The House recently released a nearly 900-page proposed bill that would make major changes to current tax laws. The bill is intended in large part to help pay for both the Biden Administration’s budget and infrastructure stimulus bill.
It’s important to keep in mind that the provisions and changes outlined below are by no means settled. Changes can (and likely will) still be made as the Senate ratifies the bill; however, the remainder of this article should give readers a good idea of the most significant provisions.
Income Tax Rates are Rising
The increase in the top income tax rate is probably the most talked about proposed change in the bill, bringing it up from 37 percent to 39.6 percent. The top marginal rate would apply to single filers with taxable income over $400,000, heads of household over $425,000 and married filing jointly taxpayers making over $450,000. The impact starts with income earned on Jan. 1, 2022, and after.
The highest capital gains rate would increase from 20 percent to 25 percent and apply to qualified dividends. The increase is effective on gains made from sales that happen on or after Sept. 13, 2021, but any gains from sales incurred before or that result from binding contracts executed before this date fall under the old rate. For example, gains received post-Sept. 13, 2021, under an installment sale entered on Aug. 31, 2021, would be subject to the old 20 percent rate.
Expansion of the Net Investment Income Tax
The bill also would redefine net investment income (NIIT) to include any income earned in the ordinary course of business. Currently, the 3.8 percent NIIT surcharge applies only to passive income. The NIIT is applied to single taxpayers with more than $400,000 in taxable income and joint filers with over $500,000, and would start Jan. 1, 2022.
New 3 Percent Surcharge on High Income Individuals
Starting after Dec. 31, 2021, a new 3 percent tax will be placed on Adjusted Gross Incomes (AGI) over $5 million ($2.5 million if married filing separately).
Small Business Tax Increases
Under the bill, the current 21 percent flat corporate (C-Corporation) tax rate would change to a three-tiered system. The structure would tax net income at 18 percent up to $400,000; 21 percent from $401,000 to $5 million; and 26 percent on net income over $5 million.
Other Miscellaneous Changes
As you can imagine in an 881-page bill, there are only so many changes that can be covered in this article, but here is a smattering of miscellaneous provisions.
- Crypto currencies would become subject to the constructive and wash sale rules (like most marketable securities such as stocks) starting Jan. 1, 2022. This means that if you are holding a position at a loss, you have until the end of 2021 to harvest the loss and immediately buy back in.
- IRAs will no longer be allowed to invest in an entity where the IRA owner has a 10 percent or greater ownership interest (down from the current 50 percent threshold) or if the IRA owner is an officer of the entity.
- $80 million is earmarked for the IRS to step up enforcement and audit more taxpayers.
- Smokers will feel the pain as the bill also doubles the excise taxes on cigarettes, small cigars and roll-your-own tobacco.
Remember that this is only the House version of the bill, and nothing is final. Also remember that Democrats control the House, and the Senate is split 50/50 with the Democratic VP as the tiebreaker. As a result, while there will be changes, the major provisions outlined above will likely be in the final law in some form or another.
It’s not uncommon for adult children or siblings to act as caregivers for family members or give them financial assistance for medical or long-term care needs. The problem is that all too often those providing the help don’t take advantage of the tax benefits.
Types of Care
Caregiving happens through many different avenues. For example, family members might pay for services that their elderly parents need, such as housekeeping, meal preparation, or nursing care. Outside the home, they may pay for all or a portion of the cost of an assisted living facility.
In other circumstances, individuals could directly provide the care instead of paying for it. This could happen in either the home of the person giving the care or in the home of the person receiving the care. They might also support the relative’s daily living expenses by paying for groceries, utilities or other essentials.
Assessing the Tax Breaks Available
Step one is to figure out if the person receiving care qualifies as a dependent on the caregiver’s tax return. While there are no longer personal or dependent exemptions, qualifying as a dependent opens the door to deduct medical expenses and other medical-related tax breaks. Let’s look at an example to understand the details better.
Under our scenario, we have Rob taking care of his mother, Laura. Rob is allowed to claim Laura as a dependent if a set of tests are met. First, Laura’s gross income must be less than $4,300 in 2021. While this might seem low, note that tax-exempt interest and Social Security benefits are usually not included.
Second, Rob needs to provide the majority of Laura’s support in the calendar year. “Support” includes basic necessities such as clothes, a place to live, medical expenses, and transportation. In cases where the cared-for relative lives with the taxpayer, they are able to use the equivalent rental value of the housing provided. Given the broad definition of support, it’s often not too hard to meet this test – but make sure to keep diligent records, tracking the amount spent versus the dependent’s total support costs. You can always plan some extra payments near year-end to bump yourself over the 50 percent threshold.
Third, Laura needs to be a United States citizen.
Fourth, the location of the dependent matters. In the case of relatives such as parents, stepparents, grandparents, great-grandparents, and aunts and uncles, these persons can be considered a dependent even if they do not live with you. This means you can be helping them to live in their own house or care facility.
Fifth, Laura cannot jointly file a return with any other taxpayer.
Brothers and Sisters
What happens if you and some of your siblings split the support of a parent? It’s easy to see how in this case no one will meet the majority support test.
In the case of multiple support providers, someone can still claim the person as a dependent as long as all the supporting siblings agree on who makes the claim, and they file an IRS Form 2120, Multiple Support Declaration noting it.
Each Form 2120 signer must contribute at least 10 percent support for the year. The siblings can rotate who claims the deduction or keep it the same each year.
Why Dependency Matters
Given that the personal and dependent exemptions have been eliminated, you might wonder what all the fuss is about the person being cared-for qualifying as a dependent. Well, the answer is the taxpayer who can claim the dependent is the one who can itemize the dependent’s medical expenses as well.
Medical Expense Tax Benefit
The potential benefit comes when Rob is able to add his mother’s medical expenses to those of the rest his family. This can allow him to take a larger medical expense deduction when he itemizes expenses on his tax return. Remember that in order to benefit from any itemized deductions, the total of all itemized deductions must exceed the standard deduction.
Indirect medical costs also can be deducted, but only if the person cared-for qualifies as a dependent. Mileage costs for providing transportation to medical appointments and treatments are deductible. In 2021, this expense is deductible at $0.16 per mile.
Tis the season for summer jobs for high school and college kids. These seasonal jobs are more than just an opportunity for teens and college students to earn some money and gain experience. They also provide the opportunity for seeding a significant retirement nest egg and even a down payment on a home through a Roth IRA.
Seems too good to be true? Well, it’s not – but as always, the devil’s in the details, and it is not exactly a free lunch. So, let’s walk through exactly how this all works.
Step 1 – Earned Income
First, teen or college students must get a job that pays – and the more the better. This is because the gateway to opening and contributing to a Roth IRA is earned income. The magic number for earned income to max out a Roth IRA in 2021 is $6,000, as this is the contribution limit. This is because contributions are limited to the lesser of the $6,000 limit or 100 percent of earned income.
Step 2 – Make the Roth IRA Contributions
The next step is to make the contributions to the working child’s Roth IRA. Let’s be honest here. It is a rare case where a kid is going to take all or nearly all their summer job earnings and stash them away in a Roth IRA for 50+ years down the road. There is a way around this, however.
A parent or grandparent can contribute to the Roth IRA in the child’s[h1] name, with two nuances. First, this contribution is still governed by the earned income limits discussed above. Second, these amounts count toward the $15,000 per year gift tax exclusion ($30,000 if married) so it will eat into that. Lastly, do not forget the deadline to make 2021 Roth IRA contributions of any type is April 18, 2022.
How Much is This Worth?
While $6,000 or so may not seem like a lot, it can make a significant difference over time due to the power of compounding returns from such a young age – coupled with the tax advantages of a Roth IRA.
To illustrate the power of this tax and investment move, let us take a scenario where a high school kid makes the $6,000 per year over three summers from age 16-18 before heading off to college, and the Roth IRA contribution is maxed out.
With contributions at just $18,000 and NEVER putting in another dime again, this will turn into the following amounts under different assumed investment returns by the time they are 66 (40 years of compounding).
- 6 percent return = $313,000
- 8 percent return = $783,000
- 10 percent return = $1.93 million
Now, before you get too excited, you must understand that 40 years from now $300,000 will not be what it used to be if inflation continues at historical rates – but the point remains. This simple move made over just a few years can create significant tax-free wealth.
Due to the characteristic of a Roth IRA, the other beneficial options relate to withdrawal. First, the contributions can be accessed any time before age 59 ½ without penalties or taxes. Second, even after all the initial contributions are removed, a first-time homebuyer can take up to $10,000 without the 10 percent early withdrawal penalty to help fund the purchase, although they will owe income tax on the withdrawal if it has been less than five years since the initial contribution.
Be VERY careful here though, because any withdrawals will dramatically lower the investment returns noted above.
Funding a Roth IRA for a high school or college child or grandchild can give them a tremendous head start in life. A few years of relatively small contributions early on can create substantial wealth over time due to compounding of returns and the tax advantages of the accounts.
Equity compensation is becoming more mainstream and is not just for executives anymore. Grants of restricted stock or restricted stock units (RSUs) are getting to be more common than stock options – and the rules are different, as is the tax planning. Below we will look at some of the particulars of how restricted stock and RSUs operate, how to understand a grant, planning for the tax consequences, and what to do after the shares vest.
How Restricted Stock and RSUs Work
At their core, restricted stock and RSU company shares that vest according to a schedule can be awarded as compensation. The vesting schedule can be tied to length of employment, meeting certain performance criteria, or a combination of both. Upon vesting, the employee owns the shares themselves and can do what they wish with them – from holding, selling, gifting, etc. While this might sound simple, the devil is in the details.
Understanding Your Grant
First, it is important to understand that restricted stock or RSUs are similar to stock options but have important tax and financial planning differences.
There are important facts you need to determine. First, how does the vesting schedule work; what amount of shares vest and when? Is the vesting simply tied to length of service or are there performance or even liquidity event triggers? Second, what are your tax-withholding choices?
From there, you can determine or at least estimate key factors such as how much the award will be worth both pre-tax and post-tax.
Tax Planning – Section 83(b) Election
Taxation can be tricky with restricted stock and RSUs. One strategy is to use a Section 83(b) election for restricted stock.
Typically, a person is taxed when the restricted stock vests regardless of whether the shares are sold. The Section 83(b) election allows the taxpayer to be taxed on the share value at the grant date instead. This election can be made within 30 days from the grant date of the restricted stock and is not an option for RSUs.
Why would you want to consider a Section 83(b) election? Remember that regardless of the election or not, you are taxed as ordinary income for the share value regardless of whether you hold or sell the shares. The advantages are that if you think the stock price will rise between the grant and vesting, then you will pay less ordinary income tax and have lower cash outflows. Second, after the initial taxation of the grant, the change in value after this point is capital gains.
Tax Planning – Withholding
The other issue to consider is not withholding enough taxes. The IRS rules say that your company is required to withhold 22 percent for restricted stock and RSUs (37 percent for income over $1 million during the same year).
The problem is that there is a good chance your margin tax bracket is higher than 22 percent if you are receiving these kinds of equity compensation awards. As a result, you will need to make some estimated payments to cover the difference. Unless you have enough cash from other sources, you may need to consider liquidating some of your shares to cover the tax bill.
The conundrum here is that if you do not see the shares immediately and the price falls, then you will be selling shares at a lower value than what you are being taxed on. It is best to consider your holistic tax scenario and work with your tax advisor to come up with a plan.
Game Plan for After Vesting
Aside from the tax consequences, you need to consider the impact on your overall financial planning. One of the biggest risks taxpayers can face is that they become heavily concentrated in the company stock. You will need to look at your overall portfolio and consider if you need to diversify depending on how much of your net worth is tied up in a single stock now.
Some financial planners recommend looking at the situation this way in an example with your shares worth $150,000 at vesting. If you had $150,000 in cash to invest, pay down debt, etc., would you use all of that to buy the company stock? If the answer is no, then why would you hold it? In other words, do not let tax implications lead your financial planning decisions.
More and more companies are issuing compensation in equity forms such as restricted stock grants or RSUs. Make sure you understand your vesting schedule and conditions so you can plan for the tax implications as well as your overall financial picture.
President Biden presented his $1.8 trillion American Families Plan, which focuses on expanding benefits for education, children and childcare. The Biden administration intends to pay for the plan with a series of tax hikes on certain individual taxpayers. Depending on your income and source of wealth, there are some clear winners and losers of this proposal, so let’s look at each and start with those who lose.
Losers Under the Plan
High Earners: The proposed plan would increase the highest individual tax rate from 37 percent up to 39.6 percent. Currently, this tax bracket starts with those earning more than $523,000 for singles and $628,000 for taxpayers who are married filing jointly. While the percentage increase may appear small, this change is projected to raise more than $111 billion over the next 10 years.
Heirs of Large Estates: The plan proposes eliminating the “step-up” in basis on assets received when an estate is passed on. The step-up in basis means that the heir now has a basis in the inherited asset equal to the fair market value at the date of death. This essentially eliminates the payment of capital gains taxes.
The plan allows for the initial $1 million in transferred gains to remain tax-protected, so this would only impact larger estates.
Wealthy Investors: A change to the long-term capital gains and qualified dividends taxation is proposed for taxpayers earning more than $1 million per year.
Currently, long-term capital gains (on assets held for more than one year) and qualified dividends are taxed at a flat 20 percent. The plan taxes long-term capital gains and qualified dividends as ordinary income, raising the rate to 39.6 percent for the taxpayer affected.
Hedge Funds and Private Equity: The Biden plan looks to eliminate the carried interest tax break, which allows partners in the funds to treat a large portion of their compensation as long-term capital gains instead of ordinary income.
Real estate investors: Currently, the tax law allows for what are called section 1031 like-kind exchanges. A 1031 exchange allows the proceeds from the sale of real estate to be reinvested in another similar or “like-kind” asset, and defer the capital gains taxes as a result.
The proposed plan would eliminate section 1031 like-kind exchanges for all sales where there are gains of $500,000 or more.
Low and Middle-Income Families with Children: The Biden tax plan calls for a five-year extension of the expanded Child Tax Credit (CTC) created in the American Rescue Plan. The CTC gives a credit of $3,000 for every child age 6 to 17 and $3,600 for children 5 and younger for single taxpayers earning $75,000 or less and married filers earning $150,000 or less. The plan would also make the existing $2,000 CTC permanently refundable.
Low-Income Individuals Without Children: The plan proposes a permanent enlargement of the Earned Income Tax Credit. The American Rescue Plan increased the maximum benefit for filers without children from $534 to $1,502 and broadened the eligibility criteria to include those under and over 65.
Working Parents: The American Rescue Plan also included a temporary enhancement of the Child and Dependent Care Tax Credit. This credit would give qualifying families a tax credit of up to $4,000 for one child or $8,000 for more than one child to compensate for childcare costs while they work, including after-school programs. The new tax plan would make this credit permanent for those making $125,000 per year or less.
The benefits of the Biden tax plan for its winners are nothing new or novel. Essentially, it calls for making permanent several the provisions originally passed in the American Rescue Plan and increases taxes on wealthier taxpayers to pay for it.
The Child Tax Credit as we know it originated during the Clinton administration, but the recently enacted American Rescue Plan created a new version. The updated version of this tax credit could have a beneficial impact on Americans struggling through the COVID-19 pandemic. There are changes to many aspects of the credit, so let’s look at each one below.
Monthly Payments Versus Once-a-Year Credit
First, the new version of the Child Tax Credit applies only to the year 2021. If a family qualifies, the credits are $3,600 for each child under age 6 and $3,000 for those ages 6 to 17.
The major difference is not the limits, but that in 2021 half of the credit will be paid on a monthly basis in the second half of the year. From July through December, the credit will be paid out at a rate of $300 for each child under age 6 and $250 for each child ages 6 to 17. In prior years, the tax credit was available only when filing an annual tax return. The other half of the credit in 2021 will be reconciled on 2021 income tax returns.
Income Limits and Phase-Outs
Similar to the stimulus checks, the tax credit is based on adjusted gross income. To receive 100 percent of the credit, the AGI limits are $75,000 for single filers, $112,500 for heads of household and $150,000 for those married filing jointly.
The phase-outs start once a taxpayer exceeds these AGI thresholds. Every $1,000 in AGI over the limit reduces the credit by $50 (per dependent child). For example, if a couple filing jointly earned an AGI of $165,000, their credit will be reduced by $750 per child.
Qualification for the Credit
While the tax credit is ultimately based on 2021 income, to facilitate the monthly payments, the new Child Tax Credit will use 2020 income tax returns. For those who haven’t filed yet, the look-back will be to 2019. The monthly payments will be based on these already filed tax returns and then the balance of the credit be reconciled based on 2021 income.
If a taxpayer receives more interim monthly payments on the tax credit than their 2021 AGI entitles them to, they will need to pay back the unqualified portion of the credit.
In the scenario where a child crosses age thresholds mid-year in 2021, the age for determining the credit will be based on how old the child is on Dec. 31, 2021. For example, a child who turns 6 before the end of the year will qualify for the lower $3,000 credit and not the $3,600 for those under 6.
Existing Child Tax Credit is Still Available
One of the unique features of the new Child Tax Credit is that the old version is still available. This version established under the Tax Cuts and Jobs Act of 2017 has significantly higher AGI thresholds: single taxpayers with an AGI of $200,000 and married filing jointly at $400,000. As a result, many taxpayers will still qualify for this version with its lower credit of $2,000 per child and no monthly payments.
Conclusion – There’s More to Come
As the July 1, 2021 start date approaches, the IRS will release more details on the new Child Tax Credit and what taxpayers can do to take advantage of the changes.