The first major overhaul of the US tax code in more than 30 years, the Tax Cuts and Jobs Act (TCJA), took effect in 2018 and is expected to significantly impact all American taxpayers through 2025. At nearly 200 pages, the Act substantively changes the tax code for both institutions and individuals, aiming to cut corporate, individual, and estate tax rates.
TCJA- A brief history
In December 2017, Congress passed the Tax Cuts and Job Acts, one of the most ambitious attempts at tax reform in decades. This tax code overhaul changed many incentives and limits. Specific TCJA provisions are due to sunset (expire) after 2025. These revisions will likely affect most Americans’ tax bills for the next couple of years.
For example, current tax brackets are slated to expire at the end of 2025. These brackets would be replaced with tax brackets in place before TCJA became law. Unfortunately, America’s deficit spending issues and possible global conflicts are prompting some pre-retirees to take advantage of TCJA while they can and plan for its sunset. There is also the possibility that Congress could act before TJCA’s expiration and either extend or modify it. Whatever happens, it’s more than reasonable to suppose taxes will be higher, not lower, in the future.
How can taxpayers prepare for higher taxes?
Since tax increases appear inevitable, now is an excellent time to meet with your financial advisor or tax expert to design a tax mitigation strategy. Putting a plan in place now may help you blunt the potentially negative impacts of rising taxes on your savings.
You may want to:
Consider a Roth IRA conversion. Many people have assets held in a traditional IRA. If this is the case with you, you may want to consider the pros and cons of a Roth IRA conversion. Roth conversion is the process of repositioning some or all of your assets in a traditional IRA, 401k, 403b, or 457b to a Roth IRA under the lower tax rates currently applicable to many individuals.
Roth conversions can be beneficial because withdrawals from a Roth IRA are tax-free, provided the account owner is at least 59½ and has had their account for at least five years. Roth IRA conversions, sometimes called “backdoor” conversions, also let you pass assets to your heirs tax-free. You should be aware that you will pay taxes on your conversion now. That’s why it’s typically wiser not to pay your tax bill with IRA funds but instead use other liquid assets, such as savings. Under TJCA, so-called “recharacterizations” that let you undo a Roth conversion are no longer permitted. The conversion is permanent and won’t expire when the law sunsets in 2025. Because conversion is now irreversible, it’s imperative that you and your advisor crunch numbers to determine if a conversion makes sense.
Pay off or pay down your mortgage.
The TCJA caps how much of your mortgage interest payments are deductible from federal taxes. Anyone taking out a mortgage between December 15, 2017, and December 31, 2025, can only deduct interest on the first $750,000 of that debt. Also, if you took out a home equity loan, you should know that interest on certain home equity loans is no longer deductible. There is one exception to this rule, though. Interest on home equity loans taken to improve a primary residence is still deductible.) Under these new limits, affluent homeowners may find it more financially advantageous to pay off their mortgages.
You might want to itemize.
The standard deduction will likely make sense for most taxpayers, particularly retirees. If you previously itemized, you may have stopped doing so once TJCA took effect. That’s because the Act nearly doubled the standard deduction to $12,950 for single filers and $25,900 for married couples who file jointly (2022). For 2023, the standard deduction will be $13,850 for single taxpayers and $27,700 for married couples filing jointly. Still, it pays to closely monitor all your expenses to determine if itemizing will help you going forward.
Revisit medical expenses.
TCJA lowered the threshold for qualified medical expense deductions. If medical expenses exceed 7.5 percent of your adjusted gross income, you can claim them as a deduction if you decide to itemize.
With new incentives, you may want to make more charitable contributions. The Tax Cuts and Jobs Act passage resulted in fewer taxpayers choosing to itemize. That, in turn, means that philanthropic donations may not be as tax-advantageous as they once were. Thankfully, though, TCJA has some new provisions to incentivize giving.
For instance, if you are 70½ or older, you can directly transfer and exclude from income up to $100,000 per year from your traditional IRA in a qualified charitable distribution. Depending on where you live, you will still have to deal with a federal and maybe a state estate tax. However, the federal exemption has significantly increased. These changes, which started in 2022, may not last long. The Federal exemption is scheduled to revert to what it was in 2018, beginning in 2026. If you want to benefit from this break, you’ll need to meet with your tax advisor soon to determine if this strategy will allow you to reduce your taxable income and taxable estate through increased gifting.
Other possible approaches to offsetting higher taxes include:
- Accelerating income before the Act expires at the end of 2025. You can do this in several ways, including exercising stock options or electing out of installment sales.
- Deferring some losses and deductions until tax rates go up.
- Taking bigger required minimum distributions than necessary. This tactic could help you fill up more favorable tax brackets.
- Using life insurance and annuities to help mitigate taxes. Life insurance and annuities can be structured to help offset tax increases. To use this strategy successfully, you’ll want to partner with an income and retirement specialist who thoroughly understands these products and how they might impact your wealth.
Bottom line: The Tax Cuts and Jobs Act may give some people more opportunities to save and grow wealth. However, this Act will expire at the end of 2025. You will want to start planning for higher taxes once it is expired. Changes to tax law can affect you in multiple, complex ways. That’s why you need to discuss your unique situation with a trusted expert as soon as possible.
Ken’s Thoughts: In Summary, The Tax Cuts and Jobs Act (TCJA) is the first major overhaul of the US tax code in over 30 years and will significantly impact all American taxpayers through 2025. Some provisions will expire after 2025, and taxes are expected to increase in the future, so taxpayers should prepare for higher taxes by meeting with financial advisors or tax experts to design a tax mitigation strategy. Strategies include considering a Roth IRA conversion, paying off or paying down mortgages, itemizing deductions, revisiting medical expenses, and making more charitable contributions. Other approaches to offsetting higher taxes include accelerating income, deferring losses and deductions, taking bigger required minimum distributions, and using life insurance and annuities. It is essential to plan for higher taxes as changes to tax laws can affect individuals in complex ways.