Eighth-grade chemistry was not very memorable except for two things: our teacher said worsh instead of wash and we had a project called “sludge” where we had to determine what was in a glob we were given by heating it, cooling it and filtering it. Things weren’t going particularly well even before my lab partner handed me the sludge and I dropped it.
The new tax proposals remind me of our sludge experiment. Congress and President Joe Biden are coming up with all sorts of tax changes, so let’s look at what’s heating up, cooling down and what we filter.
Top tax rates are definitely heating up. The proposals are calling for increases in corporate taxes, personal income taxes, estate taxes and capital-gains taxes.
We don’t know what is going to pass, but there is enough movement in this direction that you have to assume over the next couple of years that taxes are rising.
The other thing that is heating up is enforcement. No matter how you feel about the IRS and taxes, money spent on enforcement typically garners a pretty good return. One way to pay for some of the money spent on other proposals is to not only increase taxes, but to also collect them.
How you filter what to do in preparation for tax changes is complicated.
Rhetoric signals what is more likely to occur. If tax rates are going up, then you want to determine when it makes sense to defer taxes and when to accelerate them.
If your taxes are going to be higher in retirement, then Roth contributions are more attractive. Higher future taxes enhances the value of the tax-free withdrawal benefits from 529 education plans.
If you are over 70½, you want your charitable gifts to come from your Qualified Charitable Deduction through your IRA. It makes it even better to gift appreciated stock to charity rather than giving cash gifts.
Health Savings Accounts, the only vehicle where you get a tax deduction for investing and a tax-free withdrawal, look even better (especially if you can let the account build).
Rarely is it a good idea to accelerate taxes simply because tax rates are always subject to change, but if your federal tax bracket is low enough, you may wish to create some tax through Roth conversions or stock sales (be careful, though, to include potential health care cost increases from bringing in more income).
If you are retired, you want to run a few years of tax projections to decide what combination of already taxed, taxed on withdrawal, and never-taxed assets should comprise your lifestyle.
Understand the state income tax implications, especially if you think you will be changing your residence. Tax policies can change even for those states that were tax friendly. Washington, which has no state income tax, will be instituting a capital-gains tax next year. Arizona has increased its tax rate on higher earners.
Estate taxes are also heating up.
If you die today with appreciated assets, your heirs don’t pay capital-gains taxes when they sell them. There is talk about removing this step-up in basis.
The Federal estate tax exemption is likely to drop from its current $11.7 million dollars per person.
Minnesota’s exclusion is $3 million. For large estates, you can set up a structure to use the exclusion through various gifts and trusts before it is reduced.
Withdrawals from retirement plans are cooling down. You have to take required minimum distributions from your individual retirement account at 72 (up from 70½). There are proposals to increase the age of mandatory withdrawals up to age 75.
This doesn’t mean you should automatically delay pulling from your IRA; it gives you a chance to decide whether you want to take money out earlier to manage tax rates.
Itemized deductions continue to cool down for high earners.
There is talk of limiting up to 80% of itemized deductions for couples with over $400,000 of income. Since state and local income taxes and property taxes above $10,000 are not deductible, most people take a standard deduction.
Mortgage deductions have already been reduced to $750,000 for acquisition indebtedness. This means that if you want to slap on a mortgage because of low interest rates on your previously paid off home, you may not be able to deduct it.
Charitable planning, investment interest and mortgages all could require new eyes.
Related: To Avoid Chasing ‘Rabbits of Prestige,’ Stay True to Your Money Values