Thanks to Jennifer Strojny Milligan, CFP® with Avantax for sharing today's post, Upcoming Tax Changes: Implications on Tax Returns and Financial Planning, about her experience and preparation for the new year as a tax professional and financial advisor. 

Upcoming Tax Changes: Implications on Tax Returns and Financial Planning

Being a tax professional these last few years hasn't been easy, as we've seen remarkable changes in the individual and corporate tax return space. It's been challenging to keep up with updates found in "relatively recent" legislation, and it's been more important than ever to stay on top of continuing education classes to understand how these changes apply to our clients.

Recent legislation underscores the importance of integrating tax planning with investment and retirement planning to maximize clients’ financial opportunities. We recommend that all tax planners create a relationship with a financial planning firm you trust so you can provide solutions for clients’ broader financial needs. Your knowledge of how tax law can benefit them coupled with resources to implement tax-saving advice is a powerful combination that retains clients and can produce more referrals.

When Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019, it contained roughly a dozen provisions intended to encourage more employers to offer retirement plans and incentivize more employees to participate. What Congress couldn’t anticipate was the COVID-19 pandemic that hit the United States in early 2020 and affected individuals and businesses in previously unimagined ways.

In the aftermath of the pandemic, Congress passed SECURE Act 2.0 in 2022 with 92 provisions, some of which were retroactive to 2021 and others that aren't slated to take effect until 2028. It's a hefty piece of legislation with changes and updates to "recent" changes and updates—some of which are mandatory while others are optional. 

At Strojny Financial Services, we focus on holistic wealth management services—providing tax-intelligent financial planning to help individual and business clients take advantage of opportunities found in evolving legislation. Below are a handful of the SECURE Act 2.0 provisions effective in 2023 or 2024 that affect the most tax returns and financial plans we see at our firm.

Provisions Effective in 2023

RMD Rules. Required Minimum Distribution (RMD) rules are changing^[1]. The required age for an RMD beginning date is increasing. For individuals born from 1951 to 1959, the RMD beginning date is 73. For those born in 1960 or later, the RMD beginning date is 75. This includes participants and spousal beneficiaries of a participant who died prior to reaching the RMD beginning date.

This is important because for many of our wealth management clients, the age at which they'll need to start taking RMDs has been part of their financial plan since its inception. With these changes, those financial plans must change. Someone born in 1951 or later no longer has to take an RMD at 70½ years old. Instead, that money can stay in their retirement account and grow until they're 73 or 75, depending on their birth year. We've had to adjust affected plans to account for the increased required age for RMDs.

Effective 2023, the penalty for not taking an RMD is reduced. If you miss an RMD for any reason, the penalty drops from 50% to 25%. You can reduce that further to 10% if you correct the mistake within two years.

The rules for beneficiary IRAs are changing. Within 10 years, the IRA funds must be distributed to non-spousal, non-minor beneficiaries. Depending on the IRA owner's age at the date of death, an RMD may be required in years 1-9. The IRS website (irs.gov) has helpful tables for comparing new and old RMD rules.

Expanded Roth Contributions. In addition to RMD rules changing, there are revised Roth rules that include expanded Roth contributions^[2]. Employers can make Roth contributions to Simplified Employee Pensions (SEPs), Savings Incentive Match Plans for Employees (SIMPLE) IRAs, employer profit sharing and matching in 401(k) plans. However, investment companies and payroll providers are waiting on IRS guidance, most stating not available until 2024 although effective in 2022. 

This is important because starting in 2023, Roth contributions to SEPs and SIMPLE IRAs can be treated as after-tax contributions. Before SECURE Act 2.0 became law, these contributions couldn't be treated as nondeductible. Roth options allow contributions with taxed dollars, which means distributions of those contributions in retirement are tax-free.

Retroactive First Year 401(k) Elective Deferrals for Sole Proprietors. A provision from the original SECURE Act related to first-year 401(k) deferrals for sole proprietors has been updated in SECURE Act 2.0. Initially, the SECURE Act allowed an employer to establish a new profit-sharing plan after the end of the taxable year, but before the employer's tax filing date, and treat the plan as having been established on the last day of the taxable year. The plan may be funded by employer contributions up to the employer's tax filing date. SECURE Act 2.0 allows for these 401(k) plans, and when sponsored by sole proprietors, employee deferral contributions by the business owner can be received up to the filing date of the tax return for the initial year^[3].

Many of our clients are small businesses, and a number of those are sole proprietors. This retroactive elective deferral is important because it allows the sole proprietor to establish a plan and fully fund it in the first year, beginning with plan years starting after December 29, 2022. Before the original SECURE Act, the employer would have to establish the plan by the end of the year in order to fund it by the tax return due date.

It's helpful to be able to fund the retirement plans after the close of the calendar year because many times the business owner doesn't know how their financial year is going to end up. Things can happen late in the calendar year that create unexpected tax burdens. If the business owner had to set up the plan and fund it by October 1, they might not have known about a major Q4 swing in revenue that created a tax problem. In that case, their only option was a SEP IRA, which didn't work well if they had employees.

Now, they can look back at their entire calendar or fiscal year, determine their tax liability and make a more informed decision on establishing and funding a retirement plan. Also, sole proprietors who are in their first year of business often are unprepared for self-employment tax and are scrambling for a deduction at year-end. This change allows for more informed decision-making.

Retirement Plan Start-Up Credits. Tax credits available to employers starting a retirement plan are increasing^[4]. For businesses with 1-50 employees, a credit of 100% of eligible startup costs is available. Eligible startup costs include the set up and administration of the plan, as well as employee education about the plan.

For these small businesses with 50 or fewer employees, up to 100% of the employer contribution is credited for the first two years, then reduced incrementally each year through the fifth year. They receive $500 in automatic enrollment credit.

For businesses with 51-100 employees, a credit of 50% of eligible startup costs and up to 100% of the employer contribution for the first two years are available. The employer contribution credit is phased out over time based on the number of employees above 50. They also receive $500 in automatic enrollment credit.

Retirement plan startup credits are at the very heart of the purpose behind SECURE Act 2.0—to encourage more employers to offer retirement plans to their employees. By offering credits of 100% of eligible startup costs, up to 100% of the employer contribution for the first two years and $500 in automatic enrollment credit, there is no reason a business with 1-50 employees shouldn't establish a retirement plan and offer employee education about it. Opening a corporate retirement plan is a great option to lower business taxes, while rewarding employees with an added benefit.

Provisions Effective in 2024

529 Plan Assets Transferrable to Roth IRAs. Under certain conditions, SECURE Act 2.0 allows for tax- and penalty-free rollovers from 529 accounts to Roth IRAs. Beneficiaries of 529 college savings accounts would be permitted to roll over up to $35,000 during their lifetime from any 529 account in their name to their Roth IRA. These rollovers are subject to Roth IRA annual contribution limits, and the 529 account must have been open for more than 15 years^[5].

While a 529 account can be a useful addition to a financial plan for a child's education, it doesn't contemplate life's changes that may come the child's way. The beneficiary may decide not to go to college, or perhaps will earn enough scholarship and other financial aid to cover the educational costs. Starting in 2024, a tax-free, penalty-free conversion can be made from a 529 account to a Roth IRA owned by the 529 beneficiary, subject to Roth IRA contribution limits. This gives the child a leg up on retirement savings and allows them to avoid a 10% federal tax penalty for using the 529 funds for a nonqualified expense.

Qualified Charitable Distribution Amounts Indexed for Inflation. Currently, individuals who are 70½ years old or older may use a Qualified Charitable Distribution (QCD) to donate up to $100,000 to qualified charities directly from an IRA. SECURE Act 2.0 indicates that the annual IRA QCD limit of $100,000 will be indexed for inflation, effective for tax years after 2023^[6].

The U.S. Inflation Rate is currently 3.67%, compared to 3.18% last month^[7]. Before SECURE Act 2.0, the limit for a QCD was $100,000, regardless of inflation. By indexing the limit for inflation, clients can donate more than $100,000 to qualified charities in the future, which may further help offset tax liability because those dollars are never received as income.

SIMPLE IRAs Convertible to Safe Harbor 401(k)s. Employers are permitted to replace a SIMPLE IRA with a Safe Harbor 401(k) that requires mandatory employer contributions, provided certain criteria are met^[8].

This is important because the conversion allows the employer to take advantage of the Safe Harbor 401(k) plan's higher limits for elective contributions and catch-up contributions. Regarding discretionary provisions, Safe Harbor 401(k)s are more flexible than SIMPLE 401(k)s. 

Although we chose to focus on some of the most "common" implications on tax returns and financial planning from SECURE Act 2.0, dozens of other provisions pose upcoming tax changes. 

Be sure to spend some time with the new legislation ahead of tax season so that you and your team are prepared for how these changes (and those of the original SECURE Act) could affect your clients.

For more information, visit Avantax's website.

[1] https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs

[2] https://www.nstp.org/sites/default/files/2022-04/SECURE2.0_SxS_032822.pdf

[1] https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs

[2] https://www.nstp.org/sites/default/files/2022-04/SECURE2.0_SxS_032822.pdf

[5] https://www.forbes.com/advisor/retirement/529-to-roth-ira/

[6] https://www.forbes.com/sites/leonlabrecque/2023/03/30/secure-20s-new-rule-on-iras-and-charity-can-really-pay-off/?sh=41f801de7278

[7] https://www.bls.gov/cpi/

[8] https://www.finance.senate.gov/imo/media/doc/EARN%20Act%20section%20by%20section%20summary2.pdf