Over the past year and change, there has been great debate over what a change in the political scene would mean for US businesses in general and individual taxpayers in particular. And while much talk has been dedicated to the financial aspects of a Biden presidency, little has changed thus far. As a result, at least from a tax standpoint, Americans have largely been lulled into a slumber of apathy regarding this matter. But with the flip of the calendar from 2021 to 2022, it’s once again time to consider what changes might be on the horizon as far as taxes are concerned.
The following are some of the things you should be aware of, and how you can prepare for these tax changes as well.
Build Back Better
“Build Back Better” framework gives us an idea of what the Democrats have in mind with their $1.75 trillion spending program. Under the new proposal, new social programs that would impact childcare, health care, higher education, climate change, and more are on the table. Of course, this money doesn’t come out of thin air or grow on trees. You and I might be paying for it. Unfortunately, most Americans don’t know how their income stacks up against their fellow Americans. But here are some things you should bear in mind when reading about this new bill.
Increase Rates for Wealthy Americans
President Biden hopes to increase the ordinary income tax rate from 37% to 39.6%, as well as the long term capital gains tax rate for wealthier Americans. If the increase to the ordinary tax rate takes effect, what will be affected also is the short-term capital gains tax rate, which is taxed at the ordinary income tax rate. However the details of both of these increases have yet to be hammered out. For example, as of now, the highest ordinary tax rate for a Married Filing Joint filer only applies if your income is over $628,300. Biden has proposed to reduce this by potentially as much as $200,000, which would hit many more Americans hard in the belt. As for the long term capital gains rate, it is possible that the change would only affect Americans whose Adjusted Gross Income exceeds $1M. For those taxpayers, your long term capital gains tax rate might be equal to your ordinary tax rate of up to 39.6%.
One suggested strategy to mitigate any such tax hit would be to consider selling your investments before the 2021 tax year end. While it is still unclear whether this new change would take effect retroactive to part of 2021, there has been little talk about this. It is also unlikely that these changes will be in effect for the long term. As such, it might benefit the taxpayer who does not need the cash to hold off on making any investment sales until these changes- if ever enacted- run out.
Surtax on Wealthy Americans
OK, we admit, this is really not a concern for 99.9% of us. But just so you can sound education at your friend’s dinner party, we’ll mention it.
One of the proposals is a surtax on millionaires and billionaires starting in 2022. If your Modified Adjusted Gross Income (that’s your Adjusted Gross Income per your tax return, reduced by any deduction allowed for investment interest) is from $10M to $25M, you would pay an extra 5% tax. As mentioned, this is hardly a heart stopper for most people reading this. But it’s on the table. If you find yourself in this bracket, make an appointment with us to discuss. This requires a consultation!
Expanding the Net Investment Tax to Business Owners
Now this is more of a back-breaker.
Previously, the Net Investment Tax included only taxable interest, dividends, gains, passive rent annuities and royalties. But income derived from a trade or business was left off the calculation of this additional 3.8% income tax. Not anymore. Starting in 2022, Biden’s plan would expand the tax to business owners earning over $400,000 for Single or Head of Household filers, or $500,000 for Married Filing Joint filers. This is sure to affect many Americans whose sole source of revenue is business income.
But what to do about it?
The truth is, for many of our clients, the $500,000 threshold is cause for concern. But it need not be with some proper tax planning. Virtually every business has expenses it will incur in the coming months. One of the ways to reduce your business’ net income if you are a cash basis business taxpayer is by considering the capital expenses (such as vehicles, furniture, equipment, machinery and leasehold improvements) you will need early in the coming year and purchasing them before year end. As long as you put them into service before the new year, you can capture a full write off on these assets, either by using Section 179 depreciation, or Bonus Depreciation.
Furthermore, planning for retirement with the right IRA or retirement vehicle can help you put serious cash away towards retirement while saving you bundles in taxes. And it can also help you reduce your taxable income. Consider some of the retirement plans that might suit you and your business. And make a plan to start saving now!
Extending the EITC Enhancements
Jumping from the high income earners to the lowest, the 2021 earned income tax credit is due to expire at the end of this year, but is up for extension under the president’s Build Back Better plan. The proposed Earned Income Tax Credit that is only available to low and middle-income workers and families with no qualifying children includes:
- Lowering the minimum age from 25 to 19
- Eliminating the maximum age limit (65)
- Increasing the maximum credit from $543 to $1,502
Also, you’d be allowed to basse your 2022 EITC on your 2021 income (and not on your 2022 income), if it helps you (ie if your 2021 income was lower than that of 2022, thus guaranteeing you a higher tax credit).
Extension of Child Tax Credit
This popular credit is also up for extension. Two things of note with this proposal:
Firstly, just as Americans saw monthly advanced payment in 2021 for the Child Tax Credit, the proposal aims to continue this in 2022 as well. Secondly, the credit would also be made fully refundable on a permanent basis. In typical years, only $1,400 of the credit was refundable. The balance had to be used to offset tax liabilities. But if families did not have tax liabilities on their return, they were not able to claim as a refund more than $1,400. That’s no longer the case, per this proposal. Any and all amounts being claimed for the credit will be fully refundable, thus putting more cash in American families’ pockets. Of course, just as in prior years, this credit is subject to limitations based on earnings and AGI.