Proposed Tax Law Changes Individual Taxpayers Need to Watch

Patrick Horning is a senior director of Advanced Planning at Northwestern Mutual.

With Congress debating possible tax law changes, you may be wondering if there’s any action you should be taking now. Unfortunately, the political uncertainty and evolving legislative text has made planning for these possible changes difficult. While, we don’t know what items will be contained in final legislation, if any, we do know that you should talk to your financial, legal, and tax advisors now while there still might be time to take proactive measures.

Here are some proposed tax law changes that would affect individual taxpayers.

Individual income tax rates

Perhaps one of the most talked about proposals is an increase in the top marginal income tax rate to 39.6 percent. The increased rate would apply to taxpayers with taxable income of more than $450,000 (married, filing jointly) or $400,000 (single).

Capital gains tax rates

The top capital gains rate would increase from 20 percent to 25 percent for those earning more than $450,000 (married, filing jointly) or $400,000 (single). This would be effective for tax years ending after the date the legislation was introduced (September 13, 2021); however, a transition rule would keep it at 20 percent for gains recognized earlier in 2021.

Higher income surtax

The legislation would impose a new 3 percent surtax on income exceeding MAGI of $5 million ($2.5 million for married, filing separately, and $100,000 for trusts and estates).

Qualified business income deduction

The maximum allowable deduction under the Qualified Business Income Deduction (officially the Tax Cuts and Jobs Act, Provision 11011, Section 199A) would be set at $500,000 (married, filing jointly) and $400,000 (single).

Net investment income tax

One proposal that would mainly affect high earners with significant investment income focuses on the net investment income (NII) tax, which is a surtax on a portion of modified adjusted gross income (MAGI) over certain thresholds. The change would expand the application of this 3.8 percent tax rate to include net income that is derived in the ordinary course of business above $500,000 (married, filing jointly) and $400,000 (single).

Individual retirement account reform

Both the House of Representatives bill and a separate Senate document would put limits on IRAs that reach a certain amount ($5 million based on the Senate language and $10 million in the House)  

The House bill would prohibit what’s often referred to as the “backdoor Roth”, where a non-deductible IRA is converted to a Roth IRA. This change would be effective in 2022. Additionally, the House bill would eliminate all Roth conversions starting in 2032 for taxpayers who make more than $450,000 (for married, filing jointly) or $400,000 (for single filers).

Gift and estate tax exemptions

The Tax Cuts and Jobs Act of 2017 temporarily increased the amount taxpayers can pass free of gift and/or estate tax. This increased amount is set to revert automatically in 2026 to approximately $6.5 million per person ($5 million adjusted for inflation since 2011). The proposal would accelerate this sunset to 2022. The 2022 inflation adjusted exemption would be about $6 million per person. The Senate Finance Committee did not include an acceleration of the sunset in its working document.

Grantor trust rules

One proposal that would have a large impact on estate planning says that if a deceased person is deemed the owner of a grantor trust for income tax purposes, the trust will be included in the individual’s taxable estate. This would be effective for trusts created after the date of enactment and future transfers into existing grantor trusts.

The proposal would also eliminate an “estate freeze” technique, which allows a sale by a grantor to a grantor trust (in which the grantor is the deemed owner of the trust for income tax purposes) without the individual having to recognize any gain from the sale. 

Valuation discounts

The bill proposes eliminating the ability to claim a valuation discount for certain estate and gift tax transactions. This would be effective for transfers after the date any legislation is signed into law.

Talk to your financial, legal, and tax advisors about potential tax law changes now

Current law looks to be changing. While much is still uncertain, this is the time to talk to your financial, legal, and tax advisors about whether any potential changes impact you, and what actions you can take now. Waiting until legislation is passed may be too late.

This publication is not intended as legal or tax advice. This information is intended solely for the information and education of Northwestern Mutual financial representatives, their customers, and the legal and tax advisors with whom they work.  It must not be used as a basis for legal or tax advice and is not intended to be used and cannot be used to avoid any penalties that may be imposed on a taxpayer. Northwestern Mutual and its Financial Representatives do not give legal or tax advice.  Taxpayers should seek advice regarding their particular circumstances from an independent tax advisor.  Tax and other planning developments after the original date of publication may affect these discussions.