Tax Planning for the Build Back Better Act
Tax planning for 2021 has been like watching your favorite football team drive down the field to kick the game-winning field goal, and suddenly the coach calls a timeout because the goalpost keeps moving. When President Biden was elected, we expected an unfriendly tax overhaul geared toward taxing the wealthy. With that in mind, last year, we recommended accelerating income to take advantage of what we thought would be the last year of favorable tax rates. However, President Biden’s signature Build Back Better Act has changed quite a bit in the past month. As lawmakers have been horse-trading for the past few months trying to come to an agreement, we are pleasantly surprised that President Biden’s Build Back Better tax plan is not as onerous on the wealthy as we expected.
The plan looks to be keeping income and estate taxes at the current rates with a few exceptions geared toward the highest earners. The Tax Foundation (www.taxfoundation.org) has been an excellent source of information for all the latest changes. Below are the most recent provisions that could impact high earners:
- Surtax on high earners – There would be a 5% surtax on modified adjusted gross income of more than $10 million and an additional 3% surtax (for 8% total) on income of more than $25 million. This would effectively create a very top rate of 45% for the highest earners. Since these taxes would be levied on modified adjusted gross income, they cannot be avoided by taking large, itemized deductions or the qualified business income deduction.
- Increased capital gain rate on high earners – Those same taxpayers would be subject to a higher capital gains rate (28% instead of 25% in the old proposal and 20% under current law).
- 3.8% NIIT applicable to S Corporation income – The 3.8% net investment income tax would apply to S Corporation pass-through income for high earners.
- Additional funds for IRS – IRS would receive additional resources to hire more agents, enhance technology, improve taxpayer service, and ramp up audits on taxpayers making more than $400k.
Based on the above changes, it appears that the coach made the right decision by calling a timeout because it appears it was just a lot of wind moving the goalposts (unless you earn more than $10 million). Now that the wind appears to be dialing down, it is important to review your financial plan before the time runs out in 2021. A few of the most overlooked and simple actions to review before year-end are:
- Timing of income/expenses matters – Agency owners will want to review and estimate year-end taxable income. If you are in a higher income tax bracket in 2021 than you expect to be in 2022, be sure to pay off business expenses prior to December 31st. Depending on structure and accounting method, doing so may not only reduce income taxes but could also reduce self-employment taxes.
- Max out retirement savings – Review your 401(k) contributions. Each employee can contribute $19,500 (plus an additional $6,500 catch up contribution if over age 50). It is important to note that traditional IRA contributions, Roth IRA contributions, and HSA contributions don’t have to be part of your year tax planning two-minute The cutoff date for funding IRAs and HSAs is April 15, 2022.
- Harvest Loss (or Gains) – Review your investment holdings. If you have any positions that are worth less than you paid, now is a good time to realize those losses as they are valuable in reducing taxable income. On the flip side, if 2021 was a down year for income, you might consider selling some assets at a gain prior to year-end. If your taxable income happens to fall under $80,800, filing jointly, or under $40,400, filing single, you might be able to take additional gains at a 0% rate.
- Be Generous – If you are charitably inclined and have high income, 2021 is a great year to open a Donor Advise Fund (DAF). With a DAF, you can contribute a large amount of income today, get the itemized tax deduction, and invest the funds for future gifting.
Tax planning can be a complicated and confusing exercise. Just as the head football coach has offensive and defensive coordinators to provide strategy, you should have a team of professionals to help you navigate the tax laws to best meet your goals and objectives. Please feel free to reach out to BDF to discuss your year-end tax planning needs.
Jim leads the Commercial Insurance Professionals Practice Group. He uses his understanding of the insurance industry to help insurance professionals maximize their prime earning years, develop a discipline around saving those earnings and put a plan in place to best utilize assets. Jim's focus on creating financial blueprints for his clients has earned him recognition as a “Five Star Wealth Manager” by Chicago Magazine.