New Tax Reform 2021 key points
In the following article, we are going to cover just a part of the New Tax Reform that can possibly affect you as a high-income earner or business owner.
Tax Increases
One of the main proposals on the new tax reform 2021 is the increase in corporate taxes from 21% to 28%, also the raise of income taxes for people earning more than $400,000 per year from 37% to 39.6% as well as international taxes from 13% to 21%.
All of this with the “main purpose” to fund the main proposals on the infrastructure bill such as a public health service, schools, childcare/eldercare improvements among other proposals in the bill.
Biden is also proposing an increase in tax credits for corporations and individuals that choose to go with renewal energy such as electric cars. It is also proposed to increase capital gains to individuals making more than 1 million dollars long-term. The plan states t
hat taxes can be raised to the individual income tax rate.
The impact of this increase in taxes lead to around 500k fewer jobs over the next 10 years, a lower GDP and lower wages, also more money available money in the economy (inflation). This is due to an economic principle known as the Deadweight Loss which states the loss of economic activity due to higher taxes. Although this might happen or not in the future, you should always have a plan that can navigate through different changes in legislation.
SALT Improvement
Biden Infrastructure Bill aims to increase the SALT deduction to $20,000 instead of $10,000 for married couples. The SALT deduction is available for any individual with state income taxes and allows to deduct certain taxes up to $10,000. This might benefit high-income earners and have it as one of the strategies to apply when aiming to be more tax-efficient.
How to reduce my taxes in 2021?
Contribute to your Retirement Plans
Whether you are a business owner or a high-income earner, should you always consider contributing to tax-deferred retirement plans, since doing this can help you deduct contributions as part of your annual income. This will be of great help as part of your tax reduction strategy.
Among the different type of retirement plans that can help you reduce your taxes you have:
For Individuals:
Traditional IRA
Pros: You can deduct the amounts contributed to your IRA every year, which will help you reduce your taxes if you are a high-income earner, and receive the benefits at retirement when you’d possibly be in a lower income tax bracket.
Cons: Low contribution limit at $6,000 per year.
401k (other retirement plans)
Pros: Employer match. High contribution limit of $19,500, after 50 years old that numbers go up to $26,000 per year. As a high-income earner, it is important to contribute as much as you can to this retirement plan and ask for a match-up in case your employer offers it.
Cons: Low control over your assets.
For Business Owners:
Solo 401k
Pros: As a small business contributions are up to $57,000 or $63,500 if the employer has reached 50 years fully deductible.
Cons: High maintenance costs. More complicated to set up than an IRA.
Keogh Plan
Pros: Higher limits than 401k and SEP IRA.
Cons: Higher maintenance costs and less control of your assets.
SEP IRA
Pros: Low maintenance costs. Can contribute up to 25% of the profits of the business to the employees or up to $58,000 per year. It works like a Traditional IRA so you can deduct business expenses from your contribution. It can be open in conjunction with a Keogh Plan or a Solo 401k.
Cons: You cannot borrow money without a penalty if younger than 59 ½ which is not the case for the 401k. Not all types of businesses can set up a SEP IRA.
In 2019 president Trump signed the Setting Every Community Up for Retirement Enhancement (SECURE) ActSmall that will ensure Small Businesses to immediately get a tax credit for starting a 401k or SEP-IRA for their employees.
Net Gift Donations
Net Gifts can be another great strategy when it comes to reducing taxes. The way it works is different than the regular “Gift Donations” in which the donor pay the taxes, in this case, the recipient is required to agree to pay the gift tax as a condition of receiving the gift, consequently reducing the gift’s value for gift tax purposes
For example, John wants to make a $5 million dollar gift to his son Robert, at the current tax rate John will have to pay $2 million dollars in taxes which is 40% of the gift. By giving $5 million as a Net Gift Robert will have to accept paying the taxes, therefore the value of the gift will be reduced. In order to do this calculation, it is used the following formula, gift tax = tentative tax / (tax rate + 1), that would equal to $2 million / (0.40 + 1) = $1.4 million which is about 28% instead of 40%.
Taxes in this case have to be paid with the trustee funds, but there is a way to avoid this. To avoid this and ensure Robert receives the full 5 million dollars John decides to use a “finance net gift” where he makes him a loan of $1.4 million to cover all tax obligations. However, one disadvantage of doing this is that it can generate taxable capital gains for the donor if the gift tax liability assumed by the gift recipient exceeds your basis in the transferred assets.
Tax Itemization
Under the tax code, there are some eligible expenses that you can deduct in order to decrease your taxable income. The difference between this one and the standard deduction is that the standard is a fixed dollar amount deduction that you can do, on the other side itemized deductions are numbered within the tax code, however they can be most helpful if you are a high-income earner.
Some of the Itemized eligible Deductions:
- Medical and dental expenses.
- State and local taxes.
- Real estate mortgage interest, up to $750,000 if married
- Gifts by cash or check.
- Casualty and theft losses from a federally declared disaster.
- Investment interest expenses
- Gambling Losses
There are other eligible deductions you can do. check them out here. However, always make sure to consult with an expert before making a decision.
Donate to non-profit causes (not only money)
Whenever people talk about donations the first thing that comes to their minds is money, however, you not only can donate money, you can donate almost anything, such as cars, stocks, real estate even airlines miles, and clothes. Any valuable item that you have and don’t plan to keep can be donated to non-profit causes, and the best part about this is that you are not touching your accounts and still getting tax benefits.
However, remember that your donations can’t ever be greater than 60% of your adjusted gross income, and it is important that you have guidance through the process. IRS requirements for Charitable contributions.
Multi-generation trust (5 million or more)
Setting up a long-term trust for your heirs is one great way to reduce taxes. In 2018 The Tax Cuts and Jobs Act increased the gift and estate tax exemption to $11.18 million for an individual and $23.6 million for a married couple. The main benefit of setting up a multigeneration trust is that it allows you to passed down your wealth from generation to generation, however, it can be very costly, thus you should consult a professional to see if it makes sense for you to set up one.
Another great benefit of a multigeneration trust is that, in the case that you are living in a state with high taxes, you only have to pay the estate tax once at the time of transfer, as long as the money remains in the trust, no additional estate tax will apply to the trust assets.
It is important to know that this strategy may only apply to ultra-high net worth individuals who are looking to pass down their wealth in the most tax-efficient way possible. When it comes to setting up a trust there are very rigorous procedures that have to be taken into consideration, always meet with an experienced professional to see which is the best way to take in your specific situation.
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Summary
After reviewing some of the consequences that can affect you with the New Tax Reform Proposal, we can come to a conclusion that planning to reduce taxes and protect your assets can a really complex tax, there are many strategies that you can use but the DIY approach may be very risky because only a little mistake can cost you a lot of money.
That’s why here at Barnett Capital Advisors we provide you with the best tax-planning strategies to reduce your taxes, grow and protect your wealth. Always remember the times are going to change and there are going to be different types of governments with different types of tax legislations. Whether the government increases or decreases taxes you should always long-term plan and be prepared for any future scenarios.
These are just a sneak peek of the strategies we utilize to help our clients, there are many other great strategies that you can benefit from, and help you reduce even more from your tax bill at the end of the year.
You should not wait until something happens to take action, protect and start planning today!
