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What You Need To Know About Tax Changes In The Build Back Better Bill Thumbnail

What You Need To Know About Tax Changes In The Build Back Better Bill

2021 has brought wild speculation about tax law changes that have turned the world of financial planning into a sea of uncertainty and doubt. It started back in April of 2021 when the Biden administration first proposed new legislation that would change the tax landscape dramatically. That bill proposed retroactive changes to capital gain tax brackets, increases to ordinary income tax brackets, and changes to certain tax credits. To make matters more confusing, in September of 2021, newer proposals were introduced that were much different than what was considered in April. Now with what most believe will be the final version (with some minor changes) of the bill being introduced in late October, where do pharmacists need to be focusing their attention? What tax laws are staying, what are changing, and how can pharmacists prepare themselves before the end of the year?

Key Takeaways:

  • Top ordinary income tax bracket and long-term capital gains bracket will not change

  • The back-door Roth IRA strategy will remain in place

  • No SALT relief yet

  • Changes to cryptocurrency rules

  • Updates to increased tax credits for children and dependent care. 

Before you go an further, check-out this complimentary flowchart. Have you ever wondered what it takes to pull money from your IRA penalty free? Use this flowchart to help guide your decision making: Will-A-Distribution-From-My-Traditional-IRA-Be-Penalty-Free-2021.pdf

Will a long form blog post about taxes put you to sleep? That's ok! We've got you covered. Instead, take a look at this PharmD FP video to learn about 3 Backdoor Roth IRA Conversion Safety Tips!

No Increases To Top Ordinary Income Tax Brackets And Top Long-Term Capital Gains Tax Brackets

One of the biggest proposed changes that had a lot of people worried were the potential for increases to the top ordinary income tax bracket and the top of the capital gains tax bracket. Currently, the top income tax bracket sits at 37%. However, most Americans will never hit that rate due to the fact that you need to have $523,601 in income as a single filer and $628,301 as a married filing jointly tax payer. The proposed regulation would have brought the top bracket of 37% up to 39.6%. However, the Build Back Better Plan has eliminated that change. So in some instances where a pharmacist might have seen their income elevated (i.e. inheritance, windfall, etc.) to that income bracket, they won't feel the burden of having the pay that additional tax. 

The long-term capital gains tax bracket changes were targeted at increasing the top long-term capital gains tax bracket from 20% to 25%. In addition,  the Biden administration wanted to retroactively write that change into law beginning in April of 2021. Meaning that for anyone who might want to sell an appreciated capital asset, like their independent pharmacy business, would be stuck paying the higher capital gains tax. Even if they made the sale before the end of the year before the majority of these other changes would go into effect. Again, these changes were not included in the most recent bill, so many people are able to breath a sigh of relief. 

The Back-Door Roth IRA Conversion Strategy Lives On!

One of the biggest changes that was going to adversely affect pharmacists when the first two tax law proposals were introduced was the possibility of eliminating the Back-Door Roth IRA strategy. If you earn to much income within a year, you are unable to make a contribution to a Roth IRA. One way around this for many higher earning households was to use the back-door Roth IRA strategy. Because there is no income limit on making a Roth conversion (different from a Roth contribution), many pharmacist households would make a normal non-deductible contribution to an IRA (again no income limit for making a contribution to a traditional IRA) and then convert those dollars over to a Roth IRA. Therefore legally bypassing the income limits that are imposed on regular Roth contributions. 

When the second round of tax law changes were announced, this back-door Roth strategy was targeted as loop-hole that needed to be addressed. In order to address it, new regulations were going to disallow the option of converting after tax money into Roth IRAs. Essentially, this would completely eliminate the ability to make a Back-Door Roth Conversion. It would have also eliminated another popular strategy called the Mega Back-Door Roth Conversion. 

However, the Build Back Better Plan does not include any language that would disallow these actions from happening in 2022 and beyond. Meaning that the common strategy high income earners use to fund Roth IRAs will continue on. Just make sure that if you are attempting to do this, you don't have other traditional IRAs open and funded. Trying to do a Back-Door Roth Conversion while having a Traditional IRA to your name at the end of the year could make for a big problem. Read up on IRS aggregation rules to learn more. 

Back-Door Roth IRA

Still No SALT Relief (Yet)

SALT stands for State and Local Tax. SALT deductions permitted taxpayers who itemized when filing their federal income tax returns to deduct certain taxes that were paid to state and local governments. This became very important for higher earners who found themselves living in states where state and local tax rates are higher. However, when the Tax Cuts and Jobs Act was introduced in 2017, these SALT deductions were capped at $10,000/year. 

For many pharmacist families who found themselves paying much more than $10,000/year in State and local taxes, this was an unwelcomed change. This year as new tax law proposals were being tossed around, many people believed that there would be some change to the $10,0000 cap on SALT deductions. This would free up more deductions for families to use if they itemized, meaning their taxable income would become lower, which would lower their overall tax bill. 

Ultimately there doesn't look to be any changes in this area (as of now; 11/4/2021). But as the final details of the Build Back Better Plan get negotiated, this could be an areas where we see a little relief thrown in at the end. 

Cryptocurrency Gets Hit

Cryptocurrency continues to grow in popularity. It's something that more and more people are beginning to dabble in. One of the biggest tax benefits of crypto was that it is not seen as a security in the eyes of the IRS. Instead, crypto is seen as property. A huge benefit of this is that cryptocurrency is currently not subject to wash-sale rules

The wash-sale rule was created in order to keep people from taking advantage of investment losses and their tax deductibility while also being able to buy that same security back immediately after they created the loss in the first place. A common example would be selling a stock for $500 that you originally bought for $1,000. Doing this would create a loss of $500 on that investment. However, you could then take that $500 loss and use it to offset any other investment gains to reduce the tax liability of those gains. You could also use that $500 loss to offset your ordinary income in that year as well if you didn't have any additional investment gains. So even when you lose money on an investment, there still may be a benefit gained by using that loss to offset other income sources on your tax return.

The wash-sale rule makes it so that if you do take advantage of creating a loss on an investment, you can't buy that same investment back within 30 days of selling it. So in the previous example, you'd have to wait 30 days before you can by that same stock again if you want to use the $500 loss as a tax deduction. 

In the world of crypto, this 30 day wash-sale rule doesn't exist (yet). Before January 1st 2022, crypto is still seen as property and not a security. Meaning that you could sell any of your cryptocurrency at a loss and then buy it right back again, but you would get to keep that loss you created and use it as a deduction in the future if you wanted.

This is all going to change if the Build Back Better Plan gets enacted as is. There is specific language in the bill that would subject crypto transaction to the wash-sale rule, making it treated the same as more traditional securities (like stocks). So if you own crypto, it may make sense to capture any losses you have in these investments and then buy them right back. This would allow you to take advantage of not having to abide by a wash sale rule. Come next year you may not have that same luxury. 

Increases To The Child Tax Credit Will Continue Into 2022

A huge benefit for families this year was the increased credit amounts to the child tax credit. In 2020, if you had an eligible child you were granted a $2,000 credit per child. Increases to this $2,000 total were rolled out in 2021. If your child was age 0-6, your child tax credit went up to $3,600 and for children that were ages 6 -18, those credits increased to $3,000.

However, to get these additional tax credits, families had to be below a certain income threshold. For married filing jointly couples, that income threshold was $150,000. Meaning that if you kept your AGI below $150,000 in 2021, you will receive the full benefit of these higher credits. The IRS even went as far as pre-paying these benefit in 2021. This could cause a problem for some though. If you are getting these advanced child tax credit amounts deposited into your bank account each month but end out earning over the $150,000 limit in 2021, you may have to repay that money back to the IRS at tax time next year.

But, for those pharmacist families that find themselves below that $150,000 limit, you can feel good knowing that these increased credits will be around for at least another year. The advanced payment of these credits look to be continued as well.

The Larger Child and Dependent Care Credit Is Going Away

Another big win in 2021 for pharmacist families with kids was the increased credit amount available to them for a certain child care expenses. It made the decision for families on whether or not to contribute to higher Child Care FSA accounts tougher. These larger Child and Dependent Care Credits were increased so much so that it could actually cost you more by making additional FSA contributions and missing out on these higher credits.

There is no language in the Build Back Better Plan that would lead me to believe that these increased credits will be sticking around in 2022. So for all the parents who stopped making contributions into FSA child care accounts in 2021, you may want to think about starting that up again in 2022 due to the fact that the credits for Child and Dependent Care are going down. This is almost a given for many pharmacist families because of their elevated level of income. 

Bank Reporting Of Transactions Are Excluded

A big area of contempt recently for many of people was when they learned that the IRS wanted banks to report any transactions in any accounts that exceed $600. For many of us, this would be every account at the bank we own. It made headlines and the displeasure it brought to many Americans did not go unnoticed. The Build Back Better bill has excluded this. So we can all breath easy now knowing that our privacy remains in tact in this regard moving into 2022.

$600 bank reporting requirement

Bottom Line

Tax planning is critical. Rules, laws, and regulations are always changing. Some good and some bad depending on your certain financial situation. When there are tax opportunities available, you better be ready because those same opportunities may go away as fast as they came (see the Child and Dependent Care Credits). Also, when adverse tax laws are introduced, you want to make sure you are prepared to navigate those changes as efficiently as possible. 

If you're a busy person and don't think you could possibly keep up with everything that is going on in the world of tax, you are going to want to hire someone who is. It's too important and costly not to.

Finally, just because these new regulations may not impact you directly this time, doesn't mean that new changes in the future won't. Other tax regulations loom large in Congress (see SECURE Act 2.0) and being proactive and prepared will allow you to make the most of your tax planning opportunities moving forward.

Derek Delaney is a Minnesota (Minneapolis / Rochester area)  Fee-Only financial advisor serving clients across the country. PharmD Financial Planning provides professionals and families with financial planning and investment management with a focus on tax-efficient retirement planning.

As a fee-only, fiduciary, and independent financial advisor, Derek Delaney is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.

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