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Preparing for the 2025 Tax Sunset

Zach Cox, CPA

Director of Financial Education

Last Updated
July 22, 2022
Thoughtful evening mood with a young woman watching striking sunset

How to Plan for Expiring Tax Provisions

The 2018 Tax Cuts and Jobs Act (TCJA) created many tax changes for both corporations and individuals. However, only the corporate changes were signed into law, becoming permanent. Many of the biggest individual changes were written to expire after the 2025 tax year. These sunsetting tax provisions create additional complexity in an already complex tax planning environment. While the Build Back Better Act (BBB) and its corresponding new tax laws appear to be dead, there’s always the threat of a revival with elections coming up (to add to the uncertain tax landscape). But we’re only able to plan for what we know now. And barring any extension of the TCJA or a new BBB being signed into law, there are two big items we can plan for before the 2025 sunset.

Individual Income Tax Rates

Individual tax rates are set to revert to their 2017 amounts. Income brackets will also return to their previous ranges, indexed for inflation. The chart below compares the current rates and income brackets through 2025 (in black) to the rates and income brackets that will go into effect on January 1, 2026 (in red).

Individual Income Tax Rates

Tax RateSingleMarried, Filing Jointly
10%
10%
$0 - $10,725*
No Change
$0 - $20,275
No Change
12%
15%
$10,726 - $41,775
No Change
$20,276 - $83,550
No Change
22%
25%
$41,776 - $89,075
$41,776 - $101,175**
$83,551 - $178,150
$83,551 - $168,625
24%
28%
$89,076 - $170,050
$101,176 - $211,050
$178,151 - $340,100
$168,626 - $256,950
32%
33%
$170,051 - $215,950
$211,051 - $458,850
$340,101 - $431,900
$256,951 - $458,850
35%
35%
$215,951 - $539,900
$458,851 - $460,750
$431,901 - $647,850
$458,851 - $518,350
37%
39.6%
Over $539,900
Over $460,750
Over $647,850
Over $518,350
*Indexed for inflation
**Estimated, indexed for inflation

If you expect your income to be low in the years before 2026, perhaps because of retirement, plans to retire, or other changes, there’s an opportunity to take advantage of the lower rates by accelerating income with Roth conversions.

Roth Conversions

A Roth conversion is a tax strategy to convert pre-tax retirement funds, such as those from a traditional IRA, to a Roth IRA by paying taxes on the converted amount, ideally at a lower rate than you would in the future. Once the funds are in the Roth IRA, they’ll continue growing, and withdrawals are tax exempt once you reach age 59 ½ and the account is at least five years old. An easy way to think about it is that the IRS is running a sale on Roth conversions for the next three years. Each year that passes, you’re losing an opportunity to save on converting some of your pre-tax money to a Roth at the lower rates.

For example, a married couple with taxable income of $83,550 is at the top of the 12% bracket. If they complete a Roth conversion of $256,550 to max the 24% bracket, they would save $15,651 in federal taxes by performing the conversion in the next three years instead of waiting until after 2025. That’s $15,651 that will stay in their pocket and grow tax free!

If you’re expecting to retire in 2026 or later, you need to talk with your financial planner and consider the effect of the increase in taxes on your financial plan.

Estate Tax Exemption

If you have a sizeable estate, another large opportunity to take advantage of before the 2025 sunset is the increased estate and gift tax exemption amount. The exemption amount will be cut in half for each taxpayer and is estimated to be around $6.2 million in 2026 after adjusting for inflation. This change will not only affect estates over the current exemption amount of $12.06 million but also those in the $6-$12 million range, as these estates will suddenly find themselves subject to taxation. Making lifetime gifts now to take advantage of the increased exemption amounts will remove not only your assets from estate taxation but also any appreciation on said assets.

The IRS has issued regulations (Regs. Sec. 20.2010-1(c)) to prevent a clawback on your lifetime gifts made during the increased exemption period. The regulations allow you to make gifts over the lower 2026 exemption amount and up to the current exemption amount without worry that your estate will claw back the excess exemption used. Your estate would be granted an exemption amount up to the amount of excess exemption used.

For example, if you make lifetime gifts of $8 million in 2022 and pass away in 2026 when the exemption amount has reverted to $6.2 million, your estate will get the benefit of the estate tax exemption of $8 million and not just the $6.2 million.

However, an important caveat is if you gift less than the estate exemption amount in effect at your death, you will receive no benefit. In other words, if you gift less than $6.2 million before 2026, your estate will receive no additional exemption amount over the current exemption upon your death. The current increased exemption is a use it or lose it benefit if you have a large estate and live past the 2025 sunset.

In some good news, portability elections made during the increased exemption period will not be affected by the sunsetting provision. The full increased exemption amount transferred to the surviving spouse will be available for their estate after 2026.

Other Changes

There will be numerous other changes to tax provisions once the TCJA has fully sunset. Many of these don’t offer great planning opportunities but are important to be aware of to help guide you through planning.

Itemized Deductions

  • The standard deduction will lower by almost half, adjusted for inflation. This will greatly increase the likelihood that you will be itemizing your deductions going forward.
  • The $10k limitation on state and local taxes (state income taxes, real estate taxes, personal property taxes, etc.) will be removed.
  • Mortgage interest will be deductible on debt up to $1 million, up from $750k, and expands to include up to $100k in home equity debt.
  • Miscellaneous itemized deductions, most notably unreimbursed employee expenses, will be allowed.
  • Personal casualty and theft loss deductions will be reinstated.
  • The Pease limitation will be reinstated at certain income levels, which puts a cap on total deductible itemized deductions.

Family Benefits

  • Personal and dependent exemptions will be reinstated (this was previously $4,150 per qualifying taxpayer and dependent).
  • The child tax credit amount will be reduced, and income eligibility will be phased out. The credit for dependents that aren’t a qualifying child will also be removed.

Other

  • Sec 199A, the 20% qualified business income deduction (QBI) for pass-through entities will be eliminated.
  • Alternative minimum tax (AMT) exemption amounts will be reduced.

We hope you’ll find this information useful as you chart out your financial future. At Creative Planning, we help ensure our clients are maximizing their eligible deductions while minimizing their tax liabilities. To get help planning for your financial future, please schedule a call.

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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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