On this episode of The Long View, Tim Steffen, director of advanced planning for Baird, discusses Secure 2.0 Act changes, tax management strategies, retirement planning, and more.
Would a Repeal of the TCJA Cause Taxes to Rise?
Jeff Ptak: We could see some more big changes to the tax code at the end of 2025 when the provisions of the Tax Cuts and Jobs Act, which is the TCJA for short, are scheduled to end or in legislative parlance to sunset. First, let’s talk about some of the key provisions of TCJA. Is it safe to say that it generally lowered taxes for most taxpayers and a repeal would cause taxes to rise?
Tim Steffen: Yeah, I think if we go back to 2017 when this was passed and we look at what happened in 2018 and compare the two years, most individuals probably saw some form of tax cut. So, the Tax Cuts and Jobs Act had a unique combination of things. It famously eliminated a lot of deductions. So, it put more caps on our ability to deduct our state income and property taxes and our mortgage interest and some other things. And it got rid of things like miscellaneous deductions and personal exemptions for your kids. But it also then lowered the marginal tax rate. So, while for many people their taxable income went up as a result of the Tax Cuts and Jobs Act, the actual tax they paid went down. So, more income subject to tax but tax at lower rates. So, it generally meant a cut for most people.
Certainly not universal. People at very high-income levels, those who lived in very high-tax states like the ones on each coast or elsewhere around the country, they tended to be more likely to say a tax increase in this because of the loss of some of the state tax deductions. But generally, people around the country saw tax cuts as a result of this. So, if we look ahead now to where many of these provisions are set to sunset, we would see a reversing of that. And many of those who saw cuts back in 2018 could be looking at increases in 2026 assuming their situations are the same. Between 2018 and 2026 is a long time. If you retire during that window or your nature of your income shifted or the amount of your income shifted, it’d be hard to compare. But all things being equal, the people who saw cuts back in 2018 will probably see increases in 2026.
Will Congress Let the TCJA Expire?
Christine Benz: So, do you have a take on how likely it is that Congress will allow these provisions to sunset? And when would Congress need to take action in order to maintain the status quo that’s part of TCJA?
Steffen: So, as we said, there are a lot of provisions within that are set to expire at the end of 2025. And if nothing happens in Washington—there’s literally no legislation that’s passed that addresses this—all of those sunsets will come to pass. Now, I don’t think anybody fully expects the sunset to happen exactly as it’s scheduled. There’s like to be some legislation that happens that will maybe extend some of the existing provisions, let others go away and probably change some other things. So, we’ll see a whole new big tax bill that will come.
In terms of the timing on that, presumably what happens sometimes toward the latter half of 2025, December seems to be a popular time for Congress to finally pass things that will apply for the next calendar year. It’s possible it could even drag into 2026 and then be made retroactive to the beginning of the year. What we’re all fairly confident on is that nothing is going to happen in 2024, with it being an election year, I think everybody just wants to ride out the election, see who is in charge in Washington come January of 2025. And from there, we’ll have a better sense of exactly what might happen with this. The one thing we can all agree on is that no one wants to be the party in charge when a large tax increase happens. So, presumably, regardless of how the election works out, there will be some sort of compromise on these sunsetting provisions and not everything will happen exactly as it’s planned.
Costs and Benefits to Investors From the Sunsetting TCJA
Ptak: Which taxpayers stand to be the most adversely affected by the sunsetting of TCJA? And conversely, who, if anyone would benefit from its sunsetting?
Steffen: Well, again, we think we go back to 2018 and we look at all the people who benefit or were harmed, so to speak, from the changes done and we just reverse that. So, most individuals, as I said, received a tax cut in 2018. So, most of your average taxpayers are going to continue to receive an increase then. I think in particular it will be those who aren’t tending to be itemizers. So, if you’ve been benefiting from the very large standard deduction we’ve had for the last several years, and if the sunset happens and that number falls by roughly half again, and you don’t have other deductions to move you into an itemizer, you’ll feel more of an increase there because you’re going to basically be losing some of your deductions.
On the flip side, those who most benefit from large state tax deductions and property tax deductions, maybe those who paid a lot in advisor fees, tax-rep fees that have not been deductible but would be again in 2026, those individuals might be more likely to see a tax cut as a result of this. And we haven’t talked about the estate tax things, but there’s some fairly significant estate provisions that would roll off after 2025 that could mean some pretty significant liabilities for those who don’t do planning ahead of time. So, I think those are the ones, the ultra-high-net-worth, very high-income people are the ones who are going to be most affected by what might happen with the Tax Cuts and Jobs Act.
Estate Tax and the TCJA
Benz: Let’s stick with the estate tax, Tim, which you just referenced. That is a big piece of this and to the extent that I’ve read about sunsetting strategies that’s been one of the key things that gets emphasized is this change in the estate tax. So, can you discuss what potentially would go on there and who that would affect?
Steffen: So, the main estate tax provision in the Tax Cuts and Jobs Act was to take the lifetime exemption amount—this is the amount that you can pass to anyone other than a spouse or charity at your death—completely estate-tax-free. That number was effectively doubled as a result of the Tax Cuts and Jobs Act, and in the ensuing years with an inflation adjustments that we’ve had, we’re now looking at an exemption in 2024 of over $13.6 million per person. For a married couple, you’re looking at a combined amount of over $27 million. Give it another couple years of inflation adjustments as we head into 2026 and that number could easily approach $30 million for a couple or $15 million per person. If the sunsetting happens as is expected, that number falls in half. So, you’ve got this situation where you’ve got a lot of people who today are not subject to the estate tax but in a couple of years could be severely impacted by it. For example, let’s assume a high-net-worth couple with a net worth of say $30 million. Their net worth is large enough. They are always going to be on the estate-tax cusp. It’s unlikely the exemptions are ever going to get large enough for people with more than $30 million to completely escape the estate tax. Those are the folks that absolutely should be taking advantage of this exemption now before it potentially goes away and looking at some of the planning strategies that are out there.
The flip side is the couples with maybe $15 million, which admittedly is a very high percentage of the population. It’s the vast majority of the people in the country with net worths below $15 million, they’re not likely to be impacted by an estate tax even if we do get a change in the exemption amount. Their net worth is not going to be high enough where they’re really going to be a target of the estate tax. The ones that are the most to be concerned about right now are the ones in the middle—so a married couple with a net worth between say $15 and $30 million. Right now, that couple wouldn’t pay any estate tax effectively. In a couple of years, they might be subject to the tax of 40% on any assets over $15 million. So, you take that married couple who’s got say $20 million, they could be looking at a $2 million tax bill come 2026 that they don’t have today. So, there’s a pretty meaningful impact there. So, you’ve got a group of people that really aren’t too concerned about it. You’ve got another group that should always be concerned about the estate tax. And then, this group in the middle that really is not sure what to do right now but needs to be thinking about it.
SALT Tax Cap
Benz: Tim, you mentioned the SALT tax cap and that is one provision of TCJA that I think a lot of people would be happy to see go away. The question is if we don’t have that SALT tax cap would the sunsetting of all the TCJA provisions negate or undo the benefits that people would get from being able to fully deduct their property tax and their state and local tax?
Steffen: Yeah, it’s important to think of it that way because you can’t look at any tax legislation in a vacuum and just say look at this one component of this bill and how this is going to impact me because each one of those provisions is part of a larger bill. And while some may work against you, others may work for you, and you have to look at it in totality. Just like we said in 2017 with the original Tax Cuts and Jobs Act, some things may be negative, other things may be positive. The net impact for most people is positive. The same applies here with the SALT deduction. So, that’s a $10,000 limit on your state income and property taxes that you can deduct today. In 2026, that cap would theoretically go away if sunset happened, so meaning you can now deduct an unlimited amount of those income and property taxes.
But one of the other things that would likely come back if the TCJA does sunset is something called the Alternative Minimum Tax, or AMT, everybody’s favorite three-letter word. One of the provisions in AMT is that your state taxes and your property taxes are not deductible. So, yes, you may be able to deduct a larger amount of them under the regular tax system. But with AMT potentially becoming a more prevalent issue in 2026, that deduction might just go away for you there anyway, and you might find yourself back in the same situation you are now where your state taxes don’t provide you much of a federal tax benefit. So, it’s important to look at how all of these things work together. I know a lot of people in those high-tax states are anxious for that cap to go away, but that doesn’t necessarily mean they’re going to get an increased tax benefit for those taxes.
How Investors Can Preemptively Tax-Plan
Ptak: We’d like to discuss some of the strategies that should be under consideration for people in expectation of the end of TCJA at the end of 2025. But before we do, can you discuss how much people should try to be preemptive with tax planning when the laws haven’t changed yet?
Steffen: Yeah, I think we have to break at least the provisions of the TCJA into two broad categories. We talked about the estate provisions a bit. Those are ones that I think if you find yourself in that north of $30 million net worth, somebody who is always going to have an estate tax liability, you really ought to be trying to take advantage of this exemption before it potentially goes away. And again, those in that $15 million to $30 million window, they’ve got more planning and considerations to do. Maybe you do some planning for one spouse, but not the other.
When it comes to the income tax things, as we sit here in late 2023, it’s going to be a little bit trickier to plan for income tax changes in 2026 right now. I think we start thinking about some of those things, maybe look at maybe the timing of our deductions, making sure we’ve got more deductions in 2026 when they may provide more value to us than in 2024 or 2025, that bunching strategy we’ve talked about. Maybe if you’ve got income that may be coming due or that you have to recognize in 2026, you maybe look to find ways to bring that into 2024 or 2025. But in all honesty, most people don’t have a lot of control over their income and the timing of it. So, the business owners, maybe some retirees, that’d be about it.
So, the estate stuff, I think you absolutely have to be focused on for those who are going to be impacted by that. The income tax things, we’re probably a little bit premature. And then we always caution people don’t try to front-run the news on these things. Just because these things are scheduled to expire, doesn’t mean they will or that they will in the way that we expect them to. So, understand what’s being talked about, be prepared to react if they do happen, but don’t jump the gun too soon or you can find yourself having a little bit of buyer’s remorse on how you’re handling some of those strategies.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.