The Tax Cuts and Jobs Act (TCJA) was a signature tax legislation by President Trump, significantly overhauling the U.S. tax system. With many of its provisions set to expire in 2025, individuals need to be proactive in their tax planning now.
Individual Tax Rates, Standard Deduction, and Child Tax Credit
The TCJA lowered tax rates for different income levels and adjusted income thresholds for different tax brackets.
There used to be seven tax brackets with rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The TCJA changed these rates to 10%, 12%, 22%, 24%, 32%, 35%, and 37%, which generally led to lower taxes for most people.
The standard deduction was nearly doubled under the TCJA. It increased from $13,000 to $24,000 for joint filers and $6,500 to $12,000 for individuals.
The TCJA also changed how the Alternative Minimum Tax (AMT) is calculated, so it applied to only high-income individuals. It now only affects fewer people due to more significant exemption amounts ($81,300 for individuals and $126,500 for couples). However, after the TCJA expires, more people might have to pay it again because the exemption amounts and income phase-out thresholds will decrease.
The TCJA doubled the child tax credit from $1,000 to $2,000 per child. Currently, you can get this credit for each child under 17, and it starts to phase out if you make more than $200,000 as an individual or $400,000 as a couple.
After the TCJA expires, the child tax credit will decrease to $1,000 per qualifying child, and it will start to phase out if you make more than $75,000 as an individual or $110,000 as a couple.
When the TCJA expires, the tax brackets will go back to what they were before, which means some people might have to pay more in taxes since the top tax bracket will increase from the current 37% to 39.6%.
Given this situation, it would be prudent to explore avenues for pulling income forward within the next few years to leverage the current lower brackets. You can do this by exercising stock options now and avoiding deferred compensation plans.
Traditional IRAs require minimum distributions (RMDs) commencing at age 73 and are taxable as ordinary income. On the other hand, Roth IRAs do not impose RMDs, and all future growth and distributions remain exempt from taxation.
One of the benefits of early retirement is that taxpayers have several years between their retirement date and RMD age to convert their IRAs to Roth IRAs in a lower tax bracket.
If you are not planning for early retirement and your income is expected to continue to increase over the next couple of years, by converting your traditional IRA to a Roth IRA before 2026, you would assume the upfront income tax liability (potentially at a lower tax rate), rather than facing it at the time of distribution.
The SECURE Act eliminated the Stretch IRA provisions. For individuals who are subject to the 10-year rule on inherited IRAs, it is advisable to contemplate the possibility of opting for more substantial distributions before the expiration of the TCJA, especially if there is concern regarding the potential rise in tax rates during the later stages of the mandatory 10-year window for complete distribution of the account.
Carman Kubanda, CFP, says, “When we run the numbers, most clients will benefit from doing some level of a ROTH conversion strategy vs keeping assets tax deferred. Besides the imminent rate increase in a few years, we are looking ahead to single tax brackets in survivorship. That can be quite concerning for the surviving spouse facing large RMDs potentially subject to 30%+ marginal tax rates. Many of my clients are also concerned about the large tax bill they will be leaving to their heirs. With the assumption that taxes will be higher when they pass away, many want to avoid leaving that tax burden on the next generation.
Capital Gains Tax
With stock markets at record highs, investing in stocks has resulted in a lot of unrealized capital gains. With the TJCA, the tax brackets for long-term capital gains and qualified dividends are not linked to the ordinary income tax brackets. Consider selling some of your stocks if you anticipate potentially higher future tax rates.
For his clients, Jeffrey Smith, CFP is maximizing Long Term Capital Gains while in the lower bracket for their marginal rate and harvesting losses to offset gains when appropriate. He also recommends increasing giving through qualified charitable distribution while brackets are lower for those above 70 and charitably inclined.
Lifetime Gift and Estate Tax Exemption
The TCJA doubled the lifetime gift and estate tax exemption limits.
As of 2023, individuals are eligible to transfer up to $12.92 million, while married couples can transfer up to $25.84 million without incurring federal gift taxes or estate taxes, either during their lifetime or as part of their estate. This historically high exemption amount will be halved after the 2025 tax year. Tax strategy should be a key consideration when setting up living trusts.
Trust & Will provides state-specific trusts for the protection and transfer of your most important financial assets. You can also nominate legal guardians for your children to make sure they are looked after by someone you know and trust, in case something happens to you.
For individuals with estates greater than $6 million or $12 million per married couple, Peter G. Bobolia, CFP, says, “It may be worth accelerating those gifting plans to your children and grandchildren each year. For those with even larger estates, it is time to consider possible larger lifetime gifts.”
The TCJA introduced qualified business income (QBI) deduction, facilitating pass-through businesses to deduct a maximum of 20 percent of their earnings. Notice 2019-07 introduced a new safe harbor provision for rental real estate under Section 199A of the Internal Revenue Code, making rental properties eligible for QBI.
Under the Tax Cuts and Jobs Act (TCJA), the qualification for 100% bonus depreciation was introduced depending on the year you placed the assets into service. For real estate investing, many interior upgrades to buildings are eligible for purposes of bonus depreciation. Utilizing a cost segregation study is one of the methods to ensure eligibility for the available bonus depreciation percentage.
Doug Greenberg of Pacific Northwest Advisory says, “The real estate realm faces a significant shift with the potential alteration in depreciation timelines. Current provisions allow for a quicker depreciation of certain assets, which is a boon for reducing taxable income. However, post-sunset, the elongation of this timeline could mean higher taxable income. ” He recommends capitalizing on the existing provisions by accelerating depreciation to lower your taxable bracket.
|After TJCA expires
|Individual Tax Rates
|Tax rates changed to 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Also adjusted income thresholds for different tax brackets were adjusted to push more people into lower rates.
|Tax rates will revert to 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. Tax brackets will also revert.
|$13,850 for individuals and $27,700 for couples
|Reduced roughly in half.
$6,350 for individuals and $12,700 for couples
|$2,000 per qualifying child (under age 17)
Income phase-out begins at $200,000 for individuals, $400,000 for couples
|$1,000 per qualifying child.
begins at $75,000 for individuals, $110,000 for couples
|Applies to fewer taxpayers given high
$81,300 for individuals and $126,500 for couples. Income phase-out amounts ($578,150 for individuals and $1,156,300
|Will apply to more taxpayers
|Lifetime exclusion amount is
$12,920,000 per individual and married couples can transfer up to $25.84 million
|Reduced by roughly half
|20% deduction for pass through businesses (QBI). Bonus depreciation
|QBI not available. Bonus depreciation begins to phase out starting in 2023 and will totally be phased out by 2027
Hope for Extension of Tax Cuts Looks Bleak
With the 2024 Presidential election season in full swing, animosity between the parties is expected to ratchet higher. Without prompt action from Congress, the opportunity to take advantage of various tax benefits the TCJA provides is swiftly diminishing.
Although there is still time to negotiate and extend specific provisions, with the current gridlock, the automatic expiration of the various tax provisions seems more likely.
As the TCJA provisions edge closer to their expiration date of 2025, individuals must remain proactive in their tax planning efforts. It is crucial to reassess your investment strategy and explore opportunities to take advantage of the current tax provisions.
Tax planning can be complex, especially when dealing with changing tax laws. Seek guidance from a licensed tax professional to ensure your financial goals align with the evolving tax landscape.
John Dealbreuin came from a third world country to the US with only $1,000 not knowing anyone; guided by an immigrant dream. In 12 years, he achieved his retirement number.
He started Financial Freedom Countdown to help everyone think differently about their financial challenges and live their best lives. John resides in the San Francisco Bay Area enjoying nature trails and weight training.
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