Just when Americans think they understand how to calculate their income taxes – the rules evolve again.
That’s happening now as President Joe Biden has proposed a number of tax changes as part of his American Families Plan. Just how those changes might play out for any specific individual remains a work in progress, though.
“There is still time for plenty of wrangling in Washington over the final plan, so the ultimate tax implications are hard to predict,” says Rob Cordasco, author of A Framework for Growth: Smart Financial and Tax Planning Strategies Throughout the Entrepreneurial Life Cycle.
That’s especially true because of the even split in the Senate between Democrats and Republicans.
“For the first time in my career, you have a Senate stacked up where every senator has pull,” he says. “Everyone has negotiating power for this bill.”
Still, as things unfold, Cordasco says some areas worth knowing about or keeping an eye on include:
- The top income tax rate. The Biden plan would increase to 39.6% the top tax rate for ordinary income, up from the current top rate of 37%. That move restores the rate to what it was before the Tax Cuts and Jobs Act of 2017, Cordasco says. With this possibility looming, some financial professionals have been recommending that their clients convert traditional IRAs to Roth IRAs. With a Roth, you can withdraw earnings tax free in retirement. You do pay taxes when you make the conversion, but that would be under the current lower rate for anyone who acted soon. “The general strategies would be to accelerate income into 2021 and defer expenses into 2022,” Cordasco says.
- Special capital gain rates. Right now, the income tax on capital gains and dividends is lower than the rate for ordinary income. Under the Biden proposal, that would change for households making more than $1 million. “Their capital gains and dividends would be taxed as ordinary income and subject to that proposed 39.6% top rate,” Cordasco says.
- Partial elimination of step up in basis. Biden also wants to change a longstanding rule in tax law that affects the value of assets that someone bequeaths to the heirs. That rule is known as step up in basis. Here’s how it works: Let’s say that decades ago someone bought $100,000 worth of stock and that stock is worth $1.5 million today. If they sell it, they will pay a capital gain tax on their $1.4 million profit. But if the person left the stock to an heir, that heir would “step into” the current market value of $1.5 million, so if the heir sold the stock, they would owe taxes only on any capital gains above $1.5 million. “The president’s plan will close this loophole, ending the practice of ‘stepping-up’ the basis for gains in excess of $1 million for individuals,” Cordasco says.
Regardless of any changes made, or not made, Cordasco says it is important to remain agile.
“Taxpayers need to make sure they and their tax advisors are up-to-date on the rules to make sure to maximize the opportunities under the law,” he says.
Rob Cordasco, author of A Framework for Growth: Smart Financial and Tax Planning Strategies Throughout the Entrepreneurial Life Cycle, is the founder of Cordasco & Company, P.C., a boutique Certified Public Accounting firm. Cordasco is a CPA with more than three decades of experience. He holds a bachelor’s degree in accounting from Spring Hill College in Alabama.
