Though the topic is starting to show up more in financial industry publications, mainstream financial media is still mostly (and strangely) silent about the looming expiration of many tax-cuts that could significantly impact many wealthier Americans. Provisions of the 2017 Tax Cuts and Jobs Act (TCJA) are scheduled to sunset at the end of 2025 unless Congress and the president act to extend or amend them.
Just in case you need a refresher, here are some of the most important items on the list:
- Individual income tax rates revert to pre-TCJA levels (putting many taxpayers in a higher marginal bracket).
- The standard deduction will be cut roughly in half (adjusted for inflation).
- The estate-tax exemption will also be cut roughly in half (adjusted for inflation).
- The 20% pass-through deduction for certain types of businesses goes away.
- The percentage of adjusted gross income allowed as a charitable gift falls from 60% to 50%.
- The cap on the state/local tax (SALT) deduction goes away.
And there are others.
Admittedly, the last item on the above list would probably be good news for many of our clients. But the other sunsetting tax provisions — and especially the reduction of the estate tax exemption — would almost certainly adversely affect many of our high-net-worth clients.
Perhaps the most dramatic shift would be the change in estate-tax rates.
In 2017, the federal estate tax exemption was $5.49 million. (The first $5.49 million that a taxpayer passed on to heirs would transfer estate-tax free.) Today, after adjustment for inflation, that exemption stands at $12.92 million; for married couples, the combined exemption is $25.84 million.
The “big revert” would reduce the single-taxpayer exemption down to approximately $6.5 million (about $13 million for married couples). Many of your married clients with estates valued at $9 million to $12 million, who gave a big sigh of relief when the TCJA raised the bar, could find themselves back in the crosshairs if the estate tax provision sunsets on Dec. 31, 2025.
These expiring tax cuts have teeth, too
And don’t forget about the potential changes in everyone’s standard deduction. The TCJA also doubled the standard deduction, which meant that many taxpayers were better off taking the standard deduction than going to the trouble to itemize. The standard deductions for the 2017 tax year were $6,350 for single filers ($12,700 for those married filing jointly). Today, the standard deduction is $13,850 for single filers and $27,700 for married couples filing jointly. If the higher standard exemption disappears at the end of 2025, will your clients be ready for the necessary changes in their tax-filing strategy?
Absent new legislation, marginal rates will likely also rise for many taxpayers. Most Americans would pay an additional 1% to 4% in personal taxes under the post-sunset tax tables than at this time.
Take, for example, a married couple earning between $274,401 and $364,200. Today their marginal rate is 24%. But at midnight on Dec. 31, 2025, it goes up to 33%. Admittedly, for certain brackets, the rate may fall a bit. But the overall net effect is likely to be higher rates for most taxpayers.
The guidance clients need
So, what should we be telling our clients? As trusted fiduciary advisors, we are in a position to “quarterback” key members of our clients’ financial teams in order to put in place a strategy that can help them prepare for the possibilities contemplated by the sunsetting of the TCJA provisions.
Review all documents
We should be encouraging our HNW clients to get in touch with their estate planning specialists (whom we should also be in contact with) to review all estate planning documents and update wills, trusts and other instruments as necessary.
Consider ramping up gifting
We should also discuss with these clients the advisability of ramping up their annual gifting plans between now and 2025. In 2023, an individual can give away up to $17,000 in cash or other assets to any person, free of gift tax and with no requirement to file a gift tax return. Likewise, the recipient pays no taxes on the gifted amount. A married couple can give away as much as $34,000 in the same way, with the same results.
For HNW clients who already intend to transfer some or all of their assets to their children or other heirs upon their passing, annual gifting can provide an easy way to help reduce the size of the taxable estate with minimal fees and no tax liability incurred by anyone.
In addition, clients planning major charitable gifts may wish to act before the end of 2025, while the allowed percentage of AGI that can be gifted is still 60%.
Consider Roth conversations
We may want to advise clients with significant holdings in traditional retirement accounts to consider Roth conversions now, rather than waiting until marginal rates rise. We can help them understand that paying taxes on the converted amounts now, at lower rates, can help enable them to receive non-taxable income later, when tax rates may be less favorable. Alongside their tax advisors, we should help them forecast their future tax situation and, in applicable situations, take steps now to reduce the tax burden later.
Re-evaluate business structures
For business clients organized as sole proprietorships, LLCs, partnerships and other pass-through entities, it will be important to evaluate the effect of the loss of the 20% pass-through exemption on business income. In certain cases, it could make sense to reorganize as a C corporation, since the 21% tax rate for these businesses is unaffected by the sunsetting TCJA provisions.
Of course, new legislation could be passed prior to the end of 2025 that could alter the outlook, and we should be clear with our clients about this possibility. On the other hand, with the federal deficit a near-constant talking point in Washington DC, it may be increasingly difficult for lawmakers to continue making the case for any policy that would reduce the income entering the coffers at the U.S. Treasury.
No matter which way the political winds blow, our clients will appreciate the fact that we are looking at the terrain ahead and trying to help them steer clear of unwelcome taxation events that could make it harder for them to reach their financial goals. After all, they are trusting us to guide, counsel and help them steer around the rough spots, to the extent possible. That’s why they need to be hearing from us now.
Kimberly Foss is a CFP® professional at Mercer Advisors practicing in the Sacramento Valley area. The opinions expressed by the author are her own and are not intended to serve as specific financial, accounting or tax advice. Mercer Global Advisors Inc. is registered with the SEC and delivers all investment-related services. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Click here for a full disclaimer.