11/20/2023
Sunsetting TCJA Laws & What They Mean for Your Personal Finances
Pre-planning for your finances and taxes at the end of the year has many advantages. It allows you to make adjustments and gives you the time to think through purchases and changes to tax-related accounts, which can impact your year-end tax bill. There are many tax provisions put in place by the Trump administration’s Tax Cuts and Jobs Act (TCJA) which is scheduled to sunset at the end of 2025.
It’s tough for us to encourage clients to make decisions today based on what could happen in 2026. However, we are in a historically low tax rate environment, so there is a high likelihood that taxes will be lower than we could expect in 2026. There is reason to believe that 2026 rates could be more like 2017 tax rates.
Comparative Tax Rates for “Married Filing Jointly”
2024 versus 2017
2023 |
2017 |
||
|---|---|---|---|
|
10% |
$0 – $22,000 |
10% |
$0 – 18,650 |
|
12% |
$22,001 – $89,450 |
15% |
$18,651 – $75,900 |
|
22% |
$89,451 – $190,750 |
25% |
$75,901 – $153,100 |
|
24% |
$190,751 – $364,200 |
28% |
$153,101 – $233,350 |
|
32% |
$364,201 – $462,500 |
33% |
$233,351 – $416,700 |
|
35% |
$462,501 – $693,750 |
35% |
$416,701 – $470,700 |
|
37% |
$693,751+ |
39.6% |
$470,700+ |
Based on these observations, what should you do? Here are a few things to consider:
Roth conversion:
Roth IRAs are funded with after-tax dollars (at today’s tax rate), and qualified withdrawals are tax-free. They are also unique in that they do not require RMDs (required minimum distributions) which are required on other qualified plans; this means you can preserve more of your retirement capital for your later years. In contrast, a traditional IRA allows savers to contribute on a pre-tax basis and pay income tax when they withdraw the funds.
Roth IRAs are funded with after-tax dollars (at today’s tax rate), and qualified withdrawals are tax-free. They are also unique in that they do not require RMDs (required minimum distributions) which are required on other qualified plans; this means you can preserve more of your retirement capital for your later years. In contrast, a traditional IRA allows savers to contribute on a pre-tax basis and pay income tax when they withdraw the funds.
A Roth conversion at today’s tax rates eliminates the possibility of facing higher taxes in retirement than you are paying now. If you believe your tax bracket will be higher in retirement, and you have the funds to pay for taxes of a Roth conversion outside the IRA, this could be a favorable strategy.
The cost of conversion and why timing is important:
The downside of doing a Roth conversion is that the amount you convert is taxable in the year of the conversion (including investment income earned). However, given the fact that the TCJA created a low tax environment, now may be a good time to consider a conversion. Let’s assume a married couple wants to convert a $200,000 traditional IRA account – consisting of all pre-tax money – into a Roth. We’ll also assume they had $100,000 in additional income. The previously untaxed money that is reclassified as a Roth gets added to their adjusted gross income for tax purposes. In 2023, their tax bill would be $52,152 (a marginal tax rate of 24% / effective rate of 17.38%), whereas at 2017 rates, the tax bill would have been $74,217 (marginal tax rate of 33% / effective rate of 24.74%).
The downside of doing a Roth conversion is that the amount you convert is taxable in the year of the conversion (including investment income earned). However, given the fact that the TCJA created a low tax environment, now may be a good time to consider a conversion. Let’s assume a married couple wants to convert a $200,000 traditional IRA account – consisting of all pre-tax money – into a Roth. We’ll also assume they had $100,000 in additional income. The previously untaxed money that is reclassified as a Roth gets added to their adjusted gross income for tax purposes. In 2023, their tax bill would be $52,152 (a marginal tax rate of 24% / effective rate of 17.38%), whereas at 2017 rates, the tax bill would have been $74,217 (marginal tax rate of 33% / effective rate of 24.74%).
For more on understanding marginal tax rates and tax brackets, see this insights article. Keep in mind that these tax cuts are expected to be in effect until 2025, and Congress may extend them, but one sure thing is that today’s tax rates are low. Assuming you continue to contribute money and it keeps growing, your account value will increase. Thus, paying the income tax bill for the Roth conversion will cost more.
Other reasons to consider a Roth conversion:
- Is the market value of your IRA significantly lower than it was previously? The higher the investment returns experienced in your portfolio after a Roth conversion, the greater the tax-free benefit will be.
- Do you have little diversification in account types? If most of your assets are in a tax-deferred account, by converting to a Roth IRA, you’ll have assets that won’t be taxed when withdrawn, potentially allowing you to do tax planning during retirement.
Maximize Deductions and Charitable Contributions:
The TCJA doubled the standard deduction to $24,000 for married individuals filing jointly, $18,000 for head-of-household filers, and $12,000 for all other taxpayers. Again, unless legislation is passed standard deductions will revert to 2017 rates in 2026. In many cases, because of increases in the standard deduction amount, taxpayers who historically itemized deductions (including charitable contributions) may find that they are better off taking a standard deduction. But, those charitably inclined may want to consider strategies utilizing both itemized and standard deductions.
If you find yourself in a situation where the total of your itemized deductions for 2023 will be slightly below the level of the standard deduction, it could be beneficial to combine or “bunch” 2023 and 2024 charitable contributions into one tax year (2023). Itemize deductions in 2023 and take the standard deduction on 2024 taxes. This strategy could produce a larger two-year deduction than two separate years. Also, donors can also use charitable deductions to help offset tax liabilities (such as a Roth conversion).
Estate Planning:
The TCJA essentially doubled the gift and estate tax exclusion for individuals. Prior to the TCJA, an individual was allowed a united gift and estate tax exclusion amount equal to $5 million (as adjusted annually for inflation). Under the TCJA, an individual is now allowed a unified gift and estate tax exclusion amount equal to $10 million (adjusted for inflation). In 2023 this amount is $12.92 million. For those individuals able to make gifts of the entire “bonus” exclusion prior to the sunset at the end of 2025, there is an opportunity for significant tax savings.
The TCJA essentially doubled the gift and estate tax exclusion for individuals. Prior to the TCJA, an individual was allowed a united gift and estate tax exclusion amount equal to $5 million (as adjusted annually for inflation). Under the TCJA, an individual is now allowed a unified gift and estate tax exclusion amount equal to $10 million (adjusted for inflation). In 2023 this amount is $12.92 million. For those individuals able to make gifts of the entire “bonus” exclusion prior to the sunset at the end of 2025, there is an opportunity for significant tax savings.
Qualified Business Income Deduction (QBI):
This allows pass-through businesses to deduct up to 20% of their income and will also expire.
This allows pass-through businesses to deduct up to 20% of their income and will also expire.
How we can help
These are just a few planning of many planning options to consider. We encourage you to take advantage of these options early so that you don’t get caught with a surprise at the end of the year or when many of these changes are set to expire. Our team is ready to answer your questions and provide assistance to meet your specific needs.
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