In 2017, the Trump administration spearheaded a comprehensive series of tax cuts. Called the Tax Cuts and Jobs Act (TCJA), the law reduced corporate taxes by about 40% and household taxes by varying degrees for most individuals. While the corporate tax cut is permanent, most of the individual tax reductions will end in 2025 or 2026. High earners will see the most change from these expirations.
A financial advisor can help you navigate tax savings.
Why Are TCJA Provisions Sunsetting?
The Congressional Budget Office (CBO) has estimated the law’s cost at about $3.5 trillion over 15 years. To defer some of this high price tag, Congress made several of the law’s provisions temporary. Known as “sunset clauses,” these are sections of the law that will expire on their own unless specifically extended. Many, if not most, tax policy experts are critical of extending the law because of its high costs and failure to generate significant economic growth.
One economist writing at the Wharton School of Business noted, if Congress extends the TCJA permanently, it would cut revenue enough that “to avoid missing payments on its debt or other spending, the government would have to raise tax revenue, cut spending or some combination of both, by an amount equivalent in present value to 9.4 percent of all future GDP.”
Given this environment, it’s likely that Congress will allow many of the TCJA’s provisions to expire. As the main beneficiaries of the law, high earners will feel that the most. Depending on which elements of the law Congress chooses to retain, here are some of the tax changes wealthy earners might expect.
State and Local Tax (SALT) Deductions
Nathaniel Donohue, a partner and CFP® with Consilio Wealth Advisors, told SmartAsset, “Currently, because of TCJA, taxpayers that itemize their return can only deduct up to $10,000 of state and local taxes on their federal income taxes. Assuming TCJA expires, high-income clients in high-tax states will be happy to have that cap removed.”
Before the TCJA, any household that itemized their taxes could deduct any money that they paid in state taxes or local (municipal) taxes. So, for example, if you paid $25,000 in state income taxes to California, you could deduct that $25,000 on your federal income taxes. The Tax Cuts and Jobs Act capped that deduction.
Given the relatively low rate of state taxes, this change almost exclusively affects very high earners. Few lower-income households itemize their taxes and, even in higher-tax states like California or Massachusetts, it takes substantial income to even reach the current SALT deduction’s cap. But for those households, the SALT cap expiring would be a big win.
A financial advisor can help you capitalize on tax deductions.
Tax Brackets and Standard Deductions
The TCJA reduced income thresholds for tax brackets while doubling the size of the standard deduction. For high earners, reverting to pre-2018 tax levels would have a modest effect. As the Tax Policy Center notes, the post-2018 brackets boost after-tax income by about 2.9% for households in the top quintile and “even more for the top few percent of households.” By contrast, the bottom 20% of earners saw their after-tax income increase by about 0.4%.
For high earners who can structure their income, this means that 2024 may be a good year to maximize your earnings. Unless the TCJA tax brackets are extended, it’s the last chance to pay lower rates.
The standard deduction will also revert to its pre-2018 levels if the TCJA provision is not extended. This is not likely to affect most high-income households, as they are likely to itemize their taxes rather than claim even the expanded standard deduction. However it will likely mean a functional tax increase on most households below the top 10% of earners.
Asset Depreciation
Standard depreciation allows a business or qualifying taxpayer to deduct the lost value of a certain equipment and high-value assets over time. For example, a private plane or a boat will lose value each year as it grows older and more worn out. A taxpayer can deduct that lost value. Under the TCJA, qualifying taxpayers can deduct a significant portion of the purchase price of their assets up front, giving them a large lump-sum tax deduction.
Christopher Manske, CFP®, President and founder of Manske Wealth Management, told SmartAsset about the bonus depreciation provisions that are being phased out between now and 2026, unless extended: “Many high net worth individuals benefit from on-paper depreciation of their assets. Those rules affect them greatly. If not extended, the TCJA rules for depreciation will revert back to 2017 laws which, in most cases, will mean less tax benefit and much more cost.”
Pass-Through Tax Deductions
The TCJA introduced a business deduction known as the “pass-through deduction.” This allows individuals to deduct up to 20% of their income from pass-through businesses like partnerships, sole proprietorships, some LLCs and other similarly situated operations.
Like many elements of the Tax Cuts and Jobs Act, this affects a broad cross-section of taxpayers. In particular, it gives a significant above the line deduction to qualifying self-employed workers and contractors. Given the law’s definitions of qualifying pass-through businesses, the benefits of this deduction have primarily flowed to wealthier individuals. Households earning above $1 million have claimed approximately half of this deduction’s total benefits, particularly because of its generous treatment of real estate investments.
For high earners with a personal stake in various businesses, particularly anyone who owns and capitalizes on property in some way, the expiration of pass through deductions may trigger a sizable tax increase.
Gift and Estate Taxes
The TCJA doubled the estate and gift tax thresholds to their current rates. The estate tax currently only applies to estates with at least $11.2 million for an individual or $22.4 million for a married couple. Gift taxes share this same lifetime cap, meaning that applicable gifts reduce a household’s estate tax exemption.
If this provision expires, the lifetime exemption for gifts and estates will return to approximately 50% of their present value. This would increase the amount of estates subject to this tax.
As the CBO notes, because of their high caps these taxes almost exclusively affect wealthy and high-income households. “Of the 2.7 million people who died in 2016,” they write, “only about 5,500 had estates that were taxable. That is about 0.2 percent of all estates in that year.”
A financial advisor can help you navigate estate planning.
Alternative Minimum Taxes
The alternative minimum tax (AMT) applies to certain households, typically high-earners. It is a more simplified tax that has fewer deductions and allowances. Households that qualify for the AMT must calculate both their income tax and their alternative minimum tax, and then pay the greater of the two. It is designed to ensure that wealthier households pay a minimum amount of tax on their income.
The AMT has an exemption threshold. Any income below the threshold is not subject to the alternative minimum tax, even if the taxpayer does qualify to pay it. Prior to 2018, the exemption phased out at an adjusted gross income of $123,100/$164,100 single/married. The TCJA raised those caps to $500,000/$1 million single/married. Income above the alternative minimum tax cap is potentially subject to this tax, while income below the exemption is not.
This provision is set to expire in 2025, which will significantly increase the number of households and the scope of income subject to a minimum tax rate.
Bottom Line
Many of the individual tax cuts and deductions created by the Tax Cuts and Jobs Act will begin to expire in 2025. The law structured those benefits to accrue mainly to wealthy households. Households and individuals should plan their budget and taxes to best accommodate these upcoming changes.
Tax Planning Tips
- As millennials have exited their 20s and entered their 30s (if not 40s), their taxes will begin looking different. If this means you, then it’s time to start considering these four tax planning moves.
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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