Q4 2021 Returns By Asset Class

This post contains the usual returns by asset class for this past quarter (by representative ETF), last year, last five years, last ten years, and since the covid low (3/23/2020).  While there is still no predictive power in this data, I’ll continue to post this quarterly for those of you that are interested. 

Last Quarter (10/1/21-12/31/21)
Last Year (1/1/21-12/31/21)
Since Covid Low (3/23/20-12/31/21)
Last Five Years (1/1/17-12/31/21)
Last Ten Years (1/1/12-12/31/21)

A few notes:

  • Q4 was a very strong quarter (with a mid-quarter dip) for US Large Cap (+11%) and US Real Estate (+15%), but other asset classes fared substantially worse. US Small Caps still did well (+4%), but underperformed. Foreign stocks did worse with Developed Markets (+3%) and Emerging Markets (-0%) finishing down slightly on the quarter. US Bonds were flat to down 1% with Emerging Market Bonds down 3%. Commodities finished down ~2% after rallying strongly for the past two quarters.
  • For 2021 as a whole, the only truly poor performing asset class was Emerging Market Bonds (-10%) as the U.S. Dollar rallied and fears of a liquidity crunch in emerging markets dominated as the Fed begins to pull back on stimulus and even start raising rates in 2022. US significantly outperformed Foreign stocks as well. Real Estate (+41%) and Commodities (+29%) won the year as interest rates remained low as inflation spiked.
  • US Large Cap (S&P 500) has dominated over one, five, and ten years. The largest US stocks have performed best and gotten even larger, year after year. The top 2 companies in the S&P 500 (Apple and Microsoft), now make up 11.5% of the index. The top 10 make up 27.4% of the index. Diversified portfolios that include the other asset classes have underperformed as a result. Eventually though, this tide will reverse and smaller stocks will outperform larger ones. Foreign stocks, especially emerging markets, are about as cheap as they’ve ever been relative to the U.S. How long the dominance of a handful of US stocks can continue is anyone’s guess. But, the odds seem to favor a diversified portfolio outperforming the S&P 500 over the next few years.

Build Back Better Act, Property Taxes & Q4 Estimated Tax Payments

Rumor has it the Senate is ending session and heading home for the year tomorrow, and their version of the Build Back Better Act (see my last update for what’s included in the House version of the bill) hasn’t even been drafted, so it seems very very unlikely that anything will pass by end of year. That means at least a temporary end to Advance Child Tax payments, the expanded Earned Income Credit, and host of other pandemic-related programs. It also means no changes to retirement plans for now (i.e. the back-door Roth and mega-backdoor Roth remain), but those are definitely on the chopping block for a future bill. I don’t expect them to survive 2022. Lastly, it means that there won’t be a change to the 2021 State And Local Tax (SALT) deduction, again, for now. Build Back Better will re-emerge in 2022 for certain, perhaps with some provisions that are retroactive to 2021, though with a split Senate and a lack of support from at least two Democratic Senators, it’s a heavy lift to get BBB approved next year as well in it’s current form.

The fact that SALT won’t be changing for 2021 means that for those of you sitting on property tax bills for your residence or vacation home (rentals don’t matter…  property tax is always deductible on rentals) or determining if you should make state estimated tax payments for Q4, you should operate under the assumption that the SALT (State And Local Tax) cap will remain at $10K.  It’s possible that it could be retroactively changed in 2022 for 2021, but at that point, it will be too late to do anything for 2021 anyway.  That means that if both of the following are true:

  1. you already have $10K+ of state income taxes paid (check paystubs + estimated tax payments if you made any to cities/states to confirm) or sales tax paid in the case of a no income tax state (use IRS lookup for that https://www.irs.gov/credits-deductions/individuals/use-the-sales-tax-deduction-calculator) for calendar 2021  + property tax paid for calendar 2021 (check escrow statements if you escrow, otherwise you should know what you’ve paid) AND
  • your 2022 will look similar to 2021 from an income/deductions/SALT standpoint…

… then there is no incentive for you to pay property taxes or state estimated tax payments in 2021 that could be deferred to 2022 (some municipalities allow this…  if yours doesn’t, then the point is moot for you). 

If you don’t already have $10K+ of SALT for 2021, then paying property taxes or state estimated tax payments in 2021 can still be beneficial if you will itemize your deductions on your taxes 2021.  To itemize, for most people, your SALT + mortgage interest + charitable deductions need to exceed the standard deduction ($12,550 single, $18,800 head-of-household, $25,100 married filing jointly).  If you can’t itemize in 2021, then deferring property taxes / state estimated tax payments to 2022 in hopes of being able to itemize then makes sense.

If you know you will not itemize in 2022 but will itemize in 2021, then you could pay property taxes and/or state estimated tax payments in 2021 even if you’re over the SALT limit.  The thinking there is that you wouldn’t be able to deduct those tax payments in 2022 no matter what, so if you pay them in 2021, it sets you up to take advantage of a retroactive SALT deduction increase if such a thing becomes law in 2022.

If you know that you will not itemize in 2021, but will in 2022, then defer property taxes / state estimated tax payments to 2022.

This fun game of “Will I get a tax deduction” is very likely to continue into 2022. We can only hope that the rules for 2021 are finalized in advance of the April 15th, tax deadline for 2021 and maybe, just maybe, the rules for 2022 could be settled before December 2022.

7.12% risk-free?!? Well, sort of…

There is no free lunch. I’m sure you’ve heard that statement before. As it relates to financial markets, it generally means that you can’t get an expected return above the risk-free rate without taking some level of risk. The higher the potential for return, the more risk must be embedded in the investment. Currently, there is somewhat of an exception, at least for the short-term, courtesy of the United States government.

Savings bonds are generally poor investments for the long-term. There are many types (“series”) of savings bonds and all but one are beyond the scope of this post. The exception, Series I Savings Bonds (“i-bonds”). These bonds are unique in that their variable interest rate is determined by a fixed rate, set by the Treasury at issuance (currently 0% and never below 0%) and a variable rate tied to the CPI (Consumer Price Index). The fixed rate portion is intended to reflect the “real” risk-free rate (i.e. net of inflation), with a 0% floor, while the variable portion is intended to reflect inflation. In this way, i-bonds pay an inflation-protected risk-free rate. Because of the current bout of inflation, the CPI increased by just over 3.5% in the last six months ending in September 2021. The variable portion of the i-bond rate is recalculated every six months based on the annualized change in CPI from the preceding six months. That means that i-bond rate for November 2021 through April 2022 is the 0% fixed rate + 7.12% variable rate = 7.12%. These bonds are backed by the full faith and credit of the U.S. Treasury, meaning they are about as default risk-free as can be and they’re currently paying 7.12%! So what’s the catch? There’s no free lunch right? No catches per se, but there are some things to be aware of…

First of all, that 7.12% is variable and will reset in May of 2022 based on the change in CPI between November 2021 and April 2022. For each six-month period of time, you’ll receive the variable interest rate, which is not known in advance. It’s unlikely to stay anywhere near 7% over the long-term unless inflation persists. Even then, your return will always only equal inflation. In normal times, that’s not much of a goal, but in a world of negative real interest rates, keeping up with inflation alone may appeal to at least some investors. While it’s unlikely to beat equity investments over the long-term, it’s certainly better than a savings account at one of the major banks paying 0.01%. But there are a few more disadvantages here…

Second, you are required to hold i-bonds for a full year from purchase. I know what you’re thinking… there’s always a way around requirements like that (CD’s charge some interest penalty for example, or illiquid investments that can be sold at below-market prices in case of emergency). Unfortunately, there is no work-around in this case. One full year holding period is required and there is no way to liquidate during that time. Beyond the one-year holding requirement, you can liquidate at any time, but, if you liquidate during the first five years, you are charged a three-month interest penalty (e.g. if you hold for 18 months, you only get the interest for the first 15 of those months). Once you’re past five years, the bond becomes fully liquid with no penalty, and you can hold it for up to 30 years when it will mature and stop paying interest.

Third, you can only purchase $10k of i-bonds per entity per year. What does “per entity” means? It generally means per person, but if you have a business or a trust, those entities can purchase $10k per year as well. So there’s no way to park hundreds of thousands of dollars in i-bonds for the short-term while they’re paying this rate and then liquidate them if rates fall over the next few periods.

Fourth, because i-bonds pay interest rather than qualified dividends or capital gains, that interest is taxed as ordinary income taxed at your highest marginal tax rate (meaning your after-tax return is going to be well less than the rate of inflation). On the plus side though, that interest is deferred until the year you cash in the bonds, so you can choose an otherwise low-income year to keep the marginal tax rate down. Also, as an obligation of the federal government, they are state income tax free, which makes them a bit more appealing if you live in a high income tax state.

So, what’s the bottom line? Should you run out and buy $10k of i-bonds as soon as possible? Well, they’re not a great long-term investment, paying a guaranteed after-tax rate that is less than inflation. They’re not a good emergency fund given the one-year holding requirement. But, right now, in a negative real risk-free rate environment, the fact that the fixed rate portion of the bond cannot go below 0% makes them appealing for those who have significant savings in cash, beyond an emergency fund and other liquid assets. If you’re the type of investor who likes to have a surplus of cash, beyond what you’d need over the course of a year in the case of an emergency like a job loss or disability, this can be a good place to park $10k ($20k if married, $40k if married with trusts, $60k if married with trust and two businesses). It can also be a good replacement for part of the (especially short and/or inflation-protected) bond portion of an asset allocation, since it’s going to pay a higher rate of return, at least for now.

If you decide that i-bonds are for you, you can’t purchase them or hold them in a bank or brokerage account and your financial advisor can’t buy them for you. You’ll need to go to www.treasurydirect.gov and buy them directly from the US Treasury. Opening an account is fairly straight forward and you can link a bank account quickly which will allow you to schedule a purchase right away. If your information is mismatched with something in the Treasury databases, you may have to mail in a form with a Signature Guarantee (like a notarization, but obtained from a bank) to prove your identity. This is also likely if you open an account for a Trust or a business. Once the account is opened an a purchase is made, you’ll see interest being credited after the first three months you hold the bond (that’s the three-month penalty you’d incur if you sell in the first five years). You can track the bond values over time as they accrue interest and can purchase more in future years as desired. Just remember, you’ll always earn the fixed rate that was in place when you purchased the bond (currently 0%) + the variable rate for each six-month period going forward.

You can find more details about i-bonds at the Treasury’s FAQ page for i-bonds.

Special 2021 Deduction For Non-Itemizers Giving To Charity

Giving Tuesday is coming up at the end of November, so here’s a special reminder about this year’s “bonus” charitable deduction. As part of the CARES Act in 2020, Congress authorized a special charitable deduction for 2020 only for people who aren’t able to itemize due to the standard deduction being higher than their itemized deductions. The limit was $300, and that was the case whether Single, Head-Of-Household, or Married Filing Jointly. The Taxpayer Certainty and Disaster Tax Relief Act of 2020, passed late last year extended this deduction into 2021 and doubles it to $600 for joint filers.

As with last year, to qualify, the donation must be in cash, it must be to a qualifying organization (which is the same as for charitable donations as itemized deductions), it must be made by 12/31 (2021 this year), and appropriate records must be kept. As with itemized deductions, you can check whether the organization qualifies using the IRS’s Tax Exempt Organization Search. A $300 or $600 deduction may not sound like a lot, but many people have already made, or are about to make, some cash contributions for friends, colleagues, or family members that are raising money for various organizations. If you’re going to make the contribution regardless of the tax benefit, you might as well take the tax benefits that are available. In most cases, substantiation simply requires an acknowledgement from the organization (including stating that you received no benefits for your donation) and a cancelled check or credit card statement. (For detailed record keeping requirements and special cases, see Charitable Contributions – Deductions & Recordkeeping in the blog archives.) So save those “thanks for your contribution” acknowledgement emails and keep a running list of your cash donations this year, whether you itemize or not. They will come in handy to the tune of up to $300 or $600 in deductions at tax prep time.

Updates on Infrastructure & Build Back Better

As many of you know, the Infrastructure bill passed the House last week in a late night Friday vote. It had already been passed by the Senate and now waits for President Biden to sign it into law. He’s scheduled to do that via a public signing ceremony on Monday, 11/15. Not much was included in that bill from a tax or personal finance perspective (tighter cryptocurrency reporting requirements was the biggie), so I won’t dive into the details. The full text, all 1,039 pages of it, can be found at the link above.

Next up on legislators’ plates are the Build Back Better Act, funding the government, and an increase or suspension of the debt limit. The Build Back Better Act is the latest iteration of the broader social spending plan and tax changes that I discussed back in September (here and here). Many of those provisions have changed. While they’re nowhere near set in stone at this point, I wanted to provide an update of what’s currently in and what’s currently out (hint: a lot more is out than is in). Full text of BBB as of 11/3/21 can be found here.

  • Higher income tax rates – original plan was to increase the top rate from 37% to 39.6% and compress the tax brackets so that the top brackets begin at $400K Single / $450K Joint. This has been eliminated. If that stands, that means no need to accelerate any income into 2021 from 2022.
  • Net Investment Income Tax (NIIT) changes – subjects pass through active income to the 3.8% NIIT. This is still included and basically means that businesses that became S-Corps to try to avoid paying FICA on the “profits” vs the salary, will now have to pay NIIT on those profits instead.
  • Earned Income Credit (EIC) enhancements – remain
  • Surtax on millionaire income – The 3% surtax on incomes over $5M has been changed to a 5% tax on incomes over $10M and and additional 3% on incomes over $25M.
  • Higher capital gains tax rate – This has been eliminated. This means no need to intentionally realize capital gains to lock in today’s lower tax rate.
  • Change in corporate tax rate – The reduction in rate for small business and the increase in rate for all other business has been eliminated. But, a new 15% corporate alternative minimum tax on large corporations is included and a new 1% tax on corporate stock buybacks is added.
  • Changes to 199A Qualified Business Income (20% small business deduction) – This has been eliminated. All the complexity and current income caps would remain as-is.
  • IRA / Roth IRA restrictions – these have remained though some have been delayed and one has been removed:
    • Contributions to IRAs wouldn’t be allowed if the value of all your IRAs exceeds $10M and income exceeds $400k for the year.
    • RMDs would be required for IRAs/Roths over $10M.
    • The conversion of after-tax dollars from a Traditional IRA / 401k / 403b / etc, would be prohibited, effectively eliminating the Backdoor Roth and Mega-Backdoor Roth strategies. This would begin 1/1/22, which means the end of 2021 is the last chance to use these strategies. It may make sense for those who usually make IRA contributions at tax time for the previous year and then convert to their Roth (“backdoor Roth”) to do this by 12/31/21. It may also make sense to convert IRAs that have after-tax dollars mixed with pre-tax dollars even though this will generate some income in 2021 as it would be the last time to convert the after-tax portion.
    • All Roth Conversions would be prohibited for high income taxpayers after 2031 (this one is a funding gimmick that would pull forward conversions into the 10-year period over which the bill is analyzed to determine its net cost).
    • The restriction on private investments and those that could only be made by “accredited investors” has been eliminated in the latest bill.
  • Reduction in the gift/estate tax exemption – This has been eliminated, meaning the currently scheduled reduction in 2026 remains. No need to scramble and try to gift away tens of millions of dollars in advance of a 2022 change.
  • Changes to grantor trusts to pull them back into the estate of the grantor – This has been eliminated.
  • SALT (state and local tax deduction) – the current $10k limit on deductions was unaltered in the original proposal. The new bill increases the deduction cap to $72,500, but also extends the cap which would have expired in 2025, to 2031. If this goes through, anyone who can delay property tax payments or state estimated tax payments to 2022 would be better of doing that than paying in 2021.
  • Expanded Energy Tax Credits – still included
  • Expanded Plug-In Electric Vehicle Credits – still included
  • Extension of the 2021 enhanced child tax credit – still included
  • Universal Pre-K – still included
  • Credit for other dependents – eliminated
  • Extension and permanence of the 2021 Dependent Care Credit – eliminated
  • Caregiver’s credit – eliminated
  • Paid family and medical leave – still out.
  • Free community college – never made it in
  • Elimination of basis “step up” at death – still not included.
  • Elimination of the ability to borrow tax-free by pledging a securities portfolio – still not included
  • Changes to the taxation of “carried interest” – still not included.
  • “Billionaire’s Tax” – tax on unrealized capital gains of billionaires – still out
  • Medicare dental and vision – never made it in
  • Lower prescription drug prices – never made it in (though there’s talk of brining this back in the Senate)

Remember, all of this is in a high state of flux and nothing is certain at this point. The Senate is likely to produce its own version of Build Back Better and then the House and Senate versions need to be reconciled, voted on again, and signed by the president. Given the differences between the progressive and moderate sides of the Democratic party and the wholesale opposition by the Republican party, the odds of anything getting passed into law by the end of 2021 feel lower than 50%. In fact, current prediction markets are pricing the following for a law that passes by the end of 2021:

  • a 30% chance that income taxes increase in any way (including the currently proposed surtax on millionaires),
  • a 33% chance that the SALT deduction will be modified,
  • a 13% chance of a “billionaire’s tax”
  • a 10% chance of an increase in capital gains.
  • a 6% chance of a corporate tax rate increase.

Not very promising odds, but that doesn’t mean that nothing will pass. It also doesn’t mean that the whole thing isn’t punted into 2022 and passed then.

Updated 2022 Tax Numbers

The IRS has released the key tax numbers that are updated annually for inflation, including tax brackets, phaseouts, standard deduction, and contribution limits.  Due to rounding limitations, not all numbers have changed from last year, but tax bracket thresholds have increased by just over 3%.  The notices containing this information are available on the IRS website here and here.  Some notable callouts for those who don’t want to read all the way through the update:

  • Max contributions to 401k, 403b, and 457 retirement accounts will increase by $1,00 to $20,500 (+$6,500 catch-up, which remains constant, if you’re at least age 50).
  • Max contribution to a SIMPLE retirement account will increase by $500 to $14,000 (+$3,000 catch-up if you’re at least age 50).
  • Max total contribution to most employer retirement plans (employee + employer contributions) increases from $58,000 to $61,000 (+$6,500 catch-up, again for those 50 or over).
  • Max contribution to an IRA remains at $6,000 (+$1,000 catch-up if you’re at least age 50).
  • The phase out for being able to make a Roth IRA contribution is $214k (married) and $144k (single). Phase out begins at $204k (married) and $129k (single).
  • The standard deduction increases by $800 to $25,900 (married) and by $400 to $12,950 (single) +$1,750 if you’re at least age 65 and single or $1,400 each if you’re married and at least 65.
  • The personal exemption remains $0 (the Tax Cuts & Jobs Act eliminated the personal exemption in favor of a higher standard deduction and child tax credits).
  • The child tax credit reverts back to pre-2021 rules at $2,000 per child, phasing out between $400-440k (married) and $200-220k (single).  Note: it’s possible that 2021 tax treatment may be extended to 2022 or beyond, if the Build Back Better plan passes Congress.  Stay tuned.
  • The maximum contribution to a Health Savings Account (HSA) will increase to $7,300 (married) and $3,650 (single).
  • The annual gift tax exemption increases by $1,000 to $16,000 per giver per receiver.
  • The lifetime gift / estate tax exemption increases to $12,060,000.
  • Social Security benefits will rise 5.9% in 2020.  The wage base for Social Security taxes will rise to $147,000 in 2022 from $142,800.

You can find all of the key tax numbers, updated upon release, on the PWA website, under Resources.

Q3 2021 Returns By Asset Class

This post contains the usual returns by asset class for this past quarter (by representative ETF), year-to-date, last twelve months, last five years, last 10 years, and since the covid low (3/23/2020).  While there is still no predictive power in this data, I’ll continue to post this quarterly for those of you that are interested. 

Last Quarter (7/1/21-9/30/21)
Year-To-Date (1/1/21-9/30/21)
Last 12 Months (10/1/20-9/30/21)
Since Covid Low (3/23/20-9/30/21)
Last 5 Years (10/1/16-9/30/21)
Last 10 Years (10/1/11-9/30/21)

A few notes:

  • A solid first two months of the quarter hit an ugly September, which left Q3 mixed to slightly down overall. Commodities led the way (+8%) for the second straight quarter as supply chain issues led to shortages in many areas of the economy. The Fed has softened its opinion on the transitory nature of inflation, and are indicating a chance for costs rising higher than their 2% per year target for some time. They’ve indicated that if the employment picture continues to improve, they’re likely to start tapering their bond purchases (quantitative easing) in the coming months, with rate hikes down the road in late 2022 / early 2023.
  • Rounding out the performance numbers by asset class: US Bonds, US Large Cap Stocks, US Real Estate, and High-Yield Bonds all returned between 0-1% in Q3. On the losing side were Foreign Developed Stocks (-1.5%), US Smalls Caps (-2.5%), Emerging Market Debt (-3.5%), and Emerging Market Stocks (-7%). The stability of bonds made more conservative portfolios outperform in Q3. But, as you can see in the 5-year chart and the “since covid low” chart, overall performance across the financial markets has been superb.
  • While commodities have continued to roar back over the past 18 months, the 5 and 10-year charts show just how far they’ve lagged behind other asset classes. Commodities generally track inflation over the long-term, and they really suffered after the financial crisis, the oil glut, and the early part of covid. Now, higher inflation has been pushing commodities higher. Whether that continues or not depends on whether supply constraints ease and on how quickly global demand returns following the peak of the Delta variant of covid (and whatever variant of concern comes next).

Proposed Credits & Deductions in the Upcoming Infrastructure & Broader Spending Plan

In the last post, I covered the potential “pay-fors” that would… well… pay for some of the spending, deductions, and credits enabled by the proposed infrastructure and broader spending legislation that Congress is working on passing via reconciliation this fall.  That proposed legislation is currently 645 pages, and subject to many changes as it makes its way through committees in both chambers.  There are many proposed changes to the tax code (enough to make the TCJA look simple) to go along with various spending appropriations.  The majority have to do with infrastructure incentives and credits for business.  But, there are a few notable ones for individuals/families.  Keeping in mind that this is just a proposal, here is a non-exhaustive list of the provisions that may provide some benefit to you:

  • Increases the credit for adding solar to a residence back to 30% of the cost.  Extended through 2031, then phases down to 26% in 2032, 22% in 2033, and then expires.  Includes residential battery storage technology as well.
  • Extends the non-business energy property credit (energy-efficient windows, doors, furnaces, , water heaters, etc.) to 2031 and expands the credit to 30% of the cost from the current 10%.  Additionally, it eliminates the (frustrating and hard to track) lifetime limit and replaces it with a $1200 annual limit.
  • Creates a new Plug-In Electric Vehicle Credit ranging from $4000 to $12,500 (limited to 50% of the cost), depending on battery capacity, assembly location, and what portion of the vehicle is made with domestic parts.  It won’t apply to vehicles weighing more than 14,000 lbs or vehicles with an MSRP exceeding certain thresholds. The credit phases out starting at income of $400K single / $800K Joint.
  • Creates a new Plug-In Electric Vehicle Credit for purchase of used qualifying vehicles.  Much lower income thresholds, lower credit amount, and the vehicle must be at least 2 years old.
  • Creates a new credit for certain electric bicycles, and reinstates the employer provided fringe benefit for bicycle commuting (with the max benefit raised to $52.50/mo from $20/mo)
  • Extends the enhanced Child Tax Credit ($3k per child age 6-17, $3600 per child age 5 or under), as created by the American Rescue Plan (ARPA) earlier in 2021, including monthly checks of half of the expected amount of the credit, through 2025 (previously expired in 2021).  However, instead of defaulting to including the monthly checks, the default will be to not have monthly checks sent and the taxpayer will have to opt in in some manner to be determined at a later date by the Treasury/IRS.  Income phaseouts continue to apply as defined in ARPA (phaseout for the original $2k is $200K Single / $400K Married, and for the enhanced $1600 it’s $75K Single / $150K Married.
  • Makes the Child Tax Credit permanently (until changed by future legislation) refundable.  This means the credit amount can exceed the taxpayer’s total tax liability for the year and the taxpayer will still get the full credit.  No longer reverts back to the pre-ARPA rules after 2025
  • Extends the $500 credit for “Other Dependents” through 2025.
  • Makes the Dependent Care Credit changes from APRA permanent.  That increased the maximum qualifying expenses to $8K for one child or $16K for two or more children.  The amount of the credit starts at 50% of qualifying expenses.  If income exceeds $125K, the credit percentage is reduced, until it drops to 20% at $400K.  It then completely phases out if income exceeds $500K.  Also makes permanent the income exclusion for employer provided Dependent Care Assistance (e.g. Dependent Care Flexible Spending Accounts) at the ARPA enhanced level of $10,500 per year (up from the $5k limit pre-ARPA).  Note that employers still need to adopt this change in order for employees to take advantage of it.
  • Creates a new credit for caregivers of 50% of qualified expenses up to a $4K maximum credit.  Begins to phase-out at $75K of income.  This is for people who care for those with long-term care needs in their own home.
  • Enhances the Earned Income Credit.
  • Creates a new credit for contributions to a Public University that provide infrastructure for research.  The credit, available through 2032, is 40% of the amount contributed to the qualifying project (lots of rules as to what qualifies).  Note: this is a credit, not a deduction, so you don’t have to itemize to take it.

Tax Increases & Retirement Funding Limits Incoming

The House Ways and Means Committee released a tax plan designed to pay for (part of?) the bi-partisan Infrastructure Bill and the larger spending bill that Democrats are trying to pass through a process known as “reconciliation”.  The House tax plan contains fewer tax hikes and fewer changes to the tax code overall than President Biden’s initial plan released earlier this year.  While the President’s plan always seemed unlikely to garner enough support, the House plan has the makings of a real starting point for negotiation.  The Senate is moving forward with its own legislation and eventually, both Chambers will need to pass a bill, then reconcile into one bill which is re-passed.  With the Democrats having slim margins in both the House and Senate (courtesy of the VP tie-breaker there), it will be difficult to get enough support from the progressive and more moderate side of the party at the same time.  They’ll either need to do that or bring some Republicans on board in order to get enough votes to pass the broad package.  In summary, there are bound to be a lot of changes to the details here, but we’re close enough to actual proposed legislation, that I thought it would be a good idea to lay out the key portions of the current proposal.  As a side note, there is a fair shot that some/all of the changes will wind up being last minute, end-of-year, potentially retroactive to this year changes.  The timing of enactment and the effective date of each change are going to determine whether or not any action can/should be taken to minimize the impact of tax hikes, or take advantage of temporary opportunities for deductions, credits, etc.  December is going to be a fun month tax-wise, as it has been for the past several years.  Stay tuned.

Currently Included in the House Plan:

  • An increase in the top marginal income tax rate from 37%, back to where it was pre-TCJA at 39.6%.  In addition, the 32% and 35% brackets would be compressed so that the top bracket begins at $400K Single / $450K Joint.
  • A 3% “surtax” on those earning more than $5M in a given year.  A surtax is just a fancy way of adding to the income tax rate, effectively creating a new top bracket of 42.6% for those earning > $5M.
  • An increase in the tax rate on long-term capital gains (LTCG) tax for upper-income taxpayers (in the top tax bracket for LTCG which starts at ~$450K single / 500K joint) from the current 20% to 25%.  Note: this provision would become effective as of 9/13 if I’m reading it correctly (i.e. sales prior to that date would be taxed at the existing rate, sales on or after would be taxed at the new rate).  If true, there’s no ability to sell in advance, though since the rate is only going up 5%, and that might change in a future administration, I can’t see why anyone would sell anything other than for a short-term need anyway.
  • A decrease in the corporate tax rate from the current 21% to 18% for low-income (up to $400K) corporations and an increase to 26.5% for high-income (over $5M) corporations.
  • Limits on the 199A “20% small business deduction” to a max of $400K Single / $500K Joint.  Those aren’t income limits to take the deduction…  they’re limits on the max amount of the deduction.  There had been an alternate proposal (Wyden plan) to eliminate the Specified Services Trade or Business provisions as well as the W-2 income and unadjusted basis of assets provisions, and instead just institute income limits.  That’s not included in the House plan.  (Of course it’s not…  it would have simplified something!)
  • Contributions to IRAs / Roth IRAs would be prohibited if their value (in aggregate in case there are multiple accounts) exceeds $10M in value and income for the year exceeds $400k single / $450k joint.
  • Add a new Required Minimum Distribution (RMD) to IRA, Roth IRA, and defined contribution (e.g. 401k) accounts (in aggregate) that exceed $10M in value if income for the year exceeds $400k single / $450k joint.  The RMD would be 50% of the amount that exceeds $10M.  Additionally, if the balance of those accounts exceeds $20M, a 100% distribution is required from the Roth portions until the total balance is less than $20M or the Roth accounts are exhausted.
  • Roth IRA conversions and 401k Roth Conversions would be prohibited for those with income over $400k single / $450k joint.  Additionally, after-tax contributions to 401k and the conversion of after-tax contributions to Traditional IRAs would be prohibited regardless of income (i.e. the end of the “backdoor Roth” and the “mega backdoor Roth”).
  • IRAs would not be able to hold 1) private investments that can only be offered to “accredited investors”, 2) securities in which the owner has a >= 50% interest (10% if not tradable on an established securities market), and 3) the securities of an entity in which the IRA owner is an officer.
  • Lifetime gift / estate tax exclusion is reset to its 2010 level of $5M per individual (adjusted for inflation) instead of that happening after 2025 as scheduled by TCJA.
  • Changes to bring most Grantor Trusts back into the estate of the grantor and to eliminate the valuation discount frequently used when gifting portions of family limited partnerships (FLPs) to the next generation.
  • More money for the IRS to boost its audit programs.  Everyone hates and audit, but this is sorely needed.  The IRS lacks the resources to keep up with tax cheats.

Notably Not Currently Included:

  • Increase in the State And Local Tax (SALT) maximum deduction.  This is the cap put in place as part of the TCJA that limits both single and joint filers to a maximum Federal deduction of $10k for taxes paid to states and localities.  Several high-tax state representatives in the House have said they will not vote for any tax and spend package that doesn’t relax the current SALT limit, and House leadership has implied that a change to the SALT deduction is still on the table and may be added to the bill at a later date.
  • Loss of Basis “Step-Up” at death.  This feature of the current tax code allows those who inherit property (real estate, securities, farms, businesses, etc.) to have the cost basis of the property reset to its value on the date of death of the owner.  This allows substantial gains to go untaxed if the property is held until death.  The President’s tax plan would curb basis step up, but such curbs were not included in the recent draft from the House.  The head of the Senate Finance Committee has indicated that this may wind up in the Senate bill, so it’s not dead yet either.
  • Elimination of tax-free loans from securities portfolios.  The current tax code allows owners of brokerage accounts to use the account as collateral to take out loans.  The proceeds from the loans can then be used to support expenses, rather than selling assets and potentially paying capital gains tax on those sales.  This practice helps to avoid selling assets such that basis can be stepped up at death (see bullet above) and capital gains tax is never collected.

Q2 2021 Returns By Asset Class

This post contains the usual returns by asset class for this past quarter (by representative ETF), year-to-date, last twelve months, last five years, last 10 years, and since the covid low (3/23/2020).  While there is still no predictive power in this data, I’ll continue to post this quarterly for those of you that are interested. 

Last Quarter (4/1/21-6/30/21)
Year-To-Date (1/1/21-6/30/21)
Last 12 Months (7/1/20-6/30/21)
Since Covid Low (3/23/20-6/30/21)
Last 5 Years (7/1/16-6/30/21)
Last 10 Years (7/1/11-6/30/21)

A few notes:

  • Another solid quarter in Q2 for all assets classes. Commodities led the way (+15%) as the world got a strong whip of inflation. Whether that’s transitory as the Fed expects or not, remains to be seen. Real Estate Investment Trusts (REITs) (+12%) were close behind. US Large Cap (+8%), Foreign Developed (+6%), US Small Caps (+5%) and Emerging Markets (+5%) also had great quarters. Emerging Market Bonds (+4%) were the winners in fixed income, with High Yield (+2%), US Aggregate Bonds (+2%), and Short-Term Corporate Bonds (+1%) close behind. Treasury Inflation Protected Bonds (not shown on the charts) were +3% in the quarter, again on the back of higher consumer prices.
  • While commodities have roared back over the last year, the 5 and 10-year charts show just how far they’ve lagged behind other asset classes. Commodities generally track inflation over the long-term, and they really suffered after the financial crisis, the oil glut, and the early part of covid.
  • All assets classes have shown positive returns since 3/23/20 (the Covid low), amidst the worst pandemic in a century. US Small Caps are now up 130%+ over that period, dominating the other asset classes. Just about the time that the world was assuming the worst and fearing the most as lockdowns started in the US, the bottom was in for the financial markets. Yet another, among numerous historical examples, of why it doesn’t make sense to sell in the midst of a crisis, no matter how bad it looks.