Money Talk: Tax planning with big changes on the horizon
The Tax Cuts and Jobs Act (TCJA) of 2017, passed under the Trump administration, made major changes to the tax code and was widely advertised as an effort to simplify tax filings, reducing many returns to a document the size of a postcard. The postcard-sized return was attempted but only lasted for one filing season. Many other features of the Act are also likely to be relatively short-lived as the TCJA provisions related to individual taxpayers are set to expire on December 31, 2025. While Congress could vote to make these provisions permanent, the current climate in DC suggests that no action is more likely. Consequently, those who plan for the sunset of the TCJA should be less impacted by the higher tax rates that are on the horizon.
Along with a “permanent” reduction in the corporate tax rate to 21%, the TCJA restructured the tax brackets to reduce individual tax rates and simplified filing by allowing for a much larger standard deduction so that fewer taxpayers would need to itemize deductions to reduce their taxes. The downside to this change was that the deduction for state and local taxes (SALT) was capped at $10,000 for joint filers and miscellaneous itemized deductions were eliminated. The SALT deduction cap was not advantageous for higher income taxpayers in states with high income or property taxes. The TCJA also increased the threshold at which higher long-term capital gains tax rates apply and doubled the lifetime exemption for the estate and gift tax to $11.2 million (now $13.6 million). For 2026, without Congressional action, all these individual tax changes will revert back to the rates, brackets, itemized deduction rules and estate tax exemption amount that applied before 2018, adjusted for inflation.
The first thing to understand for planning is your current tax bracket and how this might change when the TCJA sunsets. There will still be 7 tax brackets, but the range of rates will span from 10% to 39.6% rather than a top rate of 37% currently. The higher rates will apply alt lower taxable income levels. Joint filers currently in the 12% bracket will find themselves paying 15% at the margin and taxpayers currently in the 22% bracket could land in the 25% or 28% marginal bracket under the old setup.
When faced with higher future tax rates, wise taxpayers will look to shift income to the present if possible so that taxes are paid at today’s lower rates .Converting traditional IRAs to Roth is a great strategy to consider in this regard Remember that, unlike traditional IRAs, Roth accounts are not subject to required minimum distribution rules that force retirees to withdraw retirement funds, increasing their taxable income. These required withdrawals used to begin at age 70 ½ but subsequent tax law changes have pushed the start date out to 73 (75 for those turning 74 after December 31, 2032). Shifting funds from traditional IRAs to Roth before these required withdrawals begin and before the TCJA sunsets should mean locking in today’s lower tax rates and providing a pool of tax-free funds in the Roth IRA to help manage taxes in retirement. Employees with stock options may want to consider exercising vested option grants before higher tax rates kick in. It also may be advantageous for employees to consider making Roth 401(k) contributions if their tax bracket in retirement is likely to be higher than their current bracket.
One potential plus to the TCJA sunset may be that you will be back to itemizing deductions, but the standard deduction will also drop back to about $15,750. State and local taxes will again be deductible without a cap, helping to push more taxpayers toward itemizing, and the miscellaneous deductions like employee business expenses, (including the home office deduction) will return. Taxpayers with children, however, will be disappointed to find the child tax credit cut in half from $2,000 to $1,000.
Finally, while few taxpayers will pay the estate and gift tax given the current lifetime exemption of $13,61 million per person, this exemption will effectively be cut in half when the TCJA sunsets. For taxpayers with estates at this level, making lifetime gifts to heirs that are under the $18,000 annual exclusion amount or taking other steps to reduce their future taxable estate will help protect more of it from the tax man when the time comes.
David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS Enrolled Three Bearings Fiduciary Advisors, Inc., a fee-only advisory firm in Hampton. He can be reached at (603) 926-1775 ordavid@threebearings.com.