How potential tax-law changes could impact your financial plan
The COVID-19 pandemic’s impact on the U.S. economy, coupled with 2020 election results, have led to the enaction of numerous tax-related laws over the past 18 months that may have implications for you.
The White House recently outlined the second half of the administration’s infrastructure plan, the “American Families Plan,” which would cost $1.8 trillion over 10 years. The cost of the plan would be offset by a series of tax increases on high-income earners. The first half of the plan, called the “American Jobs Plan,” would cost $2.25 trillion over 10 years and would be paid for with increases in corporate taxes.
As a result of these plans, members of the U.S. Senate and House of Representatives are introducing bills covering a broad spectrum of tax code changes. Whether any of these bills can or will become law is unknown, due in part to the balance of congressional power between Democrats and Republicans, especially in the Senate.
One of the keys to a successful wealth management plan is staying up to date on potential tax-law changes and understanding how they may affect your financial future. However, your strategic financial planning decisions should be driven by your goals and holistic financial strategy. We don’t recommend making quick decisions based on tax changes—especially proposals which haven’t been finalized.
Below is a brief analysis of the potential tax-law changes.
Planning considerations for proposed tax-law changes
The chart below highlights President Biden’s proposed changes to individual taxation. Keep in mind, however, the process of converting these proposals into actual laws in the tax code requires Congress to move the proposals through the legislative voting process, which takes time. Through that process, these proposals could change dramatically from their current forms.
Although current tax laws, such as estate/gift tax exemption levels and income tax deduction limitations, aren’t mentioned in the American Families Plan, they could still be modified through the legislative process.
Biden’s proposed tax plan
|Individual tax rates||Raise the top individual income tax rate to 39.6%.|
|Capital gains & qualified dividends tax rates||Raise the rate to 39.6% for taxpayers with household income over $1 million (in addition to a 3.8% Medicare surtax).|
|Basis step-up at death||Eliminate basis step-up at death, with the first $1 million exempt for an individual; the first $2.5 million exempt for a married couple; and additional unspecified exemptions for family businesses and farms.|
|1031 or “like kind” exchanges for real estate||Limit deferral of capital gains to $500,000 when engaging in a “like kind” exchange transaction.|
|Child and dependent care tax credit||Make permanent the current law providing credit for qualified child care expenses. (See below for the current law.)|
|Child tax credit||Extend (through 2025) increases in the tax credit for children ($3,600 for a child under age 6; $3,000 for a child between ages 6–17) and make the tax credit permanently fully refundable.|
|Carried interest||Eliminate preferential tax rates so carried interest will be taxed as income, not taxed at the lower capital gains rate.|
You may want to work with your advisor to review your current financial situation, including how you realize capital gains, and revisit your estate and gift plan.
Planning considerations under current tax laws
This chart illustrates tax-law changes, which were enacted in the last 18 months, that may affect your wealth planning strategy.
Current tax laws
|Required minimum distributions (RMDs) for retirement account beneficiaries||Generally, RMDs from traditional and Roth retirement accounts must be distributed within 10 years after the account owner’s death, unless a beneficiary falls within an exception (e.g., is a surviving spouse; is a minor child; has a disability or chronic illness; is no more than 10 years younger than the deceased account owner).|
|2021 RMD requirement||Individuals must satisfy their 2021 RMD requirement.|
|Charitable cash contributions||For individuals who itemize, the 100% adjusted gross income (AGI) limit for cash contributions to a qualified charity (excluding donor-advised funds or supporting organizations), which was set to expire at the end of 2020, is extended through 2021.
Individuals who don’t itemize their deductions can deduct up to $300 in charitable contributions again in 2021. In addition, for 2021 only, joint filers can claim a deduction of up to $600.
|Child and dependent care tax credit||For 2021 only, a tax credit is available (for up to 50% of qualified child care expenses for children under age 13), allowing up to a $4,000 credit for one child—or up to a $8,000 credit for 2 or more children—for households with income less than $125,000. A partial credit is available for households with income between $125,000 and $400,000. Full-time child care, summer care, and after-school care are qualified child care expenses.|
|Child tax credit||Increased, fully refundable tax credit for children ($3,600 for a child age 6 years old and under; $2,000–$3,000 for a child between ages 6–17), with the ability to take a portion of the credit as an advanced payment.|
Below are potential planning opportunities for 2021 in light of these newly approved laws and the current economic and tax environment:
Income tax planning
- Take your RMDs.
- Use tax-loss harvesting if and when the opportunity arises.
- Make strategic charitable giving decisions, especially around the timing of donations and type of assets to donate.
- Review your estate plan for retirement accounts with nonspouse beneficiaries.
- Explore opportunities (e.g., private loans, sales to defective grantor trusts, etc.) to take advantage of the low-interest rate environment.
- Continue to evaluate opportunities for making lifetime gifts, including the use of your current gift tax exemption.
- Keep apprised of legislative developments and the timing of enactment.
- View any potential changes within the context of your personal wealth planning goals.
Thank you for belonging to the Vanguard community of investors.
All investing is subject to risk, including the possible loss of the money you invest.
Advice services are provided by Vanguard Advisers, Inc. (“VAI”), a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company. Neither VAI nor its affiliates guarantee profits or protection from losses.
The services provided to clients who elect to receive ongoing advice will vary based upon the amount of assets in a portfolio. Please review Form CRS and the Vanguard Personal Advisor Services Brochure for important details about the service, including its asset-based service levels and fee breakpoints.
Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could have higher costs than the original investment and could introduce portfolio tracking error into your accounts. There may also be unintended tax implications. We recommend that you carefully review the terms of the consent and consult a tax advisor before taking action.
We recommend that you consult a tax or financial advisor about your individual situation.