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Tax Reform of 2017 Expires in 2025 - Then What?

Tax Reform of 2017 Expires in 2025 - Then What?

April 08, 2024

Tax rates are scheduled to rise in 2026, and the 2017 Tax Reform Act is the culprit. Most individual tax provisions in the act were temporary. They expire after 2025. Unless extended or modified by Congress, the provisions will revert automatically on 1/1/26 to the rule in effect for 2017. A significant factor in future tax rates will be what happens in November’s election, but with our national debt approaching 35 trillion dollars, higher taxes seem inevitable somewhere down the road.

Below are some of the more important provisions that affect most people.

 

The Negatives:

  • Tax Brackets
    See Chart. Individual tax rates declined due to the Tax Reform Act (TRA) in 2017 (for years beginning in 2018). Starting in 2026, the tax rates are scheduled to revert to the tax tables that existed in 2017.



  • Standard Deduction Amounts:
    For Married Filing Jointly, the standard deduction in 2017 was $12,700. In 2024, the standard deduction for MFJ is $29,200 – 230% increase. The higher standard deduction has allowed more taxpayers to use the standard deduction instead of actual eligible deductions.

  • Alternative Minimum Tax
    Exemption 2017 MFJ $  84,500
    Exemption 2024 MFJ $133,900

    The higher exemption amounts and phaseout limits after 2017 have resulted in far fewer individual taxpayers having to pay the AMT.
    Three percent of taxpayers paid the AMT in 2017. Fewer taxpayers are subject to AMT today because of the increased exemption and the limitations on state and property taxes ($10K max). Lowering the AMT exemption in 2026 and higher deductions due to eliminating state and local tax limitations (see “positives” below) will most likely subject more taxpayers to the AMT.

  • 20% Qualified business income deduction.
    Owners of sole proprietorships, partnerships, S corporations, LLCs, and other pass-through entities have enjoyed this deduction since 2018. Eliminating this deduction will create a greater tax liability for business profit fully taxed at ordinary income rates.  

  • Larger gift and estate tax exemption.
    2017 exemption = $5,490,000

    2024 exemption = $13,610,000
    A married couple today can shelter up to 27.2 million dollars. In 2017, the amount eligible for “tax-free” pass-through to heirs was $10.98 million. Reducing the exemption will subject more families to the estate tax.


    The Positives:

  • No “SALT” cap on Taxes for itemized deductions.
    Many taxpayers, especially those living in the Bay Area, feel the pain of this tax limitation. Currently, there is a maximum state and local tax deduction of $10,000. Property taxes are included. Beginning in 2026, the cap is scheduled to be removed. Higher-earning couples who pay higher property taxes on their homes will benefit the most from the limitation relief.

  • $1 million home mortgage interest deduction instead of $750K
    The average home sales price in the Bay Area as of January 2024 was 1.1 million dollars. If $750K is the maximum mortgage amount in which interest can be deducted, then at least a $350K down payment must be made on purchasing an average Bay Area home.
    The maximum mortgage amount qualifying for the interest deduction reverts to one million dollars in 2026.

  • Miscellaneous Itemized Deductions will be allowed again.
    These deductions were eliminated in 2018, including brokerage fees, tax return preparation fees, and unreimbursed employee expenses.

Planning Tips

Most financial decisions involve considering taxes in some form, and investment decisions are no different. Let’s look at a few investment strategies to analyze in anticipation of higher interest rates:

 Inherited (Beneficiary) IRAs
The rules for Inherited IRAs following the Secure Act of 2020 include the provision that a non-spouse beneficiary must withdraw the entire balance of the decedent’s IRA by the end of the 10th year following the year of the decedent’s death. As the above tax bracket changes, assuming everything else is constant, distributions beginning in 2026 will be taxed at a higher marginal tax rate than in 2024 and 2025.  

For Example,

 Jim, 35, inherited an IRA from his grandmother, who passed away in 2021. The amount of the IRA was $200,000. Jim has not made any distributions from the IRA since he does not need the money to pay for his living expenses. Jim has until the end of 2031 to withdraw the entire amount, including any growth since 2021. Jim believes his taxes will go up in the future, not only because of the changing rates but also because he is moving up the corporate ladder, and he will probably get married to his girlfriend, who also has a career.

 In this case, it makes sense for Jim to consider withdrawing a large portion or all of the IRA in 2024 and 2025. The higher lump sum may hike Jim to another tax rate, but he could offset the additional tax with future distributions that will be exempt from his higher expected tax. What Jim should not do is wait too long to begin taking distributions, as he may be forced to take more significant distributions at higher tax rates in the future.

See Anthony Carr's Blog "To Roth or Not to Roth."

Roth IRAs
The appeal of Roth Investments is that future withdrawals will be tax-free once certain conditions are met. The catch is that tax must be paid upfront on any contributions or conversions to a Roth IRA. A significant factor in opening a Roth is your belief that rates will rise. You could also anticipate greater income in the future (i.e., higher wages, social security, pension, rental). The goal with a Roth is to have the aggregate tax saved on future withdrawals eventually exceed any tax paid upfront.  Today, we have a law in place that will lawfully increase tax rates in 2026, and we have an opportunity to plan for it.

For example, Tracy, single, age 45, converted her IRA of $140,000 to a Roth IRA in 2024. The conversion amount plus her $$150,000 salary puts Tracy in the 35% Federal tax bracket. Tracy could split the conversion amount between 2024 and 2025 and lower her overall taxes.

See Anthony Carr's Blog "Inherited IRA Rules - A Quick Summary."

 

Qualified v. Non-Qualified Accounts
Suppose your retirement accounts include tax-deferred qualified accounts (IRAs, 401(k))  and taxable non-qualified accounts (individual, joint, trust). In that case, opportunities exist to save taxes by allocating interest income-producing investments to the tax-deferred accounts and capital appreciation investments such as stocks to the taxable accounts.

For Example,

Stacy, age 69, is retired. She has an Individual Retirement Account (IRA) and a taxable brokerage account in the name of her living trust (could be individual or joint). Both of her accounts are allocated among stocks and bonds. Since bonds are investments that pay taxable interest, allocating the bonds to the tax-deferred account (IRA) could save the taxes she would pay on any bond (or CD) interest paid through the taxable account.

 The portfolio's stock (mutual funds, ETFs) portion or any other capital-appreciating asset should be allocated to the taxable accounts as much as possible since the capital appreciation can eventually be withdrawn as lower-rate capital gains.

Retirement planning can bring many challenges, such as potential lower income during retirement, uncertain tax rates, uncertain inflation (loss of purchasing power), and the need for asset growth while managing distributions and focusing on preserving wealth for your heirs. Please call us at (925) 484-1671 or email us if you have a question or want to schedule an appointment. 

Sincerely,

Anthony B. Carr, CPA, CFP