Today’s article is from the WSJ. I’m sharing it because it serves as a ‘heads up’, and accurately paints the current tax picture and what the potential picture could be, based on recent statements and predictions. When it comes to the stock market, we never make predictions. When it comes to tax policy, being forewarned is being forearmed. ****************
Complain if you must, but we live in a Golden Age of Taxes—the lowest rates we may see for decades. President Trump’s 2017 Tax Cuts and Jobs Act lowered rates, widened brackets and simplified preparation. Gazing toward the heavens, one can almost see the smiling face of Ronald Reagan beaming down. Yet like all Golden Ages, this one will end, and we already know the date: Dec. 31, 2025. Barring a miracle, that is when the tax cuts expire and President Obama’s American Taxpayer Relief Act of 2012 becomes the law of the land once more.
To see what a good deal we have now, let’s look at the numbers. A married couple filing jointly shows $78,000 of ordinary income, their current marginal rate is 12%. When the Trump tax cuts expire, their marginal rate will more than double, to 25%.
If you receive $30,000 from Social Security and have $36,000 of other income, you will be taxed at a marginal rate of 46%, even while supposedly being in the 25% tax bracket (because of the nutty way Social Security is taxed). In some cases, your tax rate can go as high as 56%. More people will experience rising tax rates throughout retirement—first gradually, following the accelerated required minimum distributions from their retirement accounts, and then suddenly, when the first spouse dies and the survivor has to file as a single taxpayer.
The Trump tax reform doubled standard deductions, such that far fewer taxpayers still bother to itemize. It also protects estates, with an $11.58 million exclusion from taxes. People can plan to give money to whomever they want when they die, instead of playing accounting games to confound the taxman. These deductions and exemptions will be cut in half when the Tax Cuts and Jobs Act expires.
Remember the Alternative Minimum Tax, which made you do your taxes twice, under two completely different tax regimes, and then pay whichever was greater? That annual ritual has all but disappeared. Better sharpen your pencils, though, because it’s coming back in 2026 for seven million filers. Meantime, the qualified business income deduction, which lets eligible small-business owners deduct up to 20% of their income, is going away.
All this may seem a long way off. But if Joe Biden is elected and the Democrats take three more seats in the Senate, some of these changes could happen as soon as next year.
Mr. Biden has proposed to reinstate the Obama tax rates for top earners while simultaneously imposing an unlimited 12.4% Social Security payroll tax on earnings over $400,000. Wealthy Biden supporters among the coastal elites are salivating at the idea of again itemizing their state and local property taxes and mortgage interest. They will find these deductions capped at only 28% of the stated value under the Biden program.
If you thought Congress’s raid on retirement plans last year under the Secure Act was unfair, Mr. Biden proposes to eliminate the capital gains reset to fair market value at death. For long-term holdings, much of that gain is merely inflation, created by the government’s failure to maintain price stability, so this is effectively a tax on a tax. The remaining gains are usually from corporate earnings, which were already taxed once, when they came in the door. It will be difficult to keep your business or farm in the family if the Biden scheme forces it to be liquidated to pay the death taxes. If the gains are forwarded to the next generation, they may need decades of accounting records to establish a cost basis.
If a President Biden has his way, the top capital-gains tax rate will be 39.6%—the same as for ordinary income. This could be a triple whammy: cutting the estate tax exemption in half, eliminating the capital gains reset to fair market value, and then doubling the capital-gains tax rate. A small step for the government, a giant loss for the American family. If the Democrats win in November, attorneys across the country will rack up the billable hours as their wealthy clients review their estate plans between Election Day and year’s end.
It would be one thing if Mr. Biden were campaigning on a return to fiscal probity, a sound dollar, balancing the budget, and slashing the national debt, but he isn’t. The former vice president’s ambitious spending programs would more than offset any new revenue from his tax proposals. The nonpartisan Tax Foundation concludes the Biden tax plan would reduce the size of the economy by 1.51% over the long run and lead to 585,000 fewer full-time equivalent jobs while lowering after-tax income for all income quintiles. This isn’t a debate between growing the pie vs. redistributing the pie; it is about everyone settling for a smaller pie.
The smart move for high earners is to play defense. Contribute to an after-tax 401(k) plan and convert your traditional individual retirement account to a Roth. That way, you pay the taxes at today’s lower rates. If you are over 70½ you can make a qualified charitable distribution of up to $100,000 every year from your traditional IRA. This reduces required minimum distributions and helps protect against jumping into higher tax and Medicare premium brackets later. [Caveat: Congress sets the rules for ROTHs and they did change a couple of those inheritance rules a couple years back.]
As for the estate tax, use the generous lifetime gift-tax exemption now or risk losing it forever. Form a family limited partnership to get a discount in your estate valuation based on lack of marketability and control. Sell your family business to a grantor-retained annuity trust. Find private investments that require estimated valuations where experts might disagree. [These are fairly complicated maneuvers; don’t try this alone.]
A legion of helpers—financial advisers, tax attorneys, probate attorneys, accountants, insurance agents and Wall Street bankers—stand by waiting for your call. The process won’t be cheap, convenient or enjoyable, but when the Internal Revenue Service comes knocking, you want a house made of brick and not of straw. Written by Philip DeMuth; photo by Chad Crowe
The SECURE Act, which we covered back in January, has changed the game with regard to qualified money inheritances, investment options now available to qualified employer plans, small business offerings to employees and numerous other issues. There are TRILLIONS of dollars in qualified assets (IRAs, 401ks, 403bs, pensions). Congress is continually looking for ways to get access to the taxes that have been deferred.
If you’ve been diligent, like many, and have saved significant amounts of your money into retirement accounts, it may be time to explore ways to make sure you’re ‘keeping it in the family’ versus sending 30-50% back to the IRS. We can help with that. Call the office at 443-718-6311