The uncertainty around the upcoming presidential election, combined with the pending expiration of most individual tax provisions, creates a unique challenge for taxpayers.
Unless Congress acts, the TCJA will expire at the end of 2025. While there’s always some aspect of uncertainty associated with the tax code, this level of uncertainty may be unprecedented.
How can effective planning be done in this type of environment? Depending on individual circumstances, there may be ways to hedge the risk of potential tax changes or to create flexibility in plans depending on legislative action. For these reasons, we’ve seen increased interest in strategies such as Roth IRA conversions (to hedge the risk of higher income taxes) and Spousal Lifetime Access Trusts (to take advantage of the current lifetime estate tax exclusion before it is potentially reduced). Some wealthy families are creating irrevocable trusts now, but not fully funding those trusts, in anticipation of potential changes depending on the results of the election.
Individuals will want to seek professional guidance on what type of action should be considered in this uncertain tax environment.
Five observations around the expiration of the TCJA
1. A closer look at the scheduled changes to income tax rates and brackets
While there is a lot of discussion around the top tax rate on ordinary income increasing from 37% to 39.6%, there is much more to the story. Meaning, there are scheduled increases throughout the various tax brackets that need to be considered.
For example:
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- The second-lowest marginal tax bracket increases from 12% to 15%. For 2024, this includes taxpayers with taxable income between $11,600 and $47,150 for single filers and between $23,400 and $94,300 for married couples filing a joint tax return. One question is, will Congress be motivated to avoid a full expiration of the TCJA to prevent a tax hike on lower- and middle-income taxpayers?
- There are some income levels where the potential increase in the marginal tax rate is dramatic. For example, some married couples currently subject to a 24% marginal tax rate may see their rate increase to 33% on a portion of their income, an increase of nine percentage points.
2. The outlook on tax deductions is mixed
Some good news in the event the TCJA fully expires is that certain deductions not allowed or limited will be available to taxpayers. For example, miscellaneous deductions will be available again and the current $10,000 cap on deducting state and local taxes (SALT) would be repealed.
However, the standard deduction ($14,600 for single filers, $29,200 for married couples filing a joint tax return) will essentially be cut in half.
Currently, only 10% of taxpayers itemize deductions on their return compared to roughly 30% prior to the TCJA, according to the Tax Policy Center. If the TCJA expires, the number of taxpayers itemizing deductions would increase. In particular, as we head toward 2025, the debate in Congress on relaxing the $10,000 cap on deducting SALT will be interesting to follow since support is generally limited to lawmakers in higher-taxed states, and those who would generally benefit by removing the cap tend to be higher-income households.
3. Higher-wealth households need to carefully consider next steps
While very few estates owe federal estate tax, the number will roughly double in 2026 (from 4,000 to nearly 9,000), according to the Tax Policy Center. The lifetime exclusion amount is scheduled to be reduced in half after 2025 (from over $13 million currently to roughly $7 million per individual). Some higher-wealth households are taking action now by gifting assets to irrevocable trusts.
However, careful consideration must be given in the event the exclusion figure is not reduced after 2025, rendering some of this estate planning unnecessary and potentially detrimental, such as a loss of control over those assets. Also, gifts into irrevocable trust generally do not benefit from step-up in cost basis at death.1 For example, at the end of 2012, the lifetime exclusion amount was scheduled to decrease from over $5 million to $1 million. However, due to bipartisan legislation (the American Taxpayer Relief Act of 2012), the exclusion figure remained the same and eventually was doubled by the TCJA effective beginning in 2018.
4. Will the alternative minimum tax (AMT) come back in full force?
The TCJA made modifications that significantly reduced the number of taxpayers owing the alternative minimum tax (AMT) and made the tax filing process simpler for many taxpayers. Currently, the AMT impacts roughly 200,000 taxpayers annually, but that number is estimated to increase to more than seven million taxpayers upon expiration of the TCJA.2 Will Congress take steps to avoid this drastic expansion of the AMT after 2025?
5. Certain business owners may face a significant tax hike
Most business owners are not taxed as separate entities subject to the corporate tax rate of 21% (which is NOT scheduled to expire after 2025). Instead, these businesses are considered “pass-through entities” subject to individual tax rates and brackets. Many businesses are eligible for a 20% tax deduction for qualified business income (QBI). (See IRS for more details on QBI).
For example, a small business owner today subject to the maximum 37% tax rate may be able to take a 20% QBI deduction reducing their effective tax rate on business income to roughly 30%. Since the QBI deduction is scheduled to expire after 2025, that same business owner would not only lose that 20% deduction, but also be subject to a 39.6% tax rate as the top tax rate on ordinary income increases from 37% to 39.6%. Will there be pressure on Congress to take action to avoid a situation where certain businesses (many small businesses in particular) face a significant tax hike while corporations subject to the 21% corporate tax rate do not?
For more details about the impact of the expiration of the TCJA, see “Looking ahead to the expiration of the TCJA.”
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1. Note: Some trusts may include language that allows swapping or substitution powers under IRC Section 675(4)(C) which may mitigate the risk of losing step-up on cost basis on appreciated assets held within an irrevocable trust.
2, Congressional Budget Office. As of 2024.
