​The Devil Is In The Details: The American Families Plan & YOUR Tax Bracket

You may have heard about The American Families Plan. It’s a major overhaul to our system in terms of infrastructure and social safety nets. It has been proposed as an “investment in the foundation of middle class prosperity education, health care and child care.” And the proposed price tag is in the trillions of dollars.

Alongside the agenda is proposed tax reform. In many ways, this reform is a reversal of many of the tax giveaways of the 2017 tax law. The hope is that the resulting revenue will pay for the American Families Plan’s investments.

The tax proposal will impact certain American Families. It will be raising their tax liabilities through increases in a) income, b) capital gain and c) transfer taxes. This post is the first in a series of three explaining each of those aspects.

The piece of the American Families Plan that has garnered most attention is the increase in tax rates of those earning more than $400,000. But these tax policies are very nuanced, and attention to the detail is worth the time and effort.

The most startling piece of the bill is the return to the ordinary income tax bracket. It goes back to 39.6% from 37%. And it does so at a significantly reduced income level of $400,000 for single and head of household, and $450,000 for joint filers.

The current 37% top ordinary income tax bracket kicked in for married taxpayers filing jointly at $628,300 taxable income in 2021. The proposed bill would impose the top ordinary income tax rate of 39.6% at “just” $450,000 of taxable income in 2022.

Similarly, the current 37% ordinary income tax bracket does not begin to impact single filers until they have more than $523,600 in 2021. But in 2022, the top rate of 39.6% would be applied to taxable income more than $400,000 for those same filers. To say it another way, the most impact for single filers with taxable income of over $400,000 and joint filers with taxable income of over $450,000 will be a tax rate increase from 35% to 39.6%. That’s a 4.6% increase on incomes from $400,000 to $523,000. Hitting this group the hardest will be the compression of tax brackets.

You might also note that the “marriage penalty” has increased. It allows only $50,000 of joint income over the single taxpayer. In other words, because of the way our tax system and tax brackets work, some married couples who each earn under $400,000 would be subject to a higher tax, as compared to their single counterparts earning the same amount. In this instance, being unmarried and single is better — for tax purposes anyway.  

Let’s do the math, assume you have a couple (not married) each making $399,999. These taxpayers would not have reached the highest bracket for an unmarried individual. Each individual would be taxed at the 35% bracket. Using this year’s tax bracket for single filers, this results in approximately $132,989 in federal income taxes. (Or, a total of $265,978 combined for both individuals.)

If instead this couple decides to marry, they will now have a combined income of $799,998. That puts them in the highest tax bracket (39.6%) as married filing jointly. This translates to an estimated $284,412 in federal income tax, which is $18,434 more in taxes (or about 6.9%) than compared to a situation if they were single. The other option of married filing separately will yield the same result.

This will lead to all kinds of new scrutiny for some couples. I expect we’ll see a lot of tax planning around filing status and income threshold management. There will probably be detailed analyses and projections to evaluate the optimal filing status for married couples. They’ll be looking at where certain deductions, tax credits or planning opportunities would be more beneficial if applied to one spouse over the other.

In extreme cases, could this factor into one’s marital decision? In my financial planning circles, there’s been a lot of discussion about this, and about divorce. I don’t believe we should be making life decisions around taxes. But the reality is that taxes hit the bottom line, and that impact is real.

If you’d like to know more about how to navigate the coming changes with an updated wealth planning strategy, feel free to contact SJ Boyle Wealth Management by visiting our website or asking us a question.