The Bedell Frazier Financial Planning Team is following all of the tax proposals from both Presidential campaigns as we head into the autumn 2024 elections. We are also monitoring both the Senate and House of Representative races to see which party will control the upper and lower chambers impacting future tax proposals. If one party sweeps the election, we could be looking at a very different tax policy than if we have a divided government. There are many variables right now that are going to impact future tax policy. The one thing we do know is that, without Congressional action, the Tax Cuts and Jobs Act of 2017 will expire at the end of 2025. We need to be clear about this, if Congress doesn’t take any action, many of the tax breaks within the Tax Cuts and Jobs Act of 2017 will Sunset on December 31st, 2025. That is less than 18 months to consider and execute any potential adjustments to your financial planning, tax planning, and estate plans.
Higher Rates Appear on the Horizon
There are seven individual income tax rates today 10%, 12%, 22%, 24%, 32%, 35% and 37%. If the Tax Cuts and Job act expires they will revert back to 10%, 15%, 25%, 28%, 33%, 35% and the highest marginal rate tops off at 39.6%. Depending on your tax bracket, you could be looking at a 1% to 4% increase in your tax rate. Even a slight uptick in tax rates can make a significant impact, for example, a married couple with $250,000 in combined income, which would put them in the 24% tax bracket in 2024, if however TCJA expires they would likely be pushed into the 28% tax bracket with a federal tax increase of over $7,200.
With the combination of the expiration of the TCJA. Plus our huge federal deficit it seems likely higher tax rates are on the way. You may want to consider accelerating some income the next 18 months before the anticipated higher tax rates arrive. Let’s look at some strategies to accelerate income.
Roth Conversion – To do a Roth Conversion, you take a distribution from your current IRA or 401(k) and roll it into a Roth account. You pay taxes on that distribution in the current tax year while creating a Roth tax-free bucket for the remainder of your life and, if left to your heir, another 10 years of tax-free growth. I think the main takeaway here is that you are going to pay ordinary income taxes on Traditional IRA and non-Roth 401(K) withdraws. You are going to pay the taxes on distributions from those accounts, or your heirs are going to pay the taxes on those accounts, it is inevitable. The big question is: do you wish to pay those taxes while rates are potentially lower today or pay taxes down the road when they could be higher?
The conversion is not limited to the $7,000 annual contribution limit and income limits don’t apply. You can convert as much as makes sense based on your other taxable income and time horizon. A great time to execute this strategy is when you are in that “income valley” of life; when you are no longer working full time but before you begin to draw on Social Security and taking the Required Minimum Distributions from your retirement accounts. We can model this for you if you are interested in learning more.
Roth 401(k) – You could consider pushing more of your 401(K) savings into the Roth 401(K) portion while income tax rates are potentially lower the next 18 months. Roth 401(k) accounts are after-tax dollars rather than pre-tax dollars you contribute to your traditional 401(k). This is probably the easiest way for most working people to contribute to a Roth account. When you make withdrawals in retirement, they come out of the Roth tax-free rather than as ordinary income with a traditional 401(k). The decision you are making is paying taxes on the initial Roth contribution today rather than in retirement when you pull from your traditional 401(K) and pay ordinary income rates. The Roth 401(k) offers the combination of tax-free growth and tax-free withdrawals. Thanks to SECURE Act 2.0 Roth 401(k) will no longer be subject to Required Minimum Distributions beginning this year bringing them in line with Roth IRAs.
Itemized Tax Deductions
The Tax Cuts and Jobs Act changed the limits and composition of itemized deductions, including nearly doubling the standard deduction. If you do not itemize your deductions, your taxable income is derived by taking your adjusted gross income (AGI) and subtracting the standard deduction. For 2024, the Standard deduction is $14,600 for a single taxpayer and $29,200 for married filing jointly. If the TCJA expires, the standard deduction will revert back to 2017 levels and then be adjusted for inflation based on the Consumer Price Index (CPI).
State and Local Income Tax (SALT) – The Tax Cuts and Jobs Act limited the deduction for State and Local Income Taxes to $10,000 per return. Many taxpayers pay significantly more than this, especially in California, given high real estate and personal property taxes. If the SALT cap expires and the standard deduction is halved, more taxpayers will shift back to itemizing their deductions in tax year 2026.
Charitable Deductions – With the potential of a lower standard deduction in 2026, taxpayers could consider waiting until the beginning of 2026 to make taxable charitable deductions to enjoy the tax benefit. Another strategy, if currently using the standard deduction, is to bunch all your charitable giving in one year to get over the standard deduction threshold.
The Sunsetting of the Tax Cuts and Jobs Act does not impact the use of Qualified Charitable Distributions (QCD) from an Individual Retirement Account (IRA) for those age 70.5 and over.
Mortgage Interest Deduction – The Tax Cuts and Jobs Act slashed the amount of mortgage interest that taxpayers could deduct. If the TCJA expires, the cap will rise from current $750,000 on mortgage debt to $1 Million regardless of when the debt was incurred. Taxpayers will also be able to deduct the first $100,000 of home equity debt regardless of the use of the funds.
Miscellaneous Itemized Deductions – Items that qualify as miscellaneous itemized deductions include unreimbursed employee expenses, investment management and trustee fees, as well as tax planning and preparation fees. If the TCJA expires, these fees will be deductible in 2026 to the extent they exceed 2% of your adjusted gross income (AGI).
Itemized Deduction Limitation – The itemized deduction limit is often referred to as the “Pease Limitation” after Ohio Congressman Donald Pease, who first introduced the legislation in 1991. With the Sunsetting of the TCJA, this limitation will once again kick in and curtail the amount of itemized deductions that high-income taxpayers may take. It doesn’t limit all itemized deductions, it only applies to mortgage interest, State and Local Taxes, charitable contributions, and certain miscellaneous itemized deductions. It reduces these itemized deductions by up to 3% of the amount of adjusted gross income (AGI) that exceeds inflation-indexed thresholds. The adjusted gross income limit the last time this law was in place for single taxpayers in 2017 was $261,500, while the married filing jointly limit was $313,800. These limits will be adjusted for inflation if the TCJA does expire.
Business Income
We have discussed the potential sunsetting of individual taxpayer tax cuts above, but the corporate tax rate was also lowered with the Tax Cut and Jobs Act of 2017 from 35% to 21%. The corporate tax reduction was a permanent reduction; it does not sunset at the end of 2025.
To level the playing field between the taxation of C corporation income and a comparable passthrough entity, the Tax Cuts and Jobs Act introduced the Qualified Business Income (QBI) that allowed a taxpayer to obtain a 20% deduction against QBI passthrough business income. Without Congressional action the QBI deduction will Sunset and 100% of QBI income will be taxable at the beginning of 2026.
Estate and Gift Tax Exclusions
The current estate tax exclusion for 2024 is $13.61 million per person. Married couples have over a combined $27 million that they can gift or leave to their estate without any taxes. That is going to drop if there is a sunsetting of the TCJA to around $5 Million per person adjust for inflation, probably settling in just under $7 Million per person.
We Can Assist You!
Contact the Bedell Frazier Financial Planning department today. We work as team with your legal and tax professionals to plan for the best possible outcomes no matter the tax law and estate law changes.
We could get a whole new tax bill in 2025 or we could have gridlock on Capitol Hill where nothing gets done and the Tax Cut and Job Act sunsets. We can take a look at tax saving strategies to consider implementing in 2024 and 2025 while awaiting to see what direction tax policy will take after the elections this fall. Having discussions now about potential financial planning and tax strategies will help us prepare for whatever comes out of Washington.
Thomas Howard
