By Dr. James M. Dahle, WCI Founder
I went away to go canyoneering for a week, and I returned to find that Congress has been thinking about messing around with the Backdoor Roth IRA and Mega Backdoor Roth IRA. To make matters worse, that was only the beginning. Today we're going to talk about what's happening in Congress. While we're at it, why don't you send a message to your Congressperson expressing your thoughts about the proposed changes? I've already emailed mine (not that he would ever vote for this particular bill).
The Big Picture
The big picture is that the White House and both houses of Congress are controlled by a single party. When that happens, there is usually a significant change to the tax code. In 2017-2018, it was all controlled by Republicans, and taxes went down. In 2021-2022, it's all controlled by Democrats so we shouldn't be surprised to see taxes go back up. Democrats in Congress are very interested in spending a lot of money on what they are calling “infrastructure”. To pay for that, taxes need to be raised or deficit spending must be increased. President Biden has promised that people making less than $400,000 a year are not going to have their taxes raised. So all of the tax increases are theoretically going to be aimed at the demographic that reads this blog (i.e. high earners).
Just a Bill
While it is good to be informed and to try to make an impact on your elected representatives, be careful making any changes to your own financial plan and, especially, your estate plans until bills actually become laws. Only a small percentage of what is ever proposed actually becomes law. If you made a change every time someone proposed something, you would be whipsawed all over the place and pay lots of extra fees and taxes for zero benefit.
So unless there is a really good reason to do something right now, it's usually best to wait until the bills actually pass. Most of the time, changes are not retrospective. But retrospective taxes seem to be starting to show up from time to time these days, including at least one in this bill. See the end of this article for a few suggestions on things you may want to do before this bill passes.
What's Not Changing
There has been lots of talk in Congress and in the media about all kinds of changes. In my opinion, one of the worst proposals was to get rid of the step-up in basis at death. I think eliminating the step-up is bad policy for various reasons. Apparently, even the Democrats in Congress agree with me on this point. So that isn't in the bill.
Another proposal was to equalize capital gains and ordinary income tax rates (i.e. pay 37% instead of 20% on capital gains). Again, I think this is bad policy and the Democrats in charge of the Ways and Means Committee agree with me. That isn't in the bill either. Yet another proposed change that doesn't seem to be there is eliminating 1031 exchanges on like-kind real estate.
Increased Ordinary Tax Brackets
While the title of this post talks about potential changes to the Backdoor Roth IRA process, that's not actually the biggest deal in the bill. The biggest deal is the increased tax brackets. While politicians are saying, “We're just going back to the way it was before the Trump tax cuts,” that doesn't appear to be true at all. This is a bit nuanced, but the “top bracket” is going back to 39.6% from 37%. However, that top bracket is going to start at a taxable income of $400,000 ($450,000 married). Right now, the top bracket doesn't start until $523,600 ($628,300 married). So in reality, many people are going from 35% to 39.6%, not from 37% to 39.6%.
To make matters worse, the proposal will create a new bracket, even if it isn't called “a new bracket”. It's being called a 3% surtax. It starts at $5 million. While almost no doctors have a taxable income of more than $5 million, our new top tax bracket may be 42.6%. And yes, that's before the 0.9% Obamacare tax and the 2.9% Medicare tax and state taxes as high as 13.3% that would all still apply.
Increased Capital Gains Tax Brackets
Under this bill, many people who are currently in the 15% and all people in the 20% long-term capital gains bracket would see their LTCG tax rate increase to 25%. Basically, the 25% bracket will start at a taxable income of $400,000 ($450,000 married). Thankfully, Katie and I don't pay capital gains taxes because we don't sell anything with gains (we give appreciated shares to charity) and have many years' worth of tax losses saved up. However, this will presumably also apply to dividends, which we do get and on which we do pay taxes. Yes, the 3.8% NIIT will still apply.
Canyoneering guru Tom Jones getting it done. This canyon was way easier than dealing with tax changes.
QBI Deduction Changes
The qualified business income (QBI) Deduction may not be very well understood, but it's a really, really important deduction for some of us. It rivals our charitable deductions as our largest deduction. In our income situation, it's basically 20% of our ordinary business income, although it is often much less or even eliminated completely for those whose income is primarily clinical. Under the proposed changes, there would be a cap put on this deduction. The cap is $400,000 ($500,000 married). I'm not sure which would personally cost me more money—the higher tax brackets or this cap—but they're both going to hurt a lot.
NIIT Changes for S Corp Owners
To make matters worse, Congress also could be going after S Corp distributions. Right now, you don't have to pay the 3.8% NIIT tax on S Corp distributions (nor the 2.9% Medicare tax, nor the 0.9% Obamacare tax). Avoiding these taxes was the whole point of doctors forming an S Corp. Now, once your taxable income hits $400,000 ($450,000 married), you will have to pay 3.8% on S Corp distributions.
Corporate Tax Rate Increases
If you own a C Corp (and most of us do, at least via our mutual fund investments), the top tax rate there may go up from 21% to 26.5%. That potential 26.5% beats the 35% it was before, but it's going to impact your investment returns at a minimum. Most doctors haven't formed their practice as a C Corp, but there is even less incentive to do so now. Once you add on a state corporate income tax, the country's corporate income tax will again be among the highest in the world, encouraging big corporations to once more go overseas as best they can.
Death of the Backdoor Roth IRA and Mega Backdoor Roth IRA
One of the proposals would eliminate the ability to do a Roth conversion on after-tax money in retirement accounts like IRAs and 401(k)s. In effect, that means no more Backdoor Roth IRAs or Mega Backdoor Roth IRAs starting in 2022. What to do? Make sure you convert all after-tax money to Roth before the end of 2021. Then your additional savings after maxing out your other retirement accounts will probably go into taxable as non-deductible IRAs without the conversion. That's usually not an awesome deal.
Elimination of Roth Conversion for High Earners
In fact, high earners will not even be allowed to do any Roth Conversions at all under the proposed legislation, similar to how it was prior to 2010. Luckily, this provision would not go into effect until 2032. Again, the cut-off for defining high earner is a taxable income of $400,000 ($450,000 married).
Elimination of Accredited Investor Investments in Retirement Accounts
No more putting real estate syndications and private funds in your self-directed IRAs and 401(k)s. In fact, this will be a huge hit on the self-directed IRA and 401(k) industry.
New RMD Rules
If you weren't mad at Peter Thiel before, you may be now. No more $20 million-plus IRAs. Basically, if you have a high income (again, $400,000/$450,000) AND more than $10 million in retirement accounts, 50% of the amount over $10 million must come out every year and taxes must be paid. You also cannot put any more money into retirement accounts if you have more than $10 million in those retirement accounts.
There is an additional rule for Roth accounts. If you have more than $20 million in retirement accounts, the lesser of everything in Roth accounts (IRA or 401(k)) or everything over $20 million must be withdrawn.
These RMDs apply at any age, not just over 72. Luckily the 10% penalty for withdrawals prior to age 59 1/2 won't apply to these RMDs.
Defective Grantor Trust Elimination
This one is a lot more complicated to explain, but the bottom line is that this strategy (putting something in a defective grantor trust in order to get it out of your estate) is going to go away. This could also affect some irrevocable life insurance trusts. However, already existing trusts are going to be grandfathered in.
Lowered Estate Tax Exemption
Instead of being lowered in 2026, the estate tax exemption would be halved in 2022. This does create an opportunity to give a whole bunch of stuff away this year without it affecting your future exemption.
Family Limited Partnerships Become Less Useful for Estate Planning
They'll still work fine for real family businesses, but you're no longer going to get a “discount” on the value for non-business assets put in there. This technique was used to reduce estate taxes. Planning opportunity? Get those assets in before the end of 2021.
Child Tax Credit Becomes More Generous
Don't worry, many doctors will still be phased out of it! But if not, you could get as much as $3,600 per kid under 6.
Wash Sale Rules Become More Inclusive
Apparently, you could get around the wash sale rules when tax-loss harvesting cryptocurrencies and commodities and foreign currencies. Previously, they only applied to stocks and mutual funds. That will probably change.
What Should You Do About All This?
Overall, this bill should be very concerning for any high earner. You're almost surely going to be paying more taxes. However, there are a few opportunities with a deadline to be thinking about. Let's recap them:
- Get your Backdoor Roth IRA completed before the end of the year.
- Get your Mega Backdoor Roth IRA completed before the end of the year.
- Convert any other after-tax money in retirement accounts to Roth this year.
- If you want a defective grantor trust or irrevocable life insurance trust, get it before the end of the year.
- Get any nonbusiness assets you want in your FLP before the end of the year.
- Don't bother tax-gain harvesting. It sounds like LTCG rate changes will be retroactive.
- Remember that this is just a bill. The final law will likely be very different.
What do you think about this proposal? What, if anything are you planning to do about it? Comment below!
From what I’m reading, the irrevocable life insurance trust will not be grandfathered in. That is, if you set it up this year, you will NOT be able to use the yearly gift tax exclusion via Crummey powers to fund it in the future, so it will be included pro-rata in your estate (that is, you get this year’s tax break, but in future years every year will proportionally included in your estate). As you mention, grantor trusts are complicated to fathom but the net effect will be taxation of the “rich.” Any “loopholes” will be closed.
My point was that if you set it up and funded it in the past, you’ll still get the benefits from those contributions. But you’re probably right about the new ones.
I received an email from Equity Trust, my self-directed IRA custodian. While almost none of the proposed changes will affect me, the one prohibiting investments requiring accredited investor status will.
From Equity Trust:
Prohibiting the use of IRA funds for investments that require accredited investor status;
Prohibiting the use of IRA funds for investments where the IRA owner has more than a 10% interest (vs. 50%) in the investment or where the IRA owner is an officer;
Both of these types of investments that exist in IRAs at the time of enactment would be required to be divested from the IRA by December 31, 2023;
I must have missed that one. We’ll see if it stays in. Thanks for bringing it to my attention. I wonder if it applies to self directed 401ks too. If so, it’ll be the death of the self-directed industry.
Given all these proposed increases, how many are considering a large ROTH conversion this year? I am in peak earning years and have been delaying ROTH conversions but these increases are dramatic and if brackets continue to rise doing conversions now seems like a better move.
I was wondering the same thing. This would not be an ideal time to do a conversion, but I don’t want to miss my window.
Man, the tone of your article sounds very selfish. Good info, but repeated uses of “to make matters worse” and “are very concerning…” are off putting.
I make a lot of money and I’m happy to pay more in taxes so people less fortunate can benefit from that. The tone of your article is one of the reasons people can view doctors in a poor light. If an average income American read this, they’d view it very differently from you.
Feel free to add more money to that extra taxes box on your tax forms if you’re so willing to pay more. Nobody is stopping you. I have no interest in giving the feds more of my money. I am very charitable but want it to be my decision, not the govt.
I disagree with you Ryan. The blog piece is a very factual assessment of the current tax policy. It does so without emotion and simply lays out the details. This blog is aimed at high earners who are directly impacted by the various proposals outlined. When looking at things through a financial lens, it is “worse” to end up with less dollars than more. These things keep individuals from meeting their desired financial goals. You can argue about whether this is the correct tax policy for the entire nation, but WCI is aimed at doctors who want to make the best financial decisions possible. And having to pay higher amount of taxes is not in their financial interest.
On a separate note, I always chuckle to myself when I hear people say “rich” people need to lay their “fair” share- who determines who is rich and who determines what is fair.? The answer is this definition changes based on who controls Congress- not some absolute fact. As someone who lives in the Bay Area, I can assure you that $400,000 doesn’t feel quite as rich as it would in a different part of the country. We certainly are fortunate, but we are not sitting around drinking champagne and having caviar all day.
Haha ryan… nobody is stopping you from paying more… why don’t you give more to the govt then? You will never do that.
The blog post is nothing but factual and if you’re really willing to give more then you should have given more when taxes were low… there’s a study noting that republicans actually do give more money charity than democrats. (Not to sound political)
https://www.philanthropyroundtable.org/almanac/statistics/u.s.-generosity
Go to graph 15.
[Unnecessarily antagonistic comment removed.]
Ryan is actually correct.
The responses to his feedback are sad to say the least.
Hey folks, try to at least mostly stick to the facts of the proposed legislation and what you’ll do about it, rather than on whether or not it’s good tax policy. Leave that for your email to your Congressperson.
Ryan- I assume you’re talking to me, not Jennifer.
Thanks for the valuable feedback. The philosophical argument of whether the government can do more good with my money than I and my selected charities can is an interesting one. If one believes the government mostly does good, then your point of view makes sense. If not, well, it doesn’t. Actually a major difference between the two ends of the political spectrum.
I absolutely agree the average American would disagree with my view of how high earners should be taxed. I don’t write for them though. The truth is the average American has no idea how little he or she pays in federal income tax nor how much I do. In case you’re not aware, 50% pay nothing and many readers on this forum are effectively paying 25-30%+ in federal and state income taxes, more if count payroll taxes.
At any rate, reasonable people can disagree with how progressive the tax system should be. It’ll be worked out at the ballot box.
You may think I’m selfish, but I think the ratio of what I spend to what I give away (much less pay in taxes) would argue otherwise.
He really didn’t say that about you or much about the tax changes but rather those key phrases give a negative image.
I agree with some about the tone but overall enjoyed the write up.
My only objection was your use of “infrastructure” in a derogatory manner – your charities are not going to pay for infrastructure improvements, we need government spending for that, and we need it in every state of the country. I don’t know about you, but the roads I drive on and the hospital I work in are pretty important to me. I get that there is pork in the bill, it’s in every bill in Congress, but we really do need to help improve our infrastructure.
I agree that roads are infrastructure. The problem many people have is that some things being labeled infrastructure aren’t. Investopedia explains:
“Human and social infrastructure” is sleight of hand. People think it’s about roads and bridges and fiberoptics, but it’s really about free preschool and home care.
Thus the quotes around infrastructure. Sorry, thought everyone understood what was going on with that as it was all over the press when I wrote this article.
I am going to respectfully disagree in regard to the bill. Free preschool should not be viewed as some radical spending spree. We are one of the only developed countries in the world that does not offer this, yet we tend to look down upon people that fall behind in education and work lower wage jobs. I too am of the fortunate crowd that make a high salary but I am friends and family with lot of people for which daycare/preschool is a huge financial burden. It is only viewed that way it is because of how far right politically the policies of our country have become over the past 40 years compared to other developed countries. I think it’s easy to get caught in an echo chamber when you are amongst the 1% highest earners in the country.
I guess one person’s boondoggle is another person’s worthy spend.
For example, my kids got free school lunch the last two years. I thought it was ridiculous. I can’t imagine more than 5% of the kids in my kids’ schools really needed that free lunch, but there it was, all paid for with tax dollars.
As far as preschool, I wasn’t terribly impressed with the outcomes from preschool. My kids all went. I didn’t. Didn’t seem to hurt me any as far as I can tell. I don’t really see a reason why government needs to pay for it but I will certainly allow for a difference of opinion there. I could be wrong that it’s beneficial for all and I don’t doubt that it would be beneficial for some.
I agree. Nothing more off-putting than multimillionaires complaining about having to pay more in taxes. The wording does not sound objective as you pointed out, especially when words like infrastructure are in quotations. None of us got where we are without generations before us paying taxes. From roads to schools to hospitals and our salaries as residents are funded by taxes. If at the end of the day I paid a bit more in taxes but it helped keep somebody off the street, or feed them or help a mom be able to work by helping with childcare I’ll sleep better. Maybe it helped a vet get better care. The tax code isn’t perfect. I guess we’re at the point where we’re so selfish we love when we get big tax breaks even if it leaves the bottom 90% in a worse place than they were before. If there’s any downside to the WCI it’s having to read about uncontrolled greed.
I think the issue is that “multimillionaire” as you say is very different from the $400,000 cutoff being proposed. Many doctors make around that much so will see their tax bill go up. If one lives in a high tax state, has loans, no longer has SALT deductions, etc , then it is easy to see why they are concerned. Many of the readers of this blog fall into this category
I hear ya, I still don’t see the big deal. For someone in the situation you described if the tax rate goes up by 1.5% it’ll make little difference in their tax bill. Over 10, 20 or 30 years that person making 400k a year still has every bit the same opportunity to retire a millionaire. That small tax increase is not going to move the needle much. It matters much more the financial choices that person makes. Maybe I’ve got it all wrong but I’ve lived in high tax states and have been taxed at high rates and managed to do just fine, maybe I just don’t know what I’m missing. I think it’s just a slippery slope once wealthy people start obsessing over having to pay more taxes while there are people working 3 jobs just to eat and keep themselves afloat.
This is silly criticism. It doesn’t matter how much money you make, everyone is concerned about their taxes going up. That’s why taxes are always a central issue in every presidential campaign. While you’re welcome to argue there’s societal good in higher taxes, that’s a political argument, not one for a personal finance blog. When it comes to personal finances and planning the only thing I care about is whether I’m going to end up with more or less money as a result of tax changes. And, it doesn’t matter if we’re talking about taxes or the price of hotdogs; having less money in the end is a “negative” thing for the individual.
Amen brutha. The point of the blog is to help you as an individual and the more you pay in tax, the less you have to reach your goals. I find few white coat investors have a financial goal to pay more in tax.
The increase in my personal tax bill if this bill goes through as proposed is hardly insignificant. It’s likely 2-3 times what we spend in a year. For a big chunk of my income we’re talking about it being taxed at an absolute 6-8% more. Meaning 6-8% more of what I’m earning will go to the tax man. That’s like going from 34% to 42% as an effective tax rate. So yea, I think it’s a big deal from a personal view.
But the reason I wrote about it despite still being just a bill is because nearly every provision affects large percentages of the audience here.
If your only goal is to retire a millionaire and you’re making $400K, then I agree this isn’t going to be what keeps you from reaching your goal.
I’ll add on the proposed Roth conversions treatment alone is a potentially big deal. If one has angled for much of their working career to have a large tax deferred account and later planned to Roth convert this change would be huge. Especially if they had contributions at lower income for many years and a large increase in income at the time of the bill passing.
I’ll second there political vs finance blog posts. Little reason here but I will add one caution for you. It is not always about having people starve on the street vs not; that is a pretty low resolution assumption of a Esther complex and nuanced discussion. If someone doesn’t want to feed the immense defense spending machine (for example) then there are plenty of other reasons to want, politically, to curb taxes. Personally, donating to something like World Central Kitchen has a better value proposition for me to help feed the less fortunate. YMMV.
I agree that there is a big difference between the top .01% of earners and physicians. But we are still within the top 1%, which is certainly not middle class.
I could not disagree more.
While physicians are in the top 10% of earners, they easily pay their “fair share,” many 40%+ of their income in federal+ state + other taxes. How much do you want them to pay? 65%? 70%?
Meanwhile congress does nothing to the “loopholes” used by the truly wealthy to end up paying often a much, much lower percentage. The ultra wealthy don’t care about “earned” income really as most of their wealth can be re-classified into lower rates.
How about we close those loopholes first?
1000% in agreement with you about needing to close those loopholes.
One man’s deduction is another man’s loophole.
If you don’t like reading article about how to lower your tax bill as a high earner you’re probably on the wrong site. That’s got to be something like 1/3 of the content here.
It’s one thing to try to adapt to a new tax bill and another thing completely to whine about it. Nobody on this site is going to be less of a millionaire because of the bill, many people sound as if they’re going to be on food stamps soon because of it. Read the comment, it’s the whiny negative tone of the article that struck multiple chords. An objective article on strategy would’ve not triggered this.
Thanks for the feedback on tone. It’s certainly not the first time I’ve been accused of being whiney, less than objective, or being right of center on the political spectrum when it comes to taxes.
The question is what you expect out of a blog. Do you want boring, nothing but the facts, zero commentary, zero opinion write-ups or do you actually come here and read about something two weeks after it hits the news because you want to know what I think of it? And if it’s the latter, it’s only natural that every now and then you’re going to disagree with my opinion, no?
I appreciate your perspective. Totally agree that your opinion is what we seek. I also enjoy contrasting opinions, that’s how we learn. I guess maybe it felt like some politics spilled into the blog and maybe we’re all looking for a safe haven from politics these days. Maybe read into it too much. Either way thanks!
I personally want the insightful commentary… otherwise I can type “irs.gov” into an address bar with the best of them.
[Unnecessarily antagonistic comment removed]
Where Miguel goes wrong he takes WCI’s tone about taxes then goes off on that he is selfish and greedy….
“I guess we’re at the point where we’re so selfish we love when we get big tax breaks even if it leaves the bottom 90% in a worse place than they were before. If there’s any downside to the WCI it’s having to read about uncontrolled greed.”
I have no problem with the comment on tone, it’s the follow up implications that I have a problem with.
You know what I really like? The fact that we can chat about it in a civilized way. We need more of that in the world!
This blog is NOT for the average income American. It is for those that get up early, work hard and sacrifice their time and skills to help save the lives of others.
I don’t mind paying my fair share but this new proposal unfairly increasing my “fair share” but not for others.
The tone of the article speaks to the vast majority of the WCI community and is needed as the proposed legislation has serious consequences for high income earners.
I wonder how many “capitalists” paid for their flu shots and covid vaccines instead of using the socialistic government free offerings.
It is sad that my first thought with all of this Roth change is, “Wow I should work less, contribute less, and pick up less work, so that I am not paying for everyone else.” Ryan, with 50% of Americans paying zero taxes, I do not feel I should pay MORE than my 21-25% that I already pay. It is sad to think my brain actually went to “Welp, how do I work LESS in my 40s and 50s soon then.” But that is what these laws will do, in addition to off-shore movement.
It does make you feel a little less appreciated for your hard work, doesn’t it?
It’s definitely something to consider this year, even if you have to pay at 35% to do it, at least for some people.
I’ll second that question. Converted my old IRA from residency so I could start doing the backdoor Roth recently. My wife has a traditional IRA with a 60K balance that I have pondered converting. Also have roth and non roth 401k money that I guess I need to look into what I can do with…..
Considered it, but don’t think we’ll do it for reasons to be discussed in a later post. Bottom line, no point in paying taxes on money that’ll go to charity anyway.
There is no need to rush the conversion from Traditional to Roth because even under the proposal you have 10 years to do it.
I was wondering the same thing. I’m not sure this is the best course if one is at the highest tax bracket this year.
” I’m not sure this is the best course if one is at the highest tax bracket this year.”
I agree that the math has never favored doing conversions from a traditional IRA in a high-income bracket like $200k+, so even less so if you consider most of these proposals are aimed at the $400k level.
Granted, losing the Mega backdoor Roth, which is essentially a way of avoiding a taxable account over a Roth is a setback, but it is not a setback to the amount of after-tax money you can save, only a setback to the amount of tax you “might” pay on any gains you make.
It is really not that hard to essentially turn a taxable account into a Roth account by holding non-dividend-paying investments in that account. This could easily be an account that is only used in emergencies or for inheritance.
There are lots of times when someone with an income over $200K should absolutely do Roth conversions.
Great review of the new proposal and actionable steps to take. I think like you point out it’s important to realize this is not a bill yet and also like oh is that we should not let the tax tail with the dog. The same sound financial strategies that you have been propagating over the years are still the best ones to reach financial freedom. Despite the new proposed changes, there’s no need to chase exotic investment vehicles that are more likely to cause harm than to help.
I’ll hold my rant back.
Thank you for covering Dr. D
Just messaged my congress(wo)man too. Thanks for the reminder!
I tried to hold back as much as I could too. You can see how successful I was.
Anyone know if they are bringing back the SALT deduction? [political comment removed] I actually paid more taxes when Trump came in due to loss of SALT
I don’t think so. Unfortunate as that would also be a large deduction for me.
Several states now have enacted legislation to effectively bypass the SALT deduction cap, but it only benefits owners of pass through businesses. It is Entity Level Taxation, which allows you to deduct state taxes at the level of the business before it is passed through on a K1 (and then you get some sort of credit on your personal state income tax return). Only a few states allow it (and I don’t think Utah is one of them), though it seems like more states are proposing similar legislation. I’d be curious to hear Dr D’s thoughts on this SALT tax work around
Yes, there are several potential workarounds that have been implemented or discussed including trying to get the state tax paid to qualify as a charitable deduction. This particular workaround seems more serious though. I think it’s just NY and IL right now.
They ought to just revoke the SALT limitation. It was the only “bad” part of the tax cut passed a few years ago and maybe it can be the only “good” part of the tax raise now being contemplated.
Adding the SALT limit was not a “bad” part of the Trump Tax Cuts. Being able to deduct SALT gives local governments an excuse to be poorly run and raise taxes because “you can always deduct the increase on your federal!” Consequently, those living in efficiently run, low property tax places disproportionately pay a higher percentage of the federal tax burden.
Removing the SALT limit would just let local governments start running up the bill again. The root cause solution is to get local governments get their act together. Removing SALT limits encourages poor behavior.
Definitely agree that the SALT deduction is not good public policy. However on a personal level, limiting the SALT deduction is definitely “bad” for a high income person in a high income state.
By “bad” and “good” I mean “raises my taxes” and “lowers my taxes.” That’s why they were in parentheses.
You make a good argument from a policy standpoint though.
Mine was more of a political aside/commentary on the topic rather than a disagreement with the “bad” comment. I should have been more clear.
I’m definitely with you on the tax part. I’m in a deep blue locale with property taxes of $7000 on a $180k house. Insane.
Is that a typo?
We make enough for this to have an effect. We also support this proposed reform. The “just send more money to the treasury if you want to pay more!” argument is a silly one which misses the point of how taxation works.
Presumably at least half the country supports it. That’s the way politics works. I suppose if you feel that way you can email your congressperson and tell them “right on!”
Half the country doesn’t realize or refuses to believe that the top 10% of earners cover 40% of all federal tax receipts.
Half the country thinks the gov’t can create wealth and prosperity via redistribution and public spending. The notion is economically illiterate and oxymoronic. An archaic point of view that might have made more sense a half century ago (i.e NASA, internet).
Growth allows us to escape the shackles of a net-zero economy.
Net-zero economy = violence.
I believe this statistic about the proportion of federal income taxes paid by the highest earners is not accurate- I believe it omits payroll taxes which are significant. And the social security portion of them is regressive, as well. And although the statistic cited is specifically about federal income taxes, an accurate discussion should also acknowledge the large collections from state and local sales taxes, gas taxes, taxes on utility bills, etc. Omitting these from discussion may be politically expedient but does not truly further the discourse.
You’re correct that none of those are federal income taxes and this article is about federal income taxes. However, let’s be honest. For high earners, the income tax dwarfs all those other taxes and they are generally paying as much or more in those other taxes and sometimes for less relative benefit.
Social security benefits are regressive too. You may want to look at the benefit formula and the bend points.
Personally, I don’t look at social security payroll deductions as a tax and more of funding the benefit. Lower incomes get a much higher return than people past the 2nd bend point. Overall, social security is progressive, not regressive.
Social security is not a tax. It’s a failing public annuity that’s slowly turned into a Ponzi scheme because of fiscal incompetence.
Not sure of what your point is in bringing up payroll and state taxes as if the the top 10% are exempt. And like Dr. D said, they are dwarfed by federal receipts.
Intellectual dishonestly “does not truly further the discourse”.
https://www.usgovernmentrevenue.com/us_state_revenue_pie_chart
Hope this this resource is “politically expedient” for you Miss Kelton 🙂
My philosophical issue with our taxation system is that, unlike most European countries, half of the population does not pay any taxes ( maybe except payroll taxes). It is much easier then for that half of Americans to support legislation increasing taxes. In Europe the entire middle class have to pay taxes, ( real ones, not those that are returned in various forms back), so any tax increases affect a much larger swath of population.
And it’s not because European countries are so much more fair. It’s because to maintain their gargantuan welfare states they have no other choice but to collect taxes from everyone.
I agree everyone should pay something. I think the term “Alternative Minimum Tax” should actually refer to the low end of the scale. Maybe they can get their taxes way down but should still have a minimum bill. Maybe $100. Enough for everyone to feel they are contributing something.
The “just send more money to the treasury if you want to pay more!” response is not silly. What is silly are comments like “I want to pay more taxes so raise my taxes!” without acknowledging that in reality, what you really want is to raise other people’s taxes too.
I’m very early in my career (3 years post-residency). If all Roth conversions are removed for high earners, does that mean it would even be prudent to convert 401k money to Roth 401k if available?
Maybe. More likely than it was a month ago.
Definitely a negative tone to this article. Phrases like “To make matters worse” and “worst proposal” are not just facts. I would be affected by these changes and have no problem with most of them ( I would miss the backdoor Roth and conversions). Like most WCI readers, I work to maximize my savings, avoid taxes (legally) and optimize investments in order to reach FI, but I am also aware we have a huge wealth gap in this country and that it takes a federal government to correct that. That money has to come from somewhere. Does anyone think it’s fair that billionaires pay less in taxes than their secretaries? And the argument that “no one is stopping you from paying more” is ridiculous. That isn’t going to move any needles.
Agreed on all you say, and his responses in the comments make obvious his personal views. The last part of your post got me too, it’s like me saying “climate change is going to be a catastrophe, we need to encourage more green energy sources/jobs/infrastructure” and the response being “build your own windmill” or “just use paper straws.” It’s not just about one person’s actions, it’s an entire ecosystem/tax code that needs to be overhauled, and this is a positive first step, even if it somewhat affects our bottom line. We are all so privileged to be in the positions we’re in.
I think you all need to chill with the unfounded assumptions that WCI is against all taxes and doesn’t care about the country, wealth inequality, social services, billionaires who pay nearly no taxes, corporate tax avoidance by companies like Amazon, etc. Virtue signal all you want by bashing other people but you really have no idea. Why don’t you post how much money you give to charity?
This is a financial blog and thus is focused on legal tax avoidance. If you don’t want to take the advice and hence pay more in taxes then you are free to do so. This isn’t a knock on you. It’s just that the government and everyone else is looking out for #1. Don’t feel ashamed in looking out for your self.
Honestly the tax system is frankly so frustrating in so many ways. The constantly moving goal posts with changing government power is just one of my beefs.
I was stating my response to WCI’s clearly negative outlook on the proposed tax changes. I agree with WCI on many financial issues, but we apparently fall on different political sides of the spectrum. Govt is clearly inefficient, but what other entity can effect change the way it can? As stated, it will all get worked out at the ballot box. My intent was to express my opinion on the matter and not “virtue signal” or “bash other people”. Lord knows, I owe WCI a debt of gratitude for his work. Agreed that I don’t know his stance on taxing billionaires or tax avoidance by Amazon, but it was pretty clear from his use of the phrasing in the post that he is not a fan of raising taxes in general. I agree with Warren Buffett on this one and felt the need to express that opinion.
If you guys want to talk about my own personal views of tax policy sometime we can do that. But for now, all you need to realize is I don’t like seeing the tax bill of my blog readers and myself go up and I do like seeing it go down.
For now, try to focus on the bill, what it says, what you will do about it, and maybe, if you really care, whether or not you can affect the final outcome of the bill.
Our government has a spending problem not an income problem. Demonization of the “rich” is a political maneuver which ignores the primary driver of wealth inequality in this country — which is currency debasement by the Federal Reserve.
I am reading all this comments and I am in shock. In shock to see how politically divided we are nowadays. Media and propaganda did the trick! I came from Russia alone without any money, i was truly poor before and I know both sides of the story not from newspaper and CNN. Do you realize that US ALREADY has progressive tax code. Do you really think you are helping “poor people” by paying more in federal tax? I feel scared and sorry reading this comments! God Bless this country!
Is it still worth setting up a new Solo 401(k) plan right now to do a Mega Backdoor Roth this year and (if still allowed) future years, or would you wait until after the vote in Congress (until we know whether or not Backdoor Roths were eliminated)?
One financial commentator (economist) recently gave an interesting data point. For those who are on unemployment benefits, if they can’t find a job paying more than $25/hr, it’s not worth going back to work.
I just don’t see how politicians, government, large bureaucracies, are the best stewards of our money. Just stick with the basic stuff like defense, safety, utilities, etc. And let the people work the rest out.
Would the proposed changes to Roth contributions affect solo 401ks? I have a solo 401K with etrade (work 1099). I currently contribute pre-tax money as I’m in my peak earnings years but had planned to start making Roth 401k contributions in the next couple of years as I grow my real estate portfolio and decrease my taxable income through REPS/depreciation.
This legislation does not change the fact that there is no income limit for 401K contributions and that a 401K could be Roth or pre-tax. There are other proposals for completely changing the 401K system but they are not yet in this bill,
I think so.
Looks like the marriage penalty is getting larger ($21,765 ) again for us next year.
How does it not violate equal protection clause to tax married filing separately and single different rates?
That’s an excellent point. Definitely widening that penalty for high earners. Two $390K earners can stay under $400K but if they marry, they’ll be way over $450K.
The marriage penalty has two sides. On the one hand, we see things like this where two high earners get penalized when they marry. But on the other side, if one spouse makes a lot of money while the other does not, it’s no longer a penalty but instead a benefit. If the tax brackets were simply doubled for married people (as they in fact are for all current brackets below 35%), then single people could just as validly complain about the “single penalty”. Maybe the tax code should be completely agnostic to married status and just tax everyone based on their own income. But I’m sure that would come with its own set of problems.
The point is, I don’t think there is a “correct” answer to this. No matter what is done, someone will feel like they are getting the shaft. Currently that “someone” is married households earning the top 1-2% of wages.
Agreed.
It then becomes a social/political question of what should be encouraged by the government–being single or being married.
Notice how this proposed legislation increases the value of tax loss harvesting? If you had $100,000 of capital losses “banked” right now they might have a value of $23,800 for the 20% + NIIT taxpayer today but that value goes up to $28,800 if the capital gains tax get raised. It’s just another example of the deep principle that unintended consequences are inherent to all political actions and they work against the intention of the legislation.
Excellent points.
Another option to consider, is to just relax a bit… maybe work a bit less and just be content with an income under 450k.
Or even consider partial retirement/work part-time? I mean, a good many benefits become available of you decrease income a bit. Maybe work less but for longer?
This is the disincentive I feel, but it’s worse for society when the disincentivized person is an employer. The less I work the fewer jobs I create.
I was thinking the same Dr. Dahle. As a high-income earner (not doctor), this bill made me think in the back of my mind, “Well, how do I work less this decade, my 40s decade, which I was planning to work hard and produce?” That’s really sad, incentivizing people to work less.
I work in a field (not medicine) where the top earners are well above the $400k/year mark. Overall, I do feel our country would be better off if the top earners in my industry worked less, because I don’t think our work is a net good, especially for some of our most questionable/marginal projects. I think the same logic applies in certain other industries too.
That must be really hard to stay in an industry where you don’t think much of what it is accomplishing. I feel that way sometimes about how healthcare charges for its services. I’m assuming you’re in finance.
Just to clarify….even if this bill passes, if our income exceeds 400k then will we be able to continue utilizing Roth conversions/backdoor IRA up until 2031? Or does this end starting in 2022?
The ability to convert post-tax Traditional IRA contributions to Roth would end immediately under the proposed legislation.
Thanks for your reply, I am still just gaining a basic understanding of this. So what Roth conversions then are still eligible until 2032? Does this only apply to pre-tax income? Do we have any idea of when this legislation will actually be voted on?
Yes, the window for converting pre-tax IRA accounts to post-tax Roth accounts stays open for 10 years in order to maximize the taxes that will be paid over this period for scoring the bill’s budget impact. If the conversions were stopped immediately it lowers tax revenue in the near term, hence the 10 year window. Not clear when the legislation will come to a vote or what additional changes will come.
Yes, the pre-tax money can still be converted until 2032. I expect something passed by the end of the year.
It’s not law so it’s all still a bit vague and everchanging, but my understanding is the conversion of after-tax money is just going away and that has nothing to do with your income.
Via email:
If you are making over $400k per year, you are in the top 1.8% of earners in this country. Before retiring I was in that category. I wasn’t happy about paying higher taxes but conversely I was even happier that I was in the bracket that could afford higher taxes. Fifty five percent of this country earns less than $50k and half of those make less than $25K. Can you imagine trying to live on that amount paying for housing, food, clothing, transportation, medical care? A healthy diet for a family of 4 costs over $10000 a year. Decent housing runs at least that.
As an immigrant child, I came from a background that was below poverty level until I was about 8 years old at which time my father got a job as a postal worker and income rose to just above poverty level. As a child I knew what it was like to decide between spending 10 cents for the bus or walking over 4 miles with my mother to go to the free clinic to get my eyes examined for glasses we couldn’t afford. We walked.
If you are making over $400k, be happy and stop complaining and crying over the taxes you can well afford. The vast majority of people in this country would love to be in your shoes. Sure, keep on making more money and enjoying it. More power to you. But don’t gloat about not paying any capital gains taxes and don’t bitch about a higher rate while driving your _____________ (fill in whatever expensive car you drive. Consider it your patriotic duty and be thankful this country gave you the wherewithal to pay those taxes.
My favorite part was that the emailer doesn’t know why we don’t pay capital gains taxes (because we donate all our gains to charity) and that I drive a 2005 Sequoia with 262K miles on it.
Gotta love the notion that it’s “patriotic” to pay more on taxes to fund a bloated budget that half the country doesn’t want and that’s not even paid for in a country founded on the rejection of excess taxation and government intrusion.
Do you have any insight into the details on how “Elimination of Roth Conversion for High Earners” would be handled during the 10 years that remain? Can you continue to make new pretax contributions and convert them during the 10 years? What about other pre-tax accounts rolled into your Traditional IRA during the 10 years? What if you don’t convert during the 10 years but your income dips 12 years from now; does that allow conversions (effectively the same way it’s best to do conversions during the early retirement years before social security or defined benefit pensions kick in)?
I don’t see why not.
Yes.
Yes
Yes.
Curious. This is just a proposal should we still do all conversion by end of this year?
Pay attention to it and leave enough time in December to get it done if you would want it done if it passes. If you’re going to do it either way (Backdoor Roth etc) do it now.
Thanks for all you do. Doing both and will def keep an eye and do it.
Thanks for all you do. Doing both and will def keep an eye and do it.
Oh great. Another impediment to recently-graduated millennial docs like myself trying to build wealth. As if skyrocketing college and medical school tuition, stagnation of physician wages, etc. wasn’t enough. You should all consider yourselves (relatively) lucky!
I presume the income limits will be indexed to inflation. Will the $10million limit on retirement accounts be indexed to inflation as well?
I’m honestly not sure that is actually in the proposed law, on either point.
“I contend that for a nation to try and tax itself into prosperity, is like a man standing in a bucket and trying to lift himself up by the handle.”
~ Winston Churchill (1874 – 1965)
“A democracy cannot exist as a permanent form of government. It can only exist until the majority discovers it can vote itself largess out of the public treasury. After that, the majority always votes for the candidate promising the most benefits with the result the democracy collapses because of the loose fiscal policy ensuing”
We officially have a majority now that effectively pay 0 income tax (51% population). This majority despite contributing nothing and asking for free college, free healthcare, free everything, also insists that those who actually pay the steepest costs (the 1%) pay “nothing”. I cannot tell you how many times I have heard this argument. Because some billionaire wrote off a bunch of real estate or stock losses, a person making 400k a year has to pay the brunt of the nations taxes.
Top 1% pays 40% of the nations taxes. Top 25% foot nearly the entire bill for all federal spending. How much is enough? A system in which the wolves are in the majority and they are in control of how many sheep get eaten will quickly result in a lack of food.
👍👍👍
Just to clarify, it would only make sense to do a non-backdoor conversion now (pre-tax funds into Roth) if your income is such that you expect your taxable retirement income (or whenever you plan to pull out the Roth money) would be higher than it is now, correct?
Yes.
In the interest of doing a first an only (if the bill passes):
I have an IRA (under my name) that has too much of my retirement savings to be able to leave it at $0 [I do not want to roll it onto my employer 403b] by December 31 (to avoid triggering the pro rata rule). My wife (stay home mom) doesn’t have an IRA, but I would like to do the Backdoor Roth workaround for her. Is that possible? Or do they take into account my IRA for the pro-rata rule? Sorry if it is answered in another question. Thank you for your time.
Yes. Totally separate calculation for each of you.
Thank you. Who knows, it might not pass, or realize the IRS is actually loosing money from savers/backdoorers and revert in in a year or two.