I’m always a little reluctant to talk about proposed legislation, but the proposed tax changes released by the House Ways and Means Committee, has some things that should be looked at and preparations made to take action, if they become law. Here are some of my highlights:
Elimination of the Back Door Roth Conversion
At lot of retired Senior Military Officers and NCOs in second careers find out that they can’t contribute to a Roth IRA because their AGI is too high ($208,000 for married, $140,000 for single). This limit can be circumvented by a procedure called the Back Door Roth Conversion. To do this, you make a non-deductible contribution to a Traditional IRA and then convert it to a Roth IRA. Since this is done in relatively short order, there is little to know tax due. The proposed legislation eliminates the ability to convert after-tax dollars in a Traditional IRA (or any other retirement account) to a Roth account. You’re still allowed to convert pre-tax dollars, and pay the taxes on the conversion. This portion of the legislation goes into effect 1 Jan 22, so you’ll need to convert on or before 31 Dec 21.
Increase in Top Tax Bracket and Compression of 35% Bracket
Starting in 2022, the top tax bracket will increase from 37% to 39.6% (a 7% increase). But I think an even bigger deal is the compression of the 35% bracket. The 35% bracket currently runs from $418,851 - $628,000 in taxable income for married filers ($209,426 - $523,600 for single). Under the proposed legislation, the 35% bracket will run from $418,851 - $450,000 for married filers and the 39.6% bracket will kick in income above $450,000 (35% bracket ends at $400,000 for single filers). For married filers that exposes an additional $178,000 in income that could go from a 35% tax rate to 39.6% (a 13% increase). Also note that there is a significant marriage penalty as the top bracket starts at $450,000 for a married couple and $400,000 for a single taxpayer.
Extension of the Child Tax Credit
The proposed legislation extends the recently increased child tax credit ($3,000 or $3,600 per child versus previous credit of $2,000). Advance payments will continue as well and the definition of a child on which you can claim the credit is expanded (more to follow on that). From a practical standpoint, this won’t affect many of you as the additional amount phases out at $150,000 AGI for married couples ($75,000 for single filers and $112,500 for Head of Household)
Wash Sale Rules Expanded
Under wash rules if you sell a security at a loss and within 30 days (prior or after) you buy a substantially identical security, the loss is suspended. The proposed legislation extends the wash sale rules to cryptocurrencies, commodities and foreign currencies. This goes into effect in 2022.
Estate Tax Exemption Reduced
Technically, this is called the “Unified Credit” and it was increased in the Tax Cuts and Jobs Act (Trump Tax Cuts). The proposed legislation eliminates the increase and the credit/exemption will reset to around $6M in 2022.
What to do About It
Roth Conversions. Get them done before the end of the year. Normally, you can make IRA contributions up to 15 Apr and count them for the prior tax year. You can make the 2021 contribution up to that deadline, but you won’t be able to make the conversion after 31 Dec.
Delay Deductions. If you’re going to be in the 39.6% bracket, push as many deductions into 2022 as you can. This could include mortgage interest payments, property taxes, elective medical procedures (if you can deduct medical expenses), charitable contributions and estimated state income tax payments. I’d highly recommend you delay state estimated tax payments, regardless of your income, to 2022 as there are some rumblings the SALT deduction limit may eventually go away. It’s not in legislation yet, but I’m hearing there is a pretty good chance it could end up there.
Accelerate Income. To the extent you can, if you’re currently in the top 2 tax brackets, it would be to your benefit fill up the 35% tax bracket while it exceeds $450,000.
Keep Your Eyes on Child Credit. If you’re receiving the advance child tax credit payments and your income is going to increase significantly in the future, you might want to stop the advance payments. You might also want to do the same if custody of a child changes from year to year.
Watch the Wash. If you’re accustomed to buying and selling the assets not currently covered by the wash sale rules without paying attention to losses and gains, you’re likely to get burned by the wash sale rules.
Military Finances are Different
While the new tax law applies to all Americans, there are sections of the tax code that treat military members and veterans differently. And, it doesn't stop there. Your finances are as different as a civilian's as your career was or is. That is why we think you should work with a financial planner that works with Active and Retired Senior Military Officers and NCOs each and every day. If you'd like to learn more about what we do, use the button to schedule an initial consultation or give us a call.
If you found this article useful, you might like the following blog posts: