Tax Cuts & Jobs Act Expiry: In with the Old & Out with the New?

For the last six tax years, every U.S. taxpayer has been filing their returns under the Tax Cuts & Jobs Act (TCJA), which was passed by the Trump administration in 2017. This year, 2024, will be the seventh year of these tax codes, but they aren’t expected to last much longer. To pass this legislation, congressional Republicans included a sunset clause that will effectively end many of the TCJA provisions at the end of 2025.

This expected tax sunset is an important topic area for planning over the next few years. Let’s start with some background!

What Was the Tax Cuts and Jobs Act?

The TCJA was a major update to U.S. tax laws, bringing several changes. Here are the key points:

• Lower Tax Rates: Most income brackets saw reduced tax rates. For example, the top rate went from 39.6% to 37%.

• Higher Standard Deduction: The standard deduction was nearly doubled, simplifying many people’s tax returns. However, this was offset by the elimination of personal exemptions. Before TCJA, taxpayers could claim personal exemptions in addition to the standard or itemized deductions for themselves and their dependents. As you can see below, the impact of this sunset change may actually be a net benefit to many households who have at least one dependent child.

Note: The numbers shown below are inflation adjusted to 2024.

Source: Kitces Article – Planning for Changes in Client Marginal Tax Rates After TCJA’s Sunset

• Cap on State and Local Tax Deductions (SALT): Currently, taxpayers can only deduct up to $10,000 in state and local taxes, including property taxes. This deduction was, previously, unlimited and primarily affected those who live in high-tax states. Should the sunset occur, those in high-tax states will be allowed claim 100% of state taxes paid as an itemized deduction against Federal taxes.

• Increased Child Tax Credit: The credit for each child under 17 was doubled from $1,000 to $2,000, with a larger portion refundable for lower-income families.

• Small Business Benefits: A new 20% deduction for qualified business income from certain small businesses, known as the QBI Deduction, significantly lowered taxes for qualifying business owners.

Disclaimer: Please know that this is not an exhaustive list and only highlights some of the most commonly used provisions affecting most taxpayers.

What Should You Do?

If this sunset occurs, many Americans may see an increase in their overall tax liability starting in 2026, primarily due to higher marginal tax rates. For more information on these changes, click here. Due to this, it may make sense to take advantage of the currently lower tax brackets over the next few years rather than waiting until after the sunset. We call this “Tax-Bracket Arbitrage.”

Our goal, as a fiduciary financial advisor is to provide our clients with actionable information to optimize lifetime tax outcomes. Here are three tax planning strategies to consider, all of which involve shifting future income into today’s lower tax brackets:

• Roth IRA Conversions: Convert funds from a traditional IRA to a Roth IRA. This strategy involves methodically filling out favorable tax brackets. You pay taxes on the converted amount now, but future withdrawals from the Roth IRA are generally tax-free. This can be beneficial if you expect to be in a higher tax bracket in the future and want tax-free growth and withdrawals for retirement.
• Roth 401(k) Contributions: Many employer-sponsored plans now offer the option to make Roth 401(k) contributions with after-tax dollars. While the contributions are taxable in the year made, they grow and can be withdrawn tax-free in retirement. This strategy allows for slow accumulation of Roth funds each year, minimizing larger tax liabilities.
• Accelerate Inherited IRA Distributions: The SECURE Act of 2019 requires non-spouse beneficiaries to distribute the entire inherited IRA within 10 years. Accelerating distributions can take advantage of current tax brackets and minimize the tax impact of the 10-year rule. After-tax dollars can be reinvested in a taxable account or used for lifestyle purposes.

A Few Final Thoughts
One added benefit of using Roth conversions and contributions is that inherited Roth IRAs are more tax-efficient. While they are subject to the 10-year distribution rule like traditional IRAs, they do not require annual withdrawals, and withdrawals are tax-free for the beneficiary. This makes leaving a legacy for the next generation more effective and efficient through Roth IRAs.

Lastly, the upcoming national election later this year will significantly impact the future of the TCJA sunset. Our new congressional and presidential leaders will decide whether to extend, modify, or let these provisions expire. Our understanding of the TCJA’s future will become clearer in November and December.

We are here to discuss how these changes could affect your tax situation. Please reach out to your ACM wealth advisor with any questions or to discuss if any of the above strategies are right for you.

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