.
The second change: new limits on the value of the pass-through deduction.
Currently, owners can deduct 20% of their entire qualified incomes.
“You could have $100 million of income today and get the full 20% deduction. If your business qualified under current law and you make $20 million in income, you could get a $4 million deduction,” explained Sarah Allen-Anthony, managing partner of global private client services at Crowe LLP.
If the rules change, though, the maximum value of that deduction would be capped at $500,000 for pass-through owners who are couples filing jointly, and $400,000 for singles—and no more, Allen-Anthony said.
So long to a small-business break
Investors who hold QSBS, which is stock issued by C corporations with less than $50 million in assets, don’t have to pay any capital-gains taxes if they meet certain requirements, such as holding the shares for at least five years.
If Democrats have their way, QSBS owners wouldn’t be 100% tax-free. They would have to pay taxes on 50% of their shares. The change in the exclusion would be retroactive to Sept. 14.
“I work with a lot of investors and founders of start-ups in Silicon Valley and New York, and they were sideswiped. On Sept. 13, we had people frantically trying to sell tens of millions of dollars of QSBS,” Christopher Karachale, a partner at HansonBridgett, a San Francisco law firm, recounted to Barron’s.
“One client was supposed to sell next week but said, ‘We are selling $18 million by 1 p.m. today,’” he said.
SALT uncertainty
The last big thing still on the table is the $10,000 deduction limit on state and local taxes, or SALT. The cap hits high-tax states like California, New York, and New Jersey the hardest. Just this summer, California Gov. Gavin Newsom signed a SALT cap workaround.
Several House Democrats, including Reps. Josh Guttheimer of New Jersey and Thomas Suozzi of New York, are refusing to vote for the tax package without a repeal of the SALT cap. Others, mostly Republicans, argue that the cap makes sure the wealthy pay their fair share.
Numbers from the nonpartisan Tax Policy Center show that 96% of a repeal’s benefit would go to the top 20% of earners. What’s more, getting rid of the cap would mean at least an $88 billion loss in revenue next year.
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