Wealth Planning Commentary – October 7, 2024

Income Tax Planning for the TCJA Sunset

As we approach the sunset of the Tax Cuts and Jobs Act (TCJA), it is essential to consider the income tax implications that will take effect on January 1, 2026. This is current law, and while discussions around potential changes continue, we will focus on the legislative framework as it stands, avoiding speculation about future elections. It’s important to clarify that Congress – not the President – enacts tax legislation. Given the gridlocked political environment, with slim majorities likely in both the Senate and the House, significant changes in tax policy seem improbable soon. Therefore, there is no need to make hasty decisions based on campaign rhetoric. With the expiration of the TCJA, marginal income tax rates would revert to pre-2017 levels adjusted for inflation. The income tax rate would increase for many, but some may experience reduced rates, like single filers reporting income between about $200k and $500k. The highest brackets, those with income more than $518,850 (single filers) and $583,750 (MFJ), would experience an increase from 37% to 39.6%. For many taxpayers, the sunset’s net income tax effects might be negligible due to offsetting increases and decreases in deductions, exemptions, and tax rates. For instance, the impact of the reduced standard deduction could be canceled out by the return of personal exemptions. Small business owners of pass-through entities, such as partnerships or S-Corps, could lose the 20% qualified business income (QBI) deduction (Section 199A). Without this deduction, taxable income for these individuals could rise, pushing them into higher marginal tax brackets post-2025. There is some good news for individuals residing in high-tax states like New York, California, and New Jersey: the $10,000 cap on state and local tax (SALT) deductions is set to expire. This would allow for the full deduction of state and local income, real estate, and personal property taxes after 2025, which may reduce taxes for some. Income Tax Planning Strategies To help prepare for the upcoming changes, it is worth considering a few key strategies for the remainder of 2024 and 2025: Accelerating Income Where feasible, pulling income into the lower tax brackets before 2026 could be beneficial. For instance, exercising incentive stock options (ISOs) prior to rising AMT thresholds can result in tax savings. Similarly, individuals with inherited IRA required minimum distributions (RMD) under the 10-Year Rule might benefit from accelerating distributions while in the lower tax brackets rather than deferring larger, potentially more heavily taxed withdrawals after the TCJA sunset. Roth Conversions Converting traditional IRAs to Roth IRAs allows taxes to be paid at today’s lower rates, enabling tax-free growth and withdrawals in the future. This strategy is also advantageous from an estate planning perspective, as beneficiaries can inherit tax-free assets. However, older individuals may need to live for an extended period to offset the initial tax hit of the conversion, which can make it a difficult decision. For these individuals, the estate planning benefits are often more persuasive. Asset Sales and Realizing Capital Gains For those holding highly appreciated assets, it may be advantageous to realize gains before 2026. A formal plan, often starting with a valuation, can help ensure an effective strategy. This applies to assets such as land, real estate, and business but also consider appreciated securities. While capital gains tax rates are not slated to change, taking capital gains today when ordinary income rates are lower may keep total tax payments lower in the future. Deferred Compensation Plans In some cases, it may be wise to accelerate payments from non-qualified deferred compensation plans to take advantage of today’s lower marginal rates. However, this should only be done in consultation with a qualified CPA, as there are strict rules and potential penalties for noncompliance. Please reach out to your Wealth Manager with any questions regarding income tax planning.