This week, President Obama presented a $4 Trillion budget proposal to Congress for the 2017 fiscal year. Considering this is the final year of the Obama administration, it being an election year, and both houses currently being controlled by Republicans, it is unlikely that many (or any) of the tax reforms contained in this budget will be implemented in the upcoming year.

Nearly three-quarters of the budget is committed to expenses such as servicing the national debt, Social Security, Medicare, and Medicaid. The reality is that these “mandatory” expenditures will continue to increase due to demographics over the next few decades, leaving our leaders little wiggle room between the unpleasant choices of raising revenue (taxes) or cutting spending.

The “easy” tax hikes are the proposed closing of some of the “loopholes”. Unfortunately, many of our clients look at these “loopholes” as common sense incentives for saving and investing and use them to be Accountable to themselves and their families for financial security. This is why we pay attention to proposals, even those that are unlikely to be enacted today, as they may signal changes on the horizon that could result in stealth tax increases and fewer incentives to invest.

If nothing else, some of these proposals remind us that we shouldn’t take anything for granted when it comes to politicians writing checks that we ultimately will be asked to cash by paying our “fair share”.

Following is a quick summary of some of the provisions that are being proposed and lessons we should take from them:

CLOSING THE “BACK DOOR” ROTH IRA CONTRIBUTIONS

The “Back Door” Roth IRA contribution strategy has been around since 2010, when income limits on Roth conversions were removed. Before that, high-income earners couldn’t make a Roth IRA contribution, nor convert a traditional IRA into a Roth. Under the current rules, it is possible for high earners that exceed eligibility thresholds for contributing to a Roth IRA to contribute to a non-deductible traditional IRA and complete a Roth conversion of those dollars – effectively achieving the goal of a Roth IRA contribution through the “back door”.

The proposal would limit a Roth conversion to only the pre-tax portion of an IRA. Thus, a non-deductible contribution to a traditional IRA would no longer be eligible for a Roth conversion. The “back door” will effectively be closed.

The lesson – If you are above the income thresholds for a deductible Traditional IRA and/or Roth IRA, you should look into the “back door” technique while you can.

LIMITING CONTRIBUTIONS FOR RETIREMENT ACCOUNTS OVER $3.4 MILLION

The budget proposes a rule that would limit any new contributions to retirement accounts (IRAs, 401ks, 403bs, etc) once the balance across all of your retirement accounts exceeds $3.4 million. This is the amount the government estimates that a 62 year old needs today to purchase a joint-and-survivor annuity producing $210,000 a year of income. The proposal allows for inflation indexing and adjustments for annuity costs over time, so these dollar amounts would change over time.

The lesson – In addition to having some insight into what is considered “enough” by some in the government, it should encourage you to maximize those retirement contributions now.

ELIMINATION OF TAX LOT ACCOUNTING FOR SECURITIES AND A REQUIREMENT TO USE AVERAGE COST BASIS

Under current tax law, investors that hold multiple shares of a stock or mutual fund can choose which lots are sold. In other words, if you bought a share for $10 on day 1, followed by another share purchase for $20 on day 2, you would have two “lots” of shares. If you decide to sell one of those shares when the price is $15, you could elect to declare that you are selling purchase from day 2 which cost $20. The net result being a $5 loss on the sale.

The President’s budget proposes the elimination of the specific lot identification method for “portfolio stock”, along with other techniques currently available such as FIFO and LIFO cost basis. Instead, the proposal would require you to use average cost basis. In the example above, the average cost of the share is $15 so the sale at $15 would result in no gain nor loss.

The impact of this change is limiting the ability to tax-loss harvest, or “cherry pick” the most favorable shares from year to year.

The lesson – Harvesting tax losses can reduce tax burdens in current years when it may be most favorable to you. In your taxable accounts, it is a strategy that should be considered while it is a viable option.

Other proposals:

Required Minimum Distributions (RMD) for Roth IRAs
Changes to IRA distributions for non-spouse beneficiaries
Repeal of the Net Unrealized Appreciation (NUA) rules for stock in an employer retirement plan
Changes to Estate Planning rules:

o   Elimination of Grantor Retained Annuity Trusts (GRATs), installment sales to Intentionally Defective Grantor Trusts (IDGT), and Dynasty Trusts
o   Limiting the total of Present Interest Gifts through Crummy Powers
o   Replacing Step-Up Basis with a Required-Sale-At-Death rule
o   Limitations on Transfer-For-Value Rules, particularly for Life Settlements transactions

Limiting 1031 Like-Kind Exchanges on real estate transactions
Subjecting S Corporations to the 3.8% Medicare Surtax

You can read all of 2017 revenue proposals in the Treasury Greenbook.

The lesson – Even the best financial plans (investment, retirement, estate, etc) are subject to change, often for reasons out of our control such as new rules or laws. This is why we encourage you to review your plans regularly to ensure they are current and effective. If you need to review your plan, let’s get acquainted.