The Tax Cuts and Jobs Act of 2017 expires at the end of 2025, necessitating preparation for significant tax changes by both taxpayers and advisors. The expiration of these provisions will lead to higher tax rates, fewer deductions and increased tax liabilities for many individuals.
The debate over making the Tax Cuts and Jobs Act provisions permanent encompasses a range of economic, fiscal and social issues.
Proponents argue that permanent tax cuts provide stability and predictability, which are essential for long-term economic planning and growth. They assert that lower tax rates enhance disposable income for individuals and increase capital for businesses, fostering investment, job creation and overall economic expansion. Additionally, maintaining higher estate and gift tax exemptions supports wealth transfer planning and reduces the tax burden on families and businesses.
Opponents of making the tax law permanent argue that the TCJA's tax cuts disproportionately benefit higher-income individuals and corporations, exacerbating income inequality. They argue that the loss of revenue from these tax cuts could lead to larger budget deficits and national debt, necessitating cuts to essential public services and social programs. Critics also express concern that permanent tax reductions might limit the government's fiscal flexibility to respond to future economic crises and infrastructure needs.
Below is an in-depth examination of the key provisions set to sunset, their potential impacts and strategic measures recommended by tax advisors to mitigate these effects.
Key Provisions Expiring in 2025
- Individual Income Tax Rates: The TCJA lowered individual income tax rates across various brackets. These rates will revert to pre-2018 levels, resulting in higher taxes for most taxpayers.
- Standard Deduction: The TCJA nearly doubled the standard deduction, but it will revert to lower levels, decreasing the amount of income that is tax-free.
- Child Tax Credit: The credit was increased from $1,000 to $2,000 per child with a higher phase-out threshold. This will return to the previous lower amount and threshold.
- State and Local Tax Deduction: Currently capped at $10,000 by the TCJA, this will expire, potentially allowing for higher deductions for taxpayers in high-tax states.
- Estate and Gift Tax Exemption: The exemption amount was doubled under the TCJA, but will revert to the pre-2018 level, significantly lowering the tax-free transfer amount.
- Alternative Minimum Tax: Increased exemption amounts and phase-out thresholds for the AMT will revert to lower levels, potentially subjecting more taxpayers to this tax.
- Qualified Business Income Deduction (Section 199A): This 20% deduction for pass-through business income will expire, increasing the effective tax rate on such income.
With these impending changes, it is crucial for individuals and advisors to stay informed and proactively plan for a smoother transition.
Impact on Taxpayers
- Higher Tax Rates: Most taxpayers will encounter increased tax rates, resulting in higher tax liabilities.
- Reduced Standard Deduction: More taxpayers may need to itemize deductions, complicating tax filings and potentially increasing taxable income.
- Decreased Child Tax Credit: Families with children will experience a reduction in their tax credits, raising their overall tax burden.
- Estate Planning: The lower estate and gift tax exemption will require more meticulous estate planning to minimize tax liabilities.
- Increased AMT Exposure: A greater number of taxpayers may become subject to the alternative minimum tax, increasing their tax dues.
Impact of Inflation
Inflation can influence the effects of these expiring provisions in several ways:
- Bracket Creep: As incomes rise with inflation, taxpayers may find themselves in higher tax brackets, worsening the impact of higher tax rates.
- Standard Deduction and Credits: If the standard deduction and credits do not keep pace with inflation, their real value diminishes, leading to higher effective tax rates.
- Estate Tax Exemption: The real value of the estate tax exemption will decrease with inflation, potentially subjecting more estates to taxation.
Recommended Actions for Clients
Estate and Gift Tax Planning
- Maximize the Increased Exemption: Take advantage of the current elevated estate and gift tax exemption, which is significantly higher than it will be post-2025. Advisors may consider recommending making substantial gifts now to utilize the higher exemption, which will return to pre-TCJA levels (approximately $5 million, adjusted for inflation) in 2026. However, remember the lessons from 2011, when expected estate tax sunsets were extended. Those who made irrevocable gifts without contingency plans regretted their decisions.
- Set Up and Fund Trusts: Consider establishing and funding trusts to leverage the current high exemption amounts. This can include enhancing existing gift trusts, canceling grantor-grantor trust notes, or creating new gift trusts.
Income Tax Planning
- Accelerate Income: With individual tax rates poised to rise, accelerating income into the current lower tax years can be advantageous. Strategies include converting traditional IRAs to Roth IRAs, which will be taxed at the current lower rates.
- Roth IRA Conversions: Completing Roth IRA conversions before the sunset ensures locking in the current lower tax rates on converted amounts, offering tax-free growth and future withdrawals.
- Charitable Contributions: Make large charitable contributions now to take advantage of the higher deduction limit (60% of AGI), which will revert to 50% after 2025.
Business Tax Planning
- Qualified Business Income (QBI) Deduction: Pass-through entities should maximize the QBI deduction, which offers a 20% deduction on qualified business income. This deduction will expire after 2025.
- Bonus Depreciation: Businesses should capitalize on the 100% bonus depreciation available through 2025 for qualifying property. This benefit will start phasing out in 2026.
- Consider Entity Structure Changes: With the QBI deduction expiring, some business owners might benefit from restructuring their business as a C-corporation, continuing to benefit from the flat 21% corporate tax rate.
Itemized Deductions and AMT
- Plan for Itemized Deductions: With the standard deduction set to decrease significantly, taxpayers will more likely need to itemize deductions. Strategic planning for this change can optimize tax benefits.
- State and Local Tax Deduction: The $10,000 cap on the SALT deduction is set to expire, potentially allowing for larger deductions for taxpayers in high-tax states. This should be considered in tax planning.
- Alternative Minimum Tax: The AMT exemption amounts will revert to lower levels, possibly subjecting more taxpayers to the AMT. Planning ahead for this change can help mitigate its impact.
By taking these proactive steps, advisors can help clients better navigate the complexities of the TCJA sunset and potentially reduce their overall tax liabilities. As the 2025 deadline approaches, it is crucial to review and adjust financial and estate plans to ensure they align with the upcoming changes.