Update on Tax Hikes, Retirement Savings Impacts, and Other Provisions in $3.5T Infrastructure Bill

Update on Tax Hikes, Retirement Savings Impacts, and Other Provisions in $3.5T Infrastructure Bill

October 07, 2021
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As it goes within political wheelings-and-dealings, there have been changes to some initial provisions in Biden’s infrastructure bill. Keep in mind, our lawmakers are still hammering out additional details and provisions, and we may see more changes in the days and weeks ahead. But here are a few of the recent changes, along with some noteworthy provisions still in action that you may not be aware of.

We first published an article in August titled Are You Prepared for the Potential Tax Changes on the Horizon?, which explained some of the most concerning changes for Americans. Below are a few areas that have been adjusted versus the original proposals at the time this article is being written:           

  • Capital gains: The initial proposal was to move it from 20% up to 39.6%; instead, this tax rate moves to 25%.
  • Corporate tax: The good news for businesses reporting over $5m in income, the corporate tax rate moves from 21% up to 26.5% instead of to the initially proposed 28%.
  • Top income-tax bracket: This rises to 39.6% (from 37%) for individuals earning over $400k and households earning over $450k.

In addition to the above, below are provisions in Biden’s overall bill that may impact your wealth and retirement planning.

Cap on Traditional and Roth IRA Contributions

This impacts traditional and Roth IRA owners with adjusted gross incomes (AGI) of $400,000 (for individuals) or $450,000 (joint) and retirement account values that total more than $10m: You will no longer be able to make annual contributions to your traditional and Roth IRAs.

Additionally, if you your AGI is more than the $400,000/$450,000 described above and you hold $10-20 million in total retirement plan assets—Biden will require you to distribute 50 percent of your retirement account assets over $10 million. Do a quick calculation to see what your required distribution would be if your accounts total $18m. (You might want to sit down, first).

Elimination of Roth IRA Conversions for High-Income Earners

This is an interesting provision. Not everyone can contribute to a Roth IRA. Eligibility depends on your income, and if you earn too much you can’t contribute to a Roth. But Roth conversions are currently available for anyone—regardless of income. So, anyone can convert pre-tax funds in a retirement plan (like a traditional IRA) into post-tax Roth IRA funds. Now, in the year of the conversion, the account holder does incur a tax liability on those converted funds, but once the conversion is complete—the account owner is able to take full advantage of Roth IRA benefits to grow tax-free income for retirement.

Provisions in Biden’s bill excludes high-income earners ($400k+ individuals/$450k+ joint) from performing Roth IRA conversions. What makes this so interesting is that this provision won’t kick in until December 31, 2031. (Yes, that’s 2031, not 2021.) Some say the reasoning is to keep conversions alive for this 10-year timeframe to entice high earners to convert, which allows the government to capture some of that immediate income from taxes that must be paid on the converted funds.

However, if this provision is approved, starting January 1, 2022, you lose the ability to convert post-tax funds in another retirement plan to a Roth. For example, if you have 401(k) after-tax funds in an employer plan, this effectively eliminates your ability to perform a Roth conversion.

Reduction of Lifetime Gift and Estate Tax Exemption

The $10 million (per individual) unified estate and gift tax exemption is to be reduced to $5 million as Biden targets America’s top-income earners. Those individuals with estates larger than $5 million are probably scrambling to make moves such as gifting assets from their estates before 2021 ends to take advantage of the current $10 million exemption before it’s gone.

S-Corps Face a Potential 3.8% Surtax on Profits

At the moment, the profits of S-corps don’t pay either employment tax or the net investment tax. Biden’s bill will change that for high earning S-corps: If you’re an individual with a modified adjusted gross income (MAGI) of more than $400K (or joint taxpayers with MAGI over $500K), expect your S corporation profits to face a 3.8 percent surtax. Now, remember, if your income falls within this bracket, you’re already facing the income tax hike of 39.6 percent as a top earner. So, if you’re also involved with an S-corp, your total tax liability will be 43.4 percent.

Forced Divesting/Distributions of Private Equity Assets Held in Self-Directed IRAs

While this proposal takes specific aim at high new worth investors (like Peter Theil), it also affects average American investors. Middle-class self-directed IRA owners who, thanks to the Title IV of the JOBS Act, have been able to invest in certain private assets once only available to accredited investors may suffer the greatest impact.

Although it’s been said that account owners will have 2 years to remove these assets from their plans, divesting and distribution of these assets will levy an immediate tax burden on average Americans who have been able to invest in private holdings to grow their retirement nest eggs. In effect, this is taxing middle-class Americans and will cause loss of some of their hard-earned wealth and eliminates their potential to invest in alternative assets that may be crucial to the diverse income-earning potential of their current retirement portfolios. 

Parting Words to Help You Navigate These Potential Changes

These are perhaps the most sweeping changes we have faced in our lifetimes, especially when you consider the impact on retirement planning as described in those sections above. If you believe any of these provisions may impact you, keep your finger on the pulse of how this bill pans out if and when it passes, in whole or in part. Careful planning with your tax preparer and/or your financial advisor can help you transition as smoothly as possible.

 

This article was written for informational purposes only, and it contains portions of Biden’s $3t infrastructure bill that have not passed yet. The information contained within should not be construed in whole or in part as legal, tax, or financial advice. We recommend you consult the appropriate professional for guidance on this subject.