What’s in and what’s out of the congressional tax-reform proposal… for now
New research from Fidelity’s Viewpoints Blog analyzes the breadth and reach of Build Back Better. What’s in it for your clients? Reprinted with permission. Visit here for more details.
The social spending and tax reform legislation known as the Build Back Better bill is now with the Senate after passing in the House of Representatives, and negotiations remain active with more changes likely to come. Many tax reforms that would affect individual taxpayers are out of the proposal for now, while some have been adjusted to only apply to those with more than $10 million in income.
But there may still be a long way to go before a final bill becomes law.
Thin margins in Congress mean there’s more negotiating to do, and additional changes could crop up—a notable late inclusion by the House modifies the current cap on the state and local tax deduction on federal income tax returns, known as the SALT cap. Additional changes put controls on prescription drug prices and expand Medicare and Medicaid coverage.
Meanwhile, a separate infrastructure bill with an additional $550 billion in spending became law.
The situation remains fluid, to say the least, so keep checking for updates. Uncertainty in Washington can be confusing for investors, which makes it all the more important to have a solid investment plan in place and to stick with it.
“One of the benefits of having a well-diversified portfolio that’s aligned with a financial plan is that it allows you to look beyond near-term uncertainty, ” says Lars Schuster, institutional portfolio manager with Fidelity Strategic Advisers. “You can rest comfortably knowing that you’ve got appropriate market exposures that match your financial situation. Better yet, a well-diversified portfolio may help you weather any short-term ups and downs in the markets.” (Still, it’s important to note that diversification and asset allocation do not ensure a profit or guarantee against loss.)
New framework
Here are the key tax provisions in the House version of the Build Back Better bill:
- A 5% surcharge for taxpayers exceeding modified adjusted gross income (MAGI)* of $10 million, $5 million for married individuals filing separately, and $200,000 for a trust
- An additional 3% surcharge for taxpayers exceeding $25 million in modified adjusted gross income, $12.5 million for married individuals filing separately, or $500,000 for a trust
- A 15% minimum tax on the corporate profits that large corporations—those with over $1 billion in profits—report to shareholders
- A 1% surcharge on stock buybacks completed by publicly traded corporations
- Elimination of the ability to convert after-tax savings in a 401(k) or a Traditional IRA to a Roth IRA, starting in 2022
- A prohibition on converting pre-tax IRA and 401(k) plan funds to Roth savings for wealthy taxpayers starting in 2032
- Restriction of contributions to any type of IRA for those with taxable income over $400,000 (single) or $450,000 (joint) and who have a total value of IRA and defined contribution balances over $10 million, starting in 2029
- A modification of the cap on the deduction for state and local taxes known as SALT, the details of which are fluid
What’s not included in the proposal in terms of tax increases? Many of the provisions included in the last iteration.
There’s no longer mention of such items as an increase to the highest personal income tax rate, an increase in the corporate tax rate, a change to capital gains tax rates, cuts in the estate tax exemption, or changes to grantor trust rules.
While most tax increases seem like they will not materialize for now, there may be benefits for individuals through the spending provisions that remain in the Build Back Better bill. The overall $1.75-trillion price tag is down more than $1 trillion from previous targets, but it remains a significant package.
These Include:
An extension of the child tax credit, which is now available to those meeting income requirements
Childcare and preschool subsidies
Home care benefits for certain seniors
Premium tax credits under the Affordable Care Act for those in states that did not expand Medicaid eligibility
Market Impact
Political uncertainty can sometimes lead to moments of market volatility; however, Fidelity experts do not expect the markets to react negatively to the latest proposals.
Dirk Hofschire, senior vice president in the Asset Allocation Research team (AART) at Fidelity Investments, says, “Overall, on a multi-year basis, the fiscal mix continues to become more supportive of nominal growth by favoring infrastructure and manufacturing activity and transfers to low-middle-income households, all funded through higher taxes on entities with high savings rates.”
Denise Chisholm, director of quantitative market strategies for Fidelity, adds that current dynamics of the market cycle may be more important now than any action the government might take, and that those indicators point in a positive direction. “It wouldn’t be surprising for markets to look through uncertainty and climb the wall of worry. The infrastructure package is nice to have, but it may not be necessary. It’s more important what companies do in coming years regarding capital expenditures,” says Chisholm.
And it’s always important to look at the market holistically and consider the totality of factors driving the stock market, says Jurrien Timmer, head of global macro at Fidelity. Taxes are one factor but by no means the only one.
Individual Strategies
What do potential tax changes mean for your personal plan? If you had been contemplating what you might need to do in light of possible changes to your personal income tax rate or capital gains tax rates, you can largely stand down.
For those expecting more than $10 million in annual income who wonder if they need to take action, your options to make major changes before the end of the year may be limited. If you believe your tax rate will go up, you can seek opportunities to accelerate income into the current period to pay a relatively lower tax before the surcharge goes into effect. Similarly, you can seek to defer items that would reduce income into the period with the relatively higher tax.
If you were considering a long-term backdoor Roth conversion strategy on an ongoing after-tax contribution strategy, which many high-earners use to convert earnings above the contribution limits to a Roth, you might want to think about accelerating your plans to complete what you can before the end of the year. But note that it’s important to have other liquid assets to pay the associated income tax due as a result of the of conversion.
No matter your income level, you can always explore tax-smart strategies designed to help you manage, defer, and reduce taxes before making long-term financial planning decisions. Among these: tax-smart asset location, where you use tax-deferred accounts when appropriate, year-end charitable giving, and tax-loss harvesting, where you offset gains with losses.
As always, before you consider making any changes to your personal plan, make sure to look at your whole financial picture and consult your tax advisor.
“You’ve heard this many times: Don’t let the tax tail wag the investment dog,” says David Peterson, head of Wealth Planning at Fidelity. “It’s best practice to keep focused on your long-term goals but also build flexibility into your plans to be able to pivot as appropriate.”
Bottom Line
Stay flexible and keep an eye on how the legislative process progresses. If you think you may be personally affected, take the time to meet with a tax advisor and financial professional to review your situation and begin or refresh your plan.
