Posted by Doug Ewing
On March 11, President Biden signed the US $ 1.9 trillion bailout bill. This follows COVID-related spending of $ 2.6 trillion in 2020. According to the Government Accountability Office, the U.S. national debt as of September 30, 2020 was $ 26.9 trillion, with the increase US $ 4.2 trillion compared to 2019, the highest in its history.1 With this in mind, it probably came as no surprise to very few people when Bloomberg News recently announced: “Biden Eye’s first major tax hike since 1993 in the next economic plan.” 2
Yes, the prospect of higher taxes in our not-too-distant future is real. The question is what higher tax rates will look like and who will be affected. While major tax laws are still a long way off, the first signs seem positive for most retirees.
What could possibly be proposed in the upcoming legislation?
According to Bloomberg, to the extent that the Biden Plan focuses on individual income taxes, it targets the “rich”. Consistent with its election promises, the Biden Plan would impose income taxes on those earning more than $ 400,000 and capital gains taxes on those earning $ 1,000,000 annually. So what about people on lower incomes? This begs an interesting question: will the new tax legislation retain some aspects of the 2017 tax law changes made during the Trump administration?
The Tax Cut and Employment Act (TCJA) was arguably the Trump administration’s most consistent legislative achievement. The main objective was to simplify individual income taxes and reduce tax rates. However, the TCJA is expected to “go under” by the end of 2025. If Congress didn’t act, we would fall back on 2017 tax rates for the 2026 tax year.3 In which case, the impact on retirees would be significant. This is because the TCJA made several changes that will benefit many retirees.
For example, the Tax Cut and Employment Act introduced a much larger standard allowance available to most taxpayers ($ 12,550 for 2021, $ 18,800 for the head of household). At 65, the standard deduction becomes even more generous ($ 14,250 for single applicants, $ 27,800 for married applicants, and $ 20,500 for head of household). Prior to the TCJA, the standard deduction was $ 6,350 for a single applicant, $ 12,700 for a married couple, and $ 9,350 for a householder. There was also a personal exemption of $ 4,050 per dependent that was phased out for high income.
Why Standard Prints Are Important
The standard deduction is especially important for retirees who typically do not have a similar amount of individual deductions. It is estimated that around 90% of taxpayers will choose the standard deduction for 2020. The meaning of the standard deduction for retirees is that it fully offsets a corresponding amount of withdrawals from tax-deferred retirement accounts. In practice, for a 65-year-old married couple, the first $ 27,800 that is withdrawn from a tax-deferred retirement account is generally tax-free. If the standard deduction is reduced, more retirement income would be taxable.
The TCJA also expanded the 10% income tax class and replaced the 15% class with an expanded 12% class. The combination of a higher standard deduction and lower tax rates is a fantastic opportunity for retirees, especially those who are married. Based on the 2021 brackets, a married couple with no other income, both aged 65 and over, could deduct $ 108,850 from a traditional IRA and have a federal income tax liability of only $ 9,328 (that’s an effective tax rate of just 8.6 %)). Given our current budgetary position, it is difficult to imagine the tax rate falling. If the TCJA simply went under in late 2025 and reverted to the 2017 standard withholding personal exemptions and tax rates, the resulting tax liability on the same distribution would be $ 12,715 (with an effective tax rate above $ 3,300 higher of 11.6%). *
Effects on Capital Gains
Another issue to watch is long-term capital gains tax rates. Long-term capital gains continue to enjoy a simple three-parenthesis system with interest rates of 0%, 15% and 20%. The 3.8% Net Investment Income Tax (NIIT) applies to capital gains that are certain thresholds above income ($ 200,000 for single registrants and $ 250,000 for marriage registrations). It should be noted that even after the NIIT has been applied, long-term withholding tax rates are generally preferable to the corresponding ordinary income rates.
Under the Biden Plan, high earners could lose this preferential treatment.4 In particular, taxpayers who earn at least $ 1,000,000 annually would be taxed on capital gains at normal income tax rates. If net investment income tax also persists, it could translate into a long-term capital gains tax rate of up to 43.4%.
The good news is that with an income threshold of $ 1,000,000, very few of us would be directly affected by this higher tax rate. Also, remember that strategies to minimize capital gains, such as: B. the harvest of tax losses, should continue to be available. As long as tax rates on investment income remain the same for most taxpayers, investment income continues to offer many retirees an important alternative to ordinary income from tax-deferred retirement accounts.
What to look for
As we see more media coverage of potential tax proposals, keep an eye out to see if they maintain the standard withholding and lower tax brackets of the Tax Cut and Jobs Act. We also need to be careful about what happens to long-term capital gains tax rates. In the meantime, the lesson is that we never really know exactly what the future holds in terms of tax rates. Higher taxes are always possible in the future, especially depending on the activity of the Congress.
Tax laws change regularly, making tax diversification an important strategy as customers save for retirement. If a retiree can draw income from a variety of unqualified taxable assets, tax-deferred sources, or accounts that may provide tax-free income, a tax-effective retirement income strategy can be put in place that allows for significant tax savings and additional tax savings over the years to the typical portfolio.
Originally published by Nationwide, 3/30/21
3 The Tax Cuts and Jobs Act simplified the tax return process for millions of households
4 Details and Analysis of President Joe Biden’s Tax Plan
* Calculation: $ 108,850 total payout, minus the standard deduction of $ 15,800 ($ 12,700 plus $ 3,100, both 65 years), minus 2 personal exemptions of $ 4,050, equates to taxable income of $ 84,950. Total tax of $ 12,715. 12.715 / 108.850 = .1168
This information is of a general nature and does not constitute tax, legal, accounting or other professional advice.
The information provided is based on current law, which is subject to change at any time, and has not been approved by any government agency.
Neither Nationwide nor its agents provide legal or tax advice. Please let your clients consult their lawyer or tax advisor for answers to their specific tax questions.