Welcome to another episode of the “Smart Money Show”. I’m your host, Stephen Rischall, and today, I have a really important Smart Money update for you about President Biden’s proposed tax changes, which are part of the fiscal year 2022 budget. So, let’s dive right in.
There’s three things that really stick out to me with the proposed tax changes, and I can’t stress enough, these are proposed tax changes. None of this is set in stone. In fact, they haven’t even officially discussed any of this in Congress yet.
It will go through negotiations. My best guess is that some form of these will be passed, so I do think some amount of these types of tax changes are ahead of us, whether it’s this year or retroactive or next tax year. That’s to be determined, so just make sure you stay tuned in. We’re gonna have future updates for you as there’s more solid plans later in the year about what’s really going to be implemented.
Here’s the three things that really stuck out to me. First off is a potential increase to the top marginal tax rates, and also reduction in the income thresholds at which you might meet that top marginal rate. This is for ordinary income.
Next is actually about capital gains. It’s a potential increase to capital gains and qualified dividend tax rates. This is specifically for top earners, so only for top earners.
Then we’re looking at a potential repeal to the step-up in basis. This is a really, really big deal, and we’re actually to talk more about that for sure towards the end of the video. There’s a lot packed into that one. I’ll talk about how that might have serious implications for people that are maybe selling a business or for beneficiaries and transferring wealth to the next generation. Serious implications if there’s some sort of a repeal to a stepped up basis.
So, what about that marginal tax rate increase? It’s slated to maybe increase to 39.6% for top earners. Currently, it’s at 37%.
Now, no matter what, in the year 2025, this is going to increase from 37% to 39.6%. That was going to happen anyways. The difference is, if that’s going to happen earlier, and also, the bigger difference, really, is if President Biden’s proposed tax plan is going to reduce the income threshold.
Federal income tax is a progressive tax system, it’s your next dollar above that threshold that’s taxed at the higher percentage. And if this goes through, single filers that are earning over $452,000, they’ll be at this new 39.6% federal tax rate.
Married filers that are filing joint, they’ll be at this higher tax rate at $509,000 of income. And obviously, married filing separate, just split that in half, and, you know, you got $254,000, and you would find yourself potentially at this new top tax rate of 39.6%.
Now, capital gains is the next one. Typically, long-term capital gains have been advantageously taxed at a much lower rate, a flat rate. It’s proposed that, if your modified adjusted gross income for married filers is above $1 Million, and for single filers that would be above $500,000, and you have long-term capital gains, so that’s an asset that you’ve owned for at least one full year, 365-plus-one days, currently it would be 20% flat max. It’s proposed that that would just become the same as the top income tax bracket, which you just saw might be 39.6%.
Also, for qualified dividends, that that would go from 20% flat up to 39.6%. The net investment income tax, that’s the extra 3.8% that, sometimes they call it the Obamacare surcharge, that is not slated to change at all, so that would still be the same, and that would be in addition to that 39.6%.
Again, if your state has some sort of a capital gains tax system, you’ve got to factor that in, too, so make sure you think about that, you discuss that with your accountant and your tax advisors. Obviously, we’re a great resource to discuss your tax planning, too.
The next thing, to think about is if this will be retroactive? That’s actually one thing that a lot of people are concerned about.
It was announced that this potential capital gains and qualified dividends tax change would be as of April 28th, 2021. That was the date of first announcing the fiscal year 2022 budget.
If that’s the case, then really, there’s no additional planning you can do right this second to mitigate anything about capital gains specifically. You would’ve had to already rebalanced your account or sold some of these highly appreciated assets to benefit from that much, lower long-term capital gain rate.
Look, you might even want to think about this now, because, for all we know, if Congress decides, oh, this won’t be retroactive.
Well then it might be better to lock in a long-term capital gain of 20% right now, versus what could potentially be 39.6% for higher earners. So, I think that’s one thing that a lot of people are thinking about, if it’s retroactive, I’ve probably missed the boat. But we don’t know if it’s retroactive, so maybe I can sell some of my highly appreciated stock or other highly appreciated assets at the 20% long-term capital gain rate instead of 39.6%.
I don’t know about you, but 19.6% of what’s probably already a large amount, hundreds of thousands or millions of dollars of gains, that’s a pretty big tax bill, so it’s something to consider.
I also think this could lead to some unintended consequences, whereas, it might delay people from selling certain appreciated assets. Whether that be real estate or stocks or some other kind of an investment, even a business. This might delay people from selling a business this year or next year.
Certainly, you should be thinking about, if you’re selling a business, planning this six months, a year, well in advance to do tax planning, but, you know, maybe you want to think about structuring that deal a certain way now that your payments are split over a period of time, so that you don’t end up in that higher marginal tax rate. And also, hopefully, you can avoid some of that capital gains tax treatment at what could potentially be a much, much higher level. You know, the last thing that I really wanted to spend some time talking about is this potential repeal in stepped up basis. What does that even mean? Well, right now with the tax code, at the time of gift or at the time of passing away, if someone passes away and leaves money to their beneficiaries, the estate typically gets a step in basis, so all of these assets, you know, let’s say you had an asset that was a million dollars when you bought it, that’s your basis, and now it’s worth 10 million. When you pass away, that value of 10 million would actually be the amount that the folks inherit it at, and if they were to sell everything that day, there’s no capital gain. They got that step up of $9 million. It’s a pretty nice deal, obviously, really, really big tax savings. Well, potentially, what’s being discussed is completely repealing that, and moreover, making at the time of a gift or at the time of a beneficiary receiving the distribution from an estate, so at someone’s passing, let’s say, at that point in time, those assets, and by the way, the gross value of those, of that transfer, could potentially be taxed, so think about that. If you have a $10 million property that your children inherit at the time of your passing, normally, right now, that’d be stepped up to $10 million in basis. Instead, they’re talking about no step up, and oh, by the way, you’re gonna owe taxes immediately. So, if you have a $10 million building and not much liquidity, and now, all of a sudden, your heirs are going to owe a lot of money in taxes, not to mention if you have any estate taxes, that’s a totally separate conversation for another video, but there’s probably some estate tax issues, you know, that you’re gonna want to consider, but if you think about how that could really, really change and force people to have to sell assets, maybe sell assets at an inopportune time because they need to cover tax bills, this, I mean, this potential change with stepped up basis or the repeal of stepped up basis is a really, really big deal, and it’s something that we should be talking about and planning for your taxes. So, let’s keep an eye on all these things. I mean, look, we’ve got a potential change to the marginal tax rate, the highest level. We’ve gotten a potential change to capital gains and qualified dividends, how those might be taxed for married tax filers earning over a million dollars, and that’s also for single filers earning over $500,000, and maybe this big potential change to or repeal of stepped up basis. So, again, I mean, if you’ve had situations where you’ve got equity compensation from your employer, right, you work at a tech company or some other company where you’ve gotten, you know, shares of stock or options or some sort of grant that’s highly appreciated, or restricted stock units, you might all of a sudden find yourself, in any given year, at these higher marginal rates much quicker. If you’ve got appreciated stock, appreciated assets, with capital gains potentially going up significantly, you might want to consider doing some planning about how you could take advantage of lower tax rates right this moment. Again, this could be retroactive. We don’t know. And then, if that’s the case, it’s kind of already too late, but who knows? And my guess is, I don’t think it’s gonna be retroactive. That would be, it certainly could be, but that one, I’m gonna say probably isn’t going to happen, but I wouldn’t be surprised that, if and when Congress passes something like this, they’re gonna say as of this date, or hopefully, they say as of tax year 2022, and it gives all of us a lot more time to plan. Certainly, I think, tax planning, there’s going to be a lot more of that this year, and it should be happening quite a bit earlier in the tax year. And, obviously, there was a lot to unpack with the stepped up basis. So, look, if you have any questions about this, you want to know more about how these potential tax changes could affect your financial situation, you’ll also want to make sure it’s aligned with your financial plan and your retirement plan, let’s set up a time to connect. Let’s talk, let’s meet. Also, if you found this information really valuable, make sure you share it with your friends, your family, your loved ones, because I think a lot of people have questions about, and they’re reading these things about proposed tax changes, and really, these are the three key things that I think anybody really needs to keep an eye on as it relates to these proposed tax changes. So, until next time, thanks for tuning in to another episode of the “Smart Money Show”. I’m Stephen Rischall, and thanks for watching.