TAXES ARE GOING UP; IT'S TIME TO PLAN ACCORDINGLY

Income and Estate Tax Strategies for the TCJA Sunset

The 2017 Tax Cuts and Jobs Act (TCJA) went into effect on January 1, 2018, with a defined sunset on December 31, 2025. Beginning in 2026 the tax rates are to be reset to the 2017 levels which were higher than today’s tax rates. This is the current law unless Congress extends or changes the law. At this time, it is not clear what Congress will do, this makes tax planning difficult. It is doubtful the tax rates will decline.

Prior to the TCJA, the IRS used the Consumer Price Index - Urban (CPI-U) to adjust the income levels within each tax bracket. The TCJA made permanent the change to Chained Consumer Price Index - Urban (C-CPI- U) which assumes consumers can substitute their expenditure patterns toward less expensive goods within the same category. Generally, this economic substitution effect responds slower to inflation than the CPI -U. Okay, enough economics and back to taxes.

It will not take much political will of either party to let the TCJA tax structure expire, whereas the likelihood of gridlock is predictably high. Let’s work with the following:

1. We will revert to the higher tax rates before the TJCA was enacted.

2. We can estimate the income thresholds for each tax bracket.

From there we can review some tax planning strategies with the goal of preserving wealth.

For most of us, taxes are a significant expense category of our financial plan, especially while in retirement. The tax planning component of a financial plan begins with reviewing your taxable income for the last three years, and then estimating your taxable income for the current year. This establishes a solid taxable income trend line. From there you can continue that trend line by adding or subtracting estimated income to project your taxable income year-by-year going out several years. Income projections while in retirement normally have less variables than your career income. Once this is done you can estimate the income taxes that will be due for each tax year.

From now until the end of 2025, we have a window of opportunity to bring future taxable income forward to take advantage of the current lower tax rates. Once the higher tax rates are in effect, our tax deductions become more valuable. Where possible, we should plan on deferring discretionary deductions in 2026 or later.

For comparison purposes, following is a chart of the 2022 Federal income tax rates and income levels in black, followed by the 2017 tax rates that are scheduled to go in effect in 2026, with estimates of the income levels at that time (in blue font) where a reasoned forward-looking estimate of C-CPI-U was used for tax planning purposes.

The above 2026 income levels for each bracket are estimates, the official 2026 income threshold of the brackets will be published by the IRS sometime in 2025. For the estimated income tax brackets C-CPI-U inflation methodology was used.

The TCJA eliminated the Personal Exemption of $4,050 each, for individuals, spouses, and dependents. Whereas it nearly doubled the standard deduction for taxpayers as follows:

​Filing status	2022 Standard Deduction	2017 Standard Deduction	2026 Standard Deduction*
Single	$12,950	$6,350	$7,700
Married Filing Jointly	​$25,900	$12,700	​$15,400

The 2026 Stand Deductions are estimates indexed for inflation, the official 2026 Stand Deductions will be published by the IRS sometime in 2025.

With the current standard deduction level so high, compounded by the $10,000 cap on the State and Local Taxes (SALT) deduction and other changes brought on by the TCJA, many taxpayers no longer itemize deductions. This will change with the sunset of the TCJA on December 31, 2025. Therefore, we need to be planning for future itemized deductions that can work to our advantage in a higher tax rate environment.

Elimination of the Qualified Business Income (QBI or Section 199A) deduction

With the sunset of the TCJA, the QBI deduction will be eliminated. For many sole proprietors or owners of pass-through entities, the QBI reduces taxable income by 20%. This substantial deduction for most small business owners will cause taxable income to increase, and then be taxed at higher rates. It’s a double whammy. Any income that can be recognized before the expiration of the QBI will receive favorable tax treatment. Conversely, any business expenses that can be deferred until 2026 or later will be of more value in a higher tax rate environment. Business planning now can make a meaningful difference.

These business owners should be aware of the generous Simplified Employee Pension (SEP) contribution limits. Contributions an employer can make to their own along with their employee’s SEP IRA are the lesser of 25% of the employee’s compensation, or $61,000 - indexed for 2022. SEP plans are easy to set up and when they no longer meet your needs the account balances can be rolled over to a Traditional IRA. SEP plans can be terminated without notifying the IRS.

Roth Conversions

This is one of the easiest ways to bring taxable income forward while reducing future Required Minimum Distributions (RMD’s). With a few years to work through this, you can optimize the taxes due each year by maxing out your current tax bracket with the amount converted to a Roth account. For large pre-tax retirement account balances, you may want to breach your current tax bracket and convert more to a Roth now during this lower tax rate environment. A Roth conversion is a tax reclassification that involves converting tax deferred income into current taxable income. This tax strategy is more than prepaying a future tax at a potentially lower rate. Think of it as an investment in tax free future portfolio appreciation. Pre-tax retirement accounts are taxed at the ordinary income tax rates when distributions are made, not at the preferential capital gains rates. The source for this is a Traditional IRA, a 401(k) or 403(b) account from a previous employer. Many 401k plans now allow “in-plan” Roth conversions. There are no Roth income limitations for conversions.

In its simplest form, for a Roth conversion to work in your favor you are anticipating the following: My pretax account plus appreciation and then less taxes (net) will be less than the cost of converting to a Roth and paying the ordinary income taxes now. The majority of what you are investing in is the future appreciation to be tax free. If these Roth monies will not be redeemed for 10+ years, the compounding amount could be significant.

Many taxpayers spend a lot of calories on diversification of their investments, such as stock, bonds, cash equivalents, etc. while neglecting tax diversification. The power of tax diversification comes into play mainly in retirement. By having a tax-free source to draw from, you can meet your annual spend-down needs while cherry picking the assets to sell by their appropriate tax source. This provides you with the ability to do tax bracket management. You can stay in a specific tax bracket by tapping your Roth account to supplement your cash flow needs while not being thrown into a higher tax bracket from withdrawing too much from a pre-tax account.

Another way to maximize Roth in your total portfolio is to place assets with higher expected appreciation such as small or mid-cap stocks, emerging market equities, REITS, etc., while using the traditional IRA or 401(k) accounts to hold more conservative equity and fixed income investments. This allows you to keep your total investment risk level the same, while being selective with the tax buckets that hold these securities. The goal then becomes to get the most appreciation out of the tax fee Roth holdings while taming the pre-tax accounts to minimize your future taxable RMD’s.

Additional benefits of a Roth include no taxable RMD’s. Redemptions from a Roth account are not included in your Adjusted Gross Income (AGI). Your AGI level is what is used to determine the taxability of your social security benefits and it is also used to determine the amount you will pay for your Medicare premiums.

Roth is a valuable tool in retirement tax planning. From now until the end of 2025 may prove to be the optimal time to chip away at Roth conversions. For more information on Roth conversions click Here

Estate and Gift Taxes

The TCJA more than doubled the Estate and Gift Tax exemption amounts which are at historic highs. These annual thresholds (indexed for inflation) are as follows:

Year	​Applicable Estate Tax Credit Equivalency	​Applicable Gift Tax Credit Equivalency
​2017	​$5,490,000	$5,490,000
2022	$12,060,000	$12,060,000

In 2026 these exemption amounts will be reset to the 2017 levels and then indexed for inflation. This is estimated to be around $6,500,000. Now is a good time to review your estate plans. Many taxpayers who thought they would never breach the current historically high estate and gift tax exemption amounts may end up being much closer after the TCJA expires. An analysis of your projected net assets is needed. You have a window of opportunity to install various types of trusts and gift opportunities tailored to your desires. For example, to remove the death benefit proceeds paid by a life insurance policy from being included in your gross estate, an ILIT (Irrevocable Life Insurance Trust) can be installed. For an ILIT to be effective the insured person cannot own the policy within three years of their death. By transferring the ownership of the life insurance policy to your ILIT now, you have the 3-years of trust ownership to burn off prior to the sunset of high estate tax exemption at year-end of 2025. For taxpayers who miss this window of opportunity, the estate tax rates will revert to 39.6% very quickly with the condensed trust and estate tax brackets as shown on the following table:

The taxable amounts above will be indexed for inflation in 2026, although with these very condensed tax brackets it won’t make a material difference, whereas the higher tax rates will. For more information on ILITs and other types of trusts click Here

There are many other TCJA tax items to consider, all with a high likelihood of expiration late in 2025. Taking advantage of reviewing various scenarios and opportunities in your retirement and estate plans now could save you a lot in taxes later.