Unraveling TCJA's Sunset Provisions
The TCJA introduced various tax cuts and reforms, but many of these provisions are temporary and will expire by the end of 2025. This sunset clause means that tax rates, deductions, and credits will revert to their previous levels (unless new legislation is passed to extend or modify them).
The most notable changes include alterations to individual income tax brackets, the standard deduction, and the elimination of certain deductions and exemptions. Understanding these expected changes is the first step toward effective tax planning.
Steering Through Tax Bracket Shifts
With the sunset of the TCJA, individual income tax brackets may see significant shifts. The current lower tax rates will increase to the level last seen in 2017, leading to higher marginal tax rates for many taxpayers. For instance, the top individual tax rate, which was reduced to 37% under the TCJA, is expected to revert to 39.6%. Income brackets are also anticipated to shift between the marginal tax rates, meaning that taxpayers could find themselves in a higher tax bracket altogether for the same level of income earned under the TCJA.
Taxpayers should prepare for these changes by evaluating their current income levels and projected future earnings, especially between 2025 and 2026. Understanding where you fall within the new tax brackets can help you make informed decisions about early income recognition. Income recognition or deferral can be a powerful strategy to manage your tax liability when marginal tax rates shift.
Weighing the Pros and Cons of Income Recognition
With the impending tax bracket changes, it may be beneficial to accelerate income into the years with lower tax rates if you expect to be in a higher tax bracket post-2025. For example, if you are typically paid your annual bonus during the first week of January, it may be worth requesting an early payment in December to avoid reporting additional income in the 2026 tax year. If you are self-employed, it may be worth delaying a major business expense until 2026 to reduce your taxable income earned in a higher tax bracket.
Intentional Roth Conversions can also be an effective strategy to manage future tax liabilities. Converting Traditional IRA assets to a Roth IRA generates taxable income for the current year, but allows for future tax-free growth and withdrawals in retirement. As taxpayers prepare for higher tax rates, they should weigh the benefits of converting assets under the TCJA again the immediate tax implications to minimize the overall impact of taxable income in retirement.
Retirees should also consider the impact of the TCJA sunset on retirement account distributions. Higher marginal tax rates can increase the tax liability of retirement withdrawals, potentially increasing the overall tax liability. To manage their tax exposure, retirees should plan ahead for the timing and amount of withdrawals. This may include withdrawing funds early to maximize the benefits of tax rates under the TCJA.
Bracing for the Sunset of Qualified Business Income (QBI) Deductions
The QBI deduction, which allows pass-through business owners to deduct up to 20% of their qualified business income, is another key provision affected by the TCJA sunset. This deduction is set to expire after 2025, potentially leading to significantly higher taxable income for business owners.
Pass-through entities such as sole proprietorships, partnerships, and S-Corporations should consider strategies to maximize this deduction while it is still available, and brace for higher tax liabilities in the years to come. This may include accelerating business revenue to be recognized before the QBI Deduction sunsets, or delaying business expenses and retirement contributions to later years with higher tax rates. Additionally, exploring restructuring options or adjusting compensation strategies can help mitigate the impact of the QBI deduction's expiration.
Managing Expectations for SSTBs
Specified service trade or businesses (SSTBs), including self-employed dentists and doctors, may experience a negligible impact from the sunset of the QBI Deduction depending on your level of income. The QBI Deduction for SSTBs is phased out by income level, meaning that if your income is over the phase out ceiling, you are already be blocked from claiming the QBI Deduction before the TCJA sunsets.
For pass-through SSTB’s earning significant levels of income, the potential expiration of the QBI Deduction may have little no impact on tax planning strategies post-TCJA. SSTB’s that are anticipating income levels near or under the phase out ceiling should carefully monitor their income before the TCJA sunset to stay within the deduction limits. Planning strategies may involve delaying income or accelerating deductions to avoid exceeding the phaseout thresholds while the deduction is still available.
Adapting to Changes in Business Deductions and Bonus Depreciation
The TCJA introduced several favorable business deductions, including increased Section 179 expensing limits and expanded bonus depreciation. However, these provisions will also sunset, meaning businesses should consider timing major purchases and capital expenditures to benefit from current legislation. By accelerating investments into the years before the sunset, businesses can maximize their tax savings.
Bonus depreciation allows businesses to immediately deduct a significant portion of the cost of qualifying assets, rather that depreciating the asset over a number of years. With the sunset of the TCJA approaching, the percentage of bonus depreciation allowed is already gradually decreasing. By evaluating planned expenditures over the next several years, businesses can plan ahead on the timing of purchases to help lock in higher depreciation deductions before the rates decline.
Evaluating the Impact on Cash Flow Planning
Higher tax liabilities can directly impact an individual’s cash flow, requiring adjustments to financial plans and long term projections. Taxpayers should evaluate their cash flow needs and expected changes over the coming years to prepare for reduced liquidity.
This may involve revisiting spending budgets and annual savings plans to accommodate for higher tax payments. Balancing discretionary spending with increased tax payments can be critical to staying on track for savings goals. Understanding these changes ahead of time will allow taxpayers the opportunity to adjust their habits now, rather than being forced to do so once the TCJA sunsets.
Exploring opportunities for tax-efficient investments and tax-deductible savings can also help maintain current cash flow. Adopting a proactive approach to financial planning, including setting aside funds for future tax obligations, can provide greater flexibility. This balance ensures that tax changes do not disrupt overall financial stability.
Key Takeaways
The sunset of the TCJA provisions presents both challenges and opportunities for taxpayers. By understanding the anticipated changes and proactively planning for their impact, individuals and businesses can optimize their tax situation. To effectively navigate the TCJA sunset, taxpayers should develop a customized action plan tailored to their unique financial situation.
The impact of the sunset will affect each taxpayer differently depending on the specific needs and goals of each individual or business. To prepare effectively, evaluate income recognition and deferral strategies, consider maximizing available deductions, and plan for higher marginal tax rates.
If you need personalized assistance, the experts at TaxFD are here to help. Our team specializes in providing comprehensive tax planning and financial advisory services to ensure you make well-informed decisions. Contact us today to schedule a consultation and take the first step toward mastering your tax planning post-TCJA sunset.