I have been fielding several phone calls and emails regarding tax law changes and how they will impact your situation. Many rumors are circulating, and I thought it was time to set some of that straight.
Many of the proposed changes are contained with the bill named the American Families Plan. First and foremost, this bill has not passed yet. None of what I am going to discuss below is law yet. These are all potential changes. Realize that what is proposed below may be passed, may have adjustments made to the bill, or may never actually pass.
If you have been a client of Planning with Purpose for any length of time, we have probably discussed Roth conversion. I have had several panicked individuals calling or emailing, thinking the ability to convert is going away.
Setting the record straight – the current American Families Plan bill eliminates Roth conversions for high-income taxpayers. A high-income taxpayer is a single filer with a taxable income exceeding $400,000 and more than $450,000 for joint filers. If your income is below the $400k or the $450k, you would not be impacted under the current bill.
Even for those over these current income limits, this ability to no longer do Roth conversions is effective after December 31, 2031 – ten years from now. Nowhere in the current bill is there any anticipation that the ability to do Roth conversions after this year will be limited. Many government representatives want individuals doing Roth conversions since more taxes would be paid now. The looming concern is where future tax money will come from if many are working with tax-free dollars in the future.
Can we say that Roth conversions will not stop for everyone? Certainly, it is a future possibility. This is one reason why we are recommending larger conversions now if you have significant assets to convert. A second reason for converting now is potentially higher tax rates in the future as Congress attempts to wrestle with the debt concerns.
If the American Families Plan passes into law, those with income above the $400k/$450k threshold who have more than $10 million in any type of IRA account would not be allowed to make any new contributions.
The other possibility that might impact more of our local clients is those of you who have after-tax contributions in your 401(k). You will not be able to roll this into a Roth IRA. You would be able to roll those funds to a Traditional IRA. Within the 401(k) and a Traditional IRA, the earnings on these after-tax contributions would be subject to taxes once withdrawn. While the after-tax contributions remain tax-free, the earnings would be taxable. Currently, we can roll these after-tax contributions to a Roth IRA and have the funds grow tax-free in the future.
If you have after-tax contributions in your 401(k) and can roll these funds over currently, it might be good tax planning to move these to that Roth IRA before the end of the year “just in case.”
The American Families Plan makes potential changes to capital gain rates too. The current version of the plan would raise those over that $400k/$450k income threshold to 25%. Those below those income levels would see no change to their capital gains rates. There was talk about making this rate retroactive to April 2021, when it was first introduced. The current bill does not have this retroactive feature to it.
The American Families Plan does adjust tax brackets for individual taxpayers. For those filing as a single taxpayer, the changes would impact those with a taxable income greater than $200,000. The $200,000 would cause your upper tax bracket to go to 35%, and above $400,001, it would increase to 37%.
For a married filing joint filer, the American Families Plan starts the 35% tax bracket at $400,001 and increases to the 37% tax bracket at $450,001. This $450,001 is $178,300 lower than the current change from the 35% to the 37% tax bracket.
With the $400k for single and the $450k income for joint filers, the American Families Plan would bring back the marriage tax penalties for those with high incomes. A married filing joint couple with a taxable income of $500,000 would pay more in taxes than two single filers, each with an income of $250,000.
The American Families Plan would also make permanent some of the changes for the child tax credit. If passed, the credit would be permanently refundable. There is no mention in this bill of continuing the monthly child tax payments, although there is talk elsewhere of doing that.
This American Families Plan would also permanently keep the Child and Dependent Care Credit increases, potentially providing larger credits available at higher incomes and making them refundable.
I cannot stress enough that the American Families Plan is currently a bill, and none of it has become law yet. In addition to this bill passing, there are concerns about government debt, the anticipation of Social Security funding problems starting in 2033, and Medicare funding problems even earlier. In addition to other potential spending bills, these needs are likely to increase the need to raise taxes at lower income limits.
I want to remind you that the tax law changes lowering the current income tax rates were implemented in 2018 and set to expire eight years later. In 2026 unless changes are made, we go back to the 2017 tax rates. That means the 12% bracket returns to 15%, the 22% to 25%, the 24% to the 28%, and on up through to the 37% tax bracket. I believe these rates or even higher rates will likely be coming in the next few years.
While we are in this lower tax environment, it is time to do tax planning to reduce the impact of potential higher income tax rates in the future. Roth conversions while in a lower tax bracket can achieve this. Delay collecting Social Security while using taxable and tax-deferred assets can potentially lower the taxability of Social Security later. In some cases, paying taxes on an installment sale upfront rather than over time might make sense. Moving investments into tax-free rather than taxable or tax-deferred investments might be advisable.
Each person’s situation is different. If you would like a review of your tax situation and to get recommendations for now and in the future, please contact us at Riverside Income Taxes to schedule a tax review.
