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Investing Blog Roundup: Tax Provisions in the Build Back Better Act

I hope you enjoyed the Thanksgiving holiday.

The House recently passed the Build Back Better Act, which includes a range of individual income tax changes. It is not, however, a sure bet that the same will actually pass in the Senate and become law.

As far as the version passed in the House, it does include a provision that prohibits Roth conversions of after-tax amounts after 2021, which would effectively end “backdoor” Roth strategies.

Recommended Reading

Thanks for reading!

What’s the Most Tax-Efficient Way to Give? (Donating Appreciated Securities, Qualified Charitable Distributions)

A reader writes in, asking:

“I will be turning 70 1/2 next year and one way or another I plan on giving a good sum to charity. What is the most economical way to donate?

  1. QCD from IRA
  2. Roth IRA
  3. Taxable account
  4. Take from income.

I take the standard deduction for federal tax. What factors do I need to take into consideration?”

Firstly: What’s a QCD?

A qualified charitable distribution (QCD) is a distribution from a traditional IRA directly to a charitable organization (i.e., the check is made out directly to the organization rather than to you). Unlike most distributions from a traditional IRA, QCDs are not taxable as income. And they can be used to satisfy required minimum distributions (RMDs) for a given year. QCDs are limited to $100,000/year (per spouse, if you’re married).

To qualify for qualified charitable distributions you must be at least age 70.5. (Yes, it really is age 70.5. The law that increased the age for RMDs to 72 did not change the age for QCDs.)

Also note that QCDs work on a calendar year basis. That is, there’s no “I’m doing this in March of 2022, and I want it to count for 2021” option as there is for contributions to an IRA.

Which Type of IRA to Give From

Giving via QCDs from a traditional IRA is much better than donating dollars from a Roth IRA. To you, a dollar in a Roth IRA is worth a dollar of spending, whereas a dollar in a traditional IRA is worth less than a dollar of spending (because some part of the dollar would be taxed when you took it out of the account, before you could spend it).

In contrast, to a tax-exempt non-profit, a dollar from a traditional IRA is worth a dollar of spending. When you give money to a charity via a QCD from a traditional IRA, the charity doesn’t have to pay tax on that money.

In other words, from the charity’s perspective, receiving $1,000 from a traditional IRA (via a QCD) is just as good as receiving $1,000 from a Roth IRA. But giving the money from the traditional IRA effectively costs you less (because it wasn’t really worth $1,000 to you to begin with).

Donating via QCDs or Taxable Assets

When choosing between QCDs or donating taxable assets, one advantage of QCDs is that you can take advantage of them while claiming the standard deduction. Donations from taxable assets (including regular checking account dollars) give you an itemized deduction. And that’s only valuable to the extent that your itemized deductions (in total) exceed the standard deduction for the year.

Example: Sophia is single, age 65+, so her standard deduction for 2021 is $14,250. If her itemized deductions other than donations come to $10,000, then the first $4,250 of donations from taxable assets doesn’t give her any tax benefit at all.

QCDs also have the advantage that they reduce your adjusted gross income, which can sometimes produce additional beneficial results, such as allowing you to qualify for another deduction/credit or bringing your income below a particular IRMAA threshold. In contrast, the itemized deduction from donating taxable assets does not reduce your AGI and therefore will not produce any such effects.

Conversely, an advantage of donating assets from a taxable account is that, if you donate assets that have gone up in value and that you have owned for longer than one year, you get to claim an itemized deduction for the current market value of the asset and you do not have to pay tax on the appreciation. (Note: when donating taxable property that you have held for one year or less, your itemized deduction is limited to your basis in the property.) In other words, when donating appreciated taxable assets that you have held for longer than one year, the itemized deduction is saving you money at your marginal tax rate for ordinary income, and you’re saving some additional money due to not having to pay tax on the appreciation.

So in some cases donating via QCDs will be preferable, while in other cases donating appreciated securities will be preferable. An important factor here is how much the taxable asset has appreciated. If it has gone up, say, 10% since you bought it, then getting to avoid taxation on the 10% gain isn’t such a big deal. Conversely if it is now worth ten times what you paid for it, avoiding taxation on that gain — via donating the asset — could be a very big deal. (I say “could” in that prior sentence, because there’s a possibility that the gain could have avoided taxation anyway, if it were left to heirs who would then get a step-up in cost basis.)

Which Taxable Assets to Give?

And with regard to donating taxable assets, donating appreciated assets that you have owned for longer than one year is strictly better than donating other taxable account dollars (e.g., cash in a checking account). And again that’s because you do not have to pay tax on the appreciation, while still getting to claim an itemized deduction for the current market value of the assets.

For example, imagine that you have a holding with a $10,000 market value and a $6,000 cost basis (i.e., there is a $4,000 unrealized capital gain) and you have held the asset for longer than one year. If you donate this asset, you’d get an itemized deduction for $10,000. Conversely, if you were to donate $10,000 of cash, you would also get an itemized deduction for $10,000. But donating $10,000 of cash means giving up $10,000 of spendable value, whereas donating the $10,000 appreciated holding actually costs you somewhat less (because if you were to sell it, you’d have to pay tax on the $4,000 of appreciation, which would leave you with somewhat less than $10,000 to spend).

Overall Order of Priority

To briefly summarize, for somebody age 70.5 or older, the typical order of preference is:

  1. Donating appreciated taxable assets with a holding period longer than one year or donating via QCDs, depending on circumstances,
  2. Donating via whichever of the two options above was less preferable,
  3. Donating taxable account cash (e.g., checking/savings balances),
  4. Donating appreciated taxable assets that you have held for one year or less,
  5. Donating Roth IRA dollars, and finally
  6. Donating taxable assets where the current market value is less than your basis. (This one is really bad because your deduction is limited to the market value, and you don’t get to claim a loss for the decline in value. Better to sell the asset, claim the capital loss, then donate the resulting cash.)

For somebody not yet age 70.5 (and therefore ineligible for QCDs), the typical order of preference would be:

  1. Donating appreciated taxable assets with a holding period longer than one year,
  2. Donating taxable account cash (e.g., checking/savings balances),
  3. Donating appreciated taxable assets that you have held for one year or less,
  4. Donating Roth IRA or traditional IRA dollars, and finally
  5. Donating taxable assets where the current market value is less than your basis.

But as always, tax planning is case-by-case. A household could have circumstances such that the above would need to be rearranged in some way.

For More Information, See My Related Book:

Book3Cover

Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

2022 Tax Brackets, Standard Deduction, and Other Changes

The IRS recently published the annual inflation updates for 2022. If you have questions about a particular amount that I do not mention here, you can likely find it in the official IRS announcements:

Single 2022 Tax Brackets

Taxable Income
Tax Bracket:
$0-$10,275 10%
$10,275-$41,775 12%
$41,775-$89,075 22%
$89,075-$170,050 24%
$170,050-$215,950 32%
$215,950-$539,900 35%
$539,900+ 37%

 

Married Filing Jointly 2022 Tax Brackets

Taxable Income
Tax Bracket:
$0-$20,550 10%
$20,550-$83,550 12%
$83,550-$178,150 22%
$178,150-$340,100 24%
$340,100-$431,900 32%
$431,900-$647,850 35%
$647,850+ 37%

 

Head of Household 2022 Tax Brackets

Taxable Income
Tax Bracket:
$0-$14,650 10%
$14,650-$55,900 12%
$55,900-$89,050 22%
$89,050-$170,050 24%
$170,050-$215,950 32%
$215,950-$539,900 35%
$539,900+ 37%

 

Married Filing Separately 2022 Tax Brackets

Taxable Income
Marginal Tax Rate:
$0-$10,275 10%
$10,275-$41,775 12%
$41,775-$89,075 22%
$89,075-$170,050 24%
$170,050-$215,950 32%
$215,950-$323,925 35%
$323,925+ 37%

 

Standard Deduction Amounts

The 2022 standard deduction amounts are as follows:

  • Single or married filing separately: $12,950
  • Married filing jointly: $25,900
  • Head of household: $19,400

The additional standard deduction for people who have reached age 65 (or who are blind) is $1,400 for each married taxpayer or $1,750 for unmarried taxpayers.

IRA Contribution Limits

The contribution limit for Roth IRA and traditional IRA accounts is unchanged at $6,000.

The catch-up contribution limit for people age 50 or over does not get inflation adjustments and therefore is still $1,000.

401(k), 403(b), 457(b) Contribution Limits

The salary deferral limit for 401(k) and other similar plans is increased from $19,500 to $20,500.

The catch-up contribution limit for 401(k) and other similar plans for people age 50 and over is unchanged at $6,500.

The maximum possible contribution for defined contribution plans (e.g., for a self-employed person with a sufficiently high income contributing to a solo 401(k)) is increased from $58,000 to $61,000.

Health Savings Account Contribution Limits

For 2022, the maximum HSA contribution for somebody with self-only coverage under a high deductible health plan is $3,650. The limit for somebody with family coverage under such a plan is $7,300.

Capital Gains and Qualified Dividends

For 2022, long-term capital gains and qualified dividends face the following tax rates:

  • 0% tax rate if they fall below $83,350 of taxable income if married filing jointly, $55,800 if head of household, or $41,675 if filing as single or married filing separately.
  • 15% tax rate if they fall above the 0% threshold but below $517,200 if married filing jointly, $488,500 if head of household, $459,750 if single, or $258,600 if married filing separately.
  • 20% tax rate if they fall above the 15% threshold.

Alternative Minimum Tax (AMT)

The AMT exemption amount is increased to:

  • $75,900 for single people and people filing as head of household,
  • $118,100 for married people filing jointly, and
  • $59,050 for married people filing separately.

Annual Gift Tax Exclusion

For 2022 the annual exclusion for gifts has increased from $15,000 to $16,000.

Estate Tax

The estate tax exclusion is increased to $12,060,000 per decedent.

Pass-Through Business Income

With respect to the 20% deduction for qualified pass-through income, for 2022, the threshold amount at which the “specified service trade or business” phaseout and the wage (or wage+property) limitations begin to kick in will be $340,100 for married taxpayers filing jointly and $170,050 for single taxpayers, people filing as head of household, and for married people filing separately.

For More Information, See My Related Book:

Book3Cover

Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

Medicare IRMAA Appeal (a.k.a. Request for Reconsideration)

In general, once you become eligible for Medicare (either by reaching age 65 or by being on Social Security disability for two years), your Medicare premiums for a given year are based on your modified adjusted gross income (MAGI*) from two years prior. For example, a person’s 2022 premiums are based on their 2020 income level.

The law is written this way for a simple pragmatic reason: “two years ago” is generally the most recent data Medicare has at the time they must determine your premium for a given year. For example, a person’s 2022 Medicare premiums must be determined in 2021 — at which point Medicare doesn’t have the person’s 2021 information yet, so they use 2020.

However, the law also provides that, if your income declines significantly from one year to the next due to a “life changing event” you may request that your premiums be based on that more recent year’s level of income, rather than your income from two years ago. This request may be referred to as a “request for reconsideration”, “Medicare Part B premium appeal”, or “Medicare IRMAA appeal.” Life changing events include:

  • Marriage,
  • Divorce/annulment,
  • Death of a spouse,
  • You or your spouse stopped working or reduced the hours that you work,
  • You or your spouse experienced a loss of income-producing property that was not at your direction (i.e., you did not intentionally sell the property), or
  • You or your spouse experienced a cessation, termination, or reorganization of an employer’s pension plan.

Filing Form SSA-44 is how you make such a request for reconsideration.

Why Is This Important?

In short, this is most likely to be important for:

  • High earners who retire in a year they (or their spouse) turn 63 or older or
  • High earners who retire when their spouse is receiving Social Security disability benefits.

Consider this example: Amanda and Neil collectively earn about $250,000 per year. They both retire in June of 2022, at age 64, after having earned roughly $120,000 for the year. When they begin Medicare at age 65 in 2023, their premiums will initially be based on their 2021 level of income ($250,000), which puts them in the third Medicare IRMAA tier.

They can, however, file an IRMAA appeal and request that their premiums instead be based on their 2022 income level. The net result is that they save $180.30, per month, per person in Medicare Part B and D premiums by filing Form SSA-44.

*For Medicare IRMAA purposes, MAGI is calculated as your adjusted gross income, plus tax-exempt interest, plus any foreign earned income or income from US territories that was excluded from your gross income.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."
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