Tax Law Changes Are Coming - The Ride Could Be Bumpy!

 Imagine Congress being satisfied with the current tax law and doing nothing to change it for the remainder of 2024 and 2025. You might think that approach is safe and steady and least likely to create economic or political drawbacks. Unfortunately, impending forces that will not let us stay passive are waiting for us. Avoiding action until the end of 2025 is not likely due to two reasons: 1)  President-elect Trump and the Republican-led House and Senate have campaigned on lowering taxes for specific groups and will want to fulfill their pledge, and 2) The Tax Reform Act of 2018 was temporary and will expire on December 31, 2025. On Jan 01, 2026, the tax law reverts back to 2017. Congress will balance the wishes of the new administration with a review of expiring provisions to extend to 2026 and beyond.

With the economy continuing its three-year expansion and few signs of regressing, reducing taxes in the name of “trickle-down-economics” could have negative consequences as demand may pick up for items. Since the 2018 Tax Reform took effect in January 2018, our national debt has grown from 26 trillion (rounded) to 36 trillion dollars, a 38% increase in only six-plus years. Another 38% increase in our debt, and we are looking at a debt approaching 50 trillion dollars! Hello?

 The success of the planned offset (tariffs) to tax reductions is, at best, uncertain and, at worst, catastrophic. A five percent annual interest rate on a $50 trillion debt would cost taxpayers approximately 2.5 trillion dollars per year in interest. Our combined Social Security and Medicare/Medicaid annual cost is approximately 3.4 trillion dollars.

Below are a few significant areas that Congress will be looking at for probable action in 2025:

Lower individual tax rates

The individual tax rates were lowered in 2018 but will revert to the tax rates in 2017 unless action is taken. I would look for the lower individual rates to be extended and possibly even lowered for the individuals in the top brackets.

 For example, a single individual with a taxable income of $100,000 would pay approximately $20,982 with the old tax law and approximately $17,083 with the current tax law (See 2024 tax tables).

 Higher Standard Deductions

The Standard Deduction for a married couple in 2017 was $12,700. For 2024, it’s $29,200. For couples that do not own homes and would not otherwise itemize deductions, the additional $16,500 in deductions was a welcome sight. However, the $4,050 personal exemption amount for each dependent disappeared. A couple with two kids would lose, beginning in 2018, $16,200 in personal exemptions (nearly offset the gain in standard deduction).

I expect the standard deduction to remain at $29,200 (with yearly inflation adjustments), and the personal exemption deduction will forever be no more.

Alternative Minimum Tax

The regular tax may be increased for some taxpayers due to the Alternative Minimum Tax (AMT). Whether or not you may be subject to the AMT depends on the nature of the income and deductions reported on your tax return. For instance, exercising specific stock options is not a taxable event for regular tax, but the market value over the exercise price is included in AMT calculations in the year of exercise.
As a result of the 2017 legislation, far fewer taxpayers pay the AMT. A total of 207,674 filers owed AMT with their 2022 returns, totaling approximately $3.8 billion. Compare this with 5.07 million individual returns reporting $36.4 billion in AMT on 2017 returns. The expiration of higher exemption amounts (and therefore more likely to be subject to AMT) beginning in 2026 will be an area Congress will deal with. I would suspect the current higher exemptions would be extended.

20% Qualified Business Income Deduction (QBID)

Owners of sole proprietorships, partnerships, S corporations, LLCs, and other pass-through entities have benefited from this deduction since 2018. The deduction is set to expire on Dec 31, 2025. I’m not sure what to expect with this deduction. The QBID is a significant but quiet benefit that Congress may let expire to offset planned rate reductions.

Estate & Gift Tax Exemption

A married couple today can exclude $13.6 million apiece from their estate for a total of $27.2 million of assets, possibly passing to heirs tax-free. The exemption in 2017, scheduled to take effect on Jan 1, 2026, is $5.5 million for a total of 11 million in assets, possibly passing tax-free. The proposed lower income taxes and the proposed extension (or repeal) of current estate tax exemptions certainly create greater opportunities for the wealthiest Americans to engage in “Trickle-Down-Economics.”.

State & Local Tax Deduction

This is the one that we folks in California can relate to. Unlike most other provisions in the reform, such as lower tax rates and larger child tax credits, the SALT provision was a significant blow to taxpayers in California and other states with higher average income and property values.

For Example,

A married couple in California pays $12,000 in real estate taxes and $20,000 in state and local taxes (10% rate on $200K income). Of the total state and property taxes of $32K, only $10K will be deductible through 2025 - a $22K loss in deductions! Ouch!

Planning Areas

Taxes can have a tremendous impact on planning and investment decisions. For instance, properly analyzing the following financial areas requires tax considerations to make the optimal decision. Most tax decisions center on whether to pay tax now or later.

Roth IRAs - Future tax liability compared to your current situation should be the primary factor in choosing Roth IRAs.

Beneficiary IRAs - Rules for distributions from inherited IRAs allow matching future tax liability with income withdrawals.

Social Security Strategies - Waiting until age 70 could depend on the taxable nature of the income planned to replace social security from age 67 to 70.

Selling/Renting Home - Choosing to sell or rent your residence will include decisions loaded with tax analysis to help select the optimal strategy to match your goals.

Please feel free to call us at (925) 484-1671 or email us to schedule a no-charge consultation to discuss with me your financial goals and how you would like to achieve them.