By Jeremy Kritt
The Tax Cuts and Jobs Act (“TCJA”), which went into effect with the 2018 tax year, enacted a variety of changes to the Internal Revenue Code that are set to expire, or sunset, beginning with the 2026 tax year. While Congress still has time to extend or make some or all of the sunsetting provisions permanent -- and taxpayers should always consult with their personal tax advisors regarding their personal tax situation – it’s important for taxpayers to familiarize themselves with the changes that are coming and the potential tax-saving opportunities they present.
Tax Rates
As the name implies, the Tax Cuts and Jobs Act lowered tax rates for most individual income tax brackets. Taxpayers – especially high-income taxpayers who have the ability to accelerate ordinary income into 2024 or 2025 -- should consider doing so while the reduced tax rates are still in effect.
Traditional to Roth IRA Conversion
But the truth is that most taxpayers have limited opportunities to control the timing of when they receive ordinary income. One such opportunity that’s widely available -- and now may make sense for more taxpayers than ever -- is the conversion of a traditional IRA into a Roth IRA.
When a taxpayer converts a traditional IRA into a Roth IRA, the value of the assents in her account is included in her gross income, but, importantly, future withdrawals are tax-free. Compare this to a traditional IRA where withdrawals are both required by law and subject to tax. So, converting a traditional IRA into a Roth IRA allows a taxpayer to choose to pay tax now, rather than in the future when income tax rates are scheduled to increase.
In fact, any taxpayer who anticipates that she will be subject to higher tax rates in retirement than she is now should consider whether a conversion might be appropriate for her. This is particularly true for younger taxpayers who will likely have higher incomes in the future. They are likely to see their retirement accounts appreciate between now and their retirement, so converting their traditional IRAs into a Roth IRAs now could allow them to pay taxes both at a lower tax rate and on a smaller amount that has not had as much time to appreciate.
Conversely, taxpayers with a traditional IRA who are over the age of 59 ½, and thus can make penalty-free withdrawals, may not necessarily benefit from converting into a Roth IRA, but should still consider whether taking larger withdrawals now, before the tax rates increase in 2026.
Standard & Itemized Deduction
When the TCJA expires, the standard deduction will be cut approximately in half. The likely result is that many more taxpayers will find it beneficial to begin to itemize deductions starting in 2026.
As is the case with accelerating income, most taxpayers have limited opportunities to control when they can claim a given tax deduction. But such opportunities do, in fact, exist. For example, medical and dental expenses are generally deductible as itemized deductions, so some taxpayers who are not currently itemizing deductions but are likely to do so in 2026, may want to consider delaying certain medical expenses, such as laser eye surgery, or certain fertility-related treatments and procedures.
Similarly, gifts to charity are generally deductible as itemized deductions. So taxpayers who make annual cash contributions to charity and anticipate that they will start itemizing deductions in 2026 may want to consider accumulating their planned cash contributions until 2026, when they can increase the taxpayer’s itemized deductions. On the other hand, taxpayers who are already itemizing deductions may want to accelerate future cash contributions to charities into 2024 and 2025 tax years, because when the TCJA expires, taxpayers’ deductions for cash gifts to charities will be limited to 50% of their adjusted gross incomes -- not 60%, as is currently the case.
Taxpayers who are considering taking out a home equity loan for non-emergency reasons may also benefit from holding off until 2026. When the TCJA expires, its elimination of the itemized deduction for interest on home equity loans will also expire. Beginning in 2026, taxpayers will again be able to deduct the interest on a certain amount of home equity indebtedness – debt that’s secured by a qualified residence, but was not incurred to acquire, construct or substantially improve that qualified residence.
Estate & Gift Tax Lifetime Exemption Amount
Of all of the sunsetting provisions of the TCJA, the expiration of the increased estate and gift tax lifetime exemption amount likely presents the most urgent tax-planning -- and tax-saving -- opportunities for affected taxpayers.
The estate and gift tax is a transfer tax that is generally applied against the amount that the combined value of a taxpayer’s taxable gifts during life and taxable estate at death exceeds the estate and gift tax lifetime exemption amount. The estate and gift tax exemption amount is thus essentially the maximum amount that a taxpayer can transfer tax-free during lifetime and at death without incurring estate or gift tax liability.
In 2024, the lifetime exemption amount was $13.61 million per person, or $27.22 million per married couple, but after December 31, 2025, that amount is set to be cut approximately in half.
To illustrate the significance of this: If a single taxpayer were to make a taxable gift of $10 million now, her lifetime exemption amount would be reduced by $10 million, meaning that the value of any other taxable gifts that she makes during her lifetime, plus the value of her estate at death, would need to be more than $3.61 million for her estate to be subject to gift and estate tax. After December 31, 2025, when the lifetime exemption amount is reduced -- let’s assume to $7 million per person for simplicity -- that $10 million gift would exceed the $7 million lifetime exemption amount, and the estate and gift tax would be applied against the $3 million excess, plus the value of any other taxable gifts that she makes during her lifetimeand the value of her estate at death. In this example, the taxpayer making the taxable gift before December 31, 2025, thus allows her to transfer an additional $3 million of assets free of tax.
Taking advantage of the currently higher lifetime exemption amount now is most critical for taxpayers who are in the position to make a gift of an amount that is less than the current lifetime exemption amount, but larger than the lifetime exemption amount that will take effect in 2026. Taxpayers who fit that description can make gifts to beneficiaries directly, but should also consider utilizing more nuanced estate planning strategies, such as irrevocable trusts, to make gifts to beneficiaries indirectly.
In either case, making a gift now has the added benefit of avoiding estate and gift taxes on any appreciation that accumulates between the date of the gift and the date of the taxpayer’s death, as the taxpayer’s lifetime exemption amount will be reduced by the value of the gift on the date that it is made, and any subsequent appreciation of those assets will altogether escape estate and gift taxes.
Finally, taxpayers whose net worth is around half the current lifetime exemption amount should considerstrategies for reducing the value of their estates without reducing their lifetime exemption amount, tax-free gifts among them. In 2024, taxpayers can make gifts of up to $18,000 per beneficiary ($36,000 for married couples) -- and directly pay certain medical and education expenses -- without reducing their lifetime exemption amount.
To discuss these tax-saving opportunities and others, please feel free to reach out to Marc Lane in confidence at 312/372-1040 or mlane@marcjlane.com.