Sunset of Tax Cuts and Jobs Act Creates Planning Challenges

In December 2017 the Tax Cuts and Jobs Act (TCJA) was passed, making substantial changes in the tax code, including increased gift and estate tax exclusions and modifications to tax brackets. However, many changes made under the TCJA are set to expire December 31, 2025.  Potential reversion back to pre-2017 law is impacting income tax and estate and gift planning.^[1]

Income Tax Planning

Tax brackets will revert to 2017 rates (adjusted for inflation), with the maximum tax rate increasing to 39.6% from the current 37%. Tax brackets will revert to 2017 levels, growing with inflation. The table below compares joint filers’ 2024 tax bracket with 2017 brackets, adjusted for inflation.

To avoid paying higher taxes on retirement assets, consider converting retirement accounts into Roth accounts. Tax qualified retirement accounts that are converted to Roth accounts are taxed at current income tax rates. If an individual is currently in a lower income bracket but expects to be in a higher one in the future, this strategy can reduce their overall tax burden. The objectives of a Roth conversion are to minimize income taxes in the long-term and the avoidance of all tax on all distributions including those resulting from increases in market value. Each conversion should be evaluated on a case-by-case basis.

Other consequences of reverting to 2017 tax law are described in the following paragraphs.

Standard Deductions.  Standard deductions for individuals and married couples will decrease. For individuals, the deduction will fall from $13,850 to $6,500, and for married couples, it will drop from $27,700 to $13,000.

Child Tax Credit.  The child tax credit will decrease to $1,000 from $2,000 per child, with a phase-out beginning at $110,000 for married couples filing jointly instead of the current $400,000.

State and Local Tax Deduction Cap.  The $10,000 state and local tax deduction cap will be removed, benefiting those living in higher tax states.

Mortgage Interest Deduction.  The ceiling on mortgage interest deductions will increase back to $1,000,000 from the current $750,000.

Gift and Estate Tax Planning

Reversion to 2017 gift and estate tax rates will increase the estate tax rate and reduce the exemption amount, as shown in the following table.

The combined gift and estate tax exemption will revert to pre-TCJA levels of $5 million, growing with inflation (projected $6.7 million), decreasing from $13.61 million, and potentially increasing the importance of estate tax planning. For more people the reversion would significantly reduce the tax-free amount that can be passed on to heirs. Under current regulations, individuals that have a net worth of $13.61 million at death pay no estate tax due to the estate tax exemptions (assuming that a portion of the exemption has not be used for lifetime gifts). With the TCJA sunset, the individual would have to pay $3.1 million in taxes, assuming a 45% tax rate, thus reducing the passed down estate to $10.3 million—a 25% decrease. Trusts can be used to take advantage of current tax law. One example of a trust frequently used as a vehicle for reducing the size of an estate for tax purposes, is a Spousal Lifetime Access Trust (SLAT).

SLAT.^[2]  When creating a SLAT, a donor gifts property to a Trust where the spouse non-donor is a life beneficiary and can access the income and principal as needed. Through the beneficiary, the donor has indirect access to the principal and income of the trust. The donor can continue to pay taxes on the income of the SLAT. Upon death of the beneficiary, the assets are transferred to the contingent beneficiaries and the grantor loses all indirect access to them. Thus, it is important to make sure the SLAT is consistent with the planning needs of the grantor. If the gift to the SLAT does not exceed the $13.61 million estate tax exemption, the gift is nontaxable, and the grantor can potentially reduce their future estate taxes. It is important to note that no joint assets can be gifted to the SLAT and that distributions from the SLAT cannot go to a joint account but can be used for the joint benefit of the spouses. A SLAT comes with risks, such as the reciprocal trust doctrine,^[3] it is important to consult an attorney to assist with the formation of the trust.

The probability of the TCJA sunset depends on various factors, including election outcomes. Given the uncertainty of politics, it is important to plan for possible tax changes. Sound, comprehensive financial planning should incorporate a range of potential outcomes.^[4]

Important Note: This article is distributed for informational purposes and is not construed as an offer, solicitation, recommendation or endorsement of any particular security, product or service.