Death and taxes are certainties of life, but the amount of taxes you pay varies significantly with each piece of tax legislation passed. Some changes are the result of legislative wrangling; other changes can occur when legislation expires.   Just as the Economic Growth and Tax Relief Reconciliation Act of 2001 was designed to expire December 31, 2010, due to Senate procedural rules, there is a significant tax law that was passed in 2017 is set to expire December 31, 2025.

Whether or not the tax cuts in the 2017 Tax Cuts and Jobs Act (TCJA) will be made permanent is an ongoing debate. If history is any guide — and it probably is — a large part of the tax cuts will likely continue to be enshrined in the tax code, despite the outcome of the upcoming election. For instance, the 2001 tax cuts were extended for two years in 2010, and 82% of the cuts were made permanent in 2013.

However, we cannot assume that everything will stay the same.  Regardless of the political party in power, they will be forced to address the expiration of the TCJA.  To understand what this means and how changes may impact your tax bill, let’s look at some of the significant changes implemented in the 2018 tax year that are currently set to expire after 2025.  Please note that these provisions pertain to income taxes only. Estate tax law changes could be very significant and are beyond the scope of this article.

• Eliminated the personal and dependent deduction
• Doubled the standard deduction
• Effectively eliminated the individual alternative minimum tax (AMT) for most people
• Reduced the tax rates for most taxpayers
• Doubled and expanded the Child Tax Credit

• Eliminated the reduction in deductions based on income levels
• Eliminated the taxation of alimony for post-2018 divorces (nontaxable to recipient, and nondeductible by payer)
• New limit of $10,000 on the combined state income tax and property tax deduction (regardless of whether filing as single or married; importantly, this limit was not tied to inflation!)
• Eliminated the miscellaneous itemized deductions (investment management fees, tax prep, unreimbursed business expenses such as home office and mileage)
• Limited the deductibility of mortgage interest to $750,000 of debt for post-2017 mortgages
• Eliminated the deductibility of interest on any home equity loan not used to buy or remodel the home
• Eliminated the deduction for moving expenses

Tax rate changes and shifting tax brackets have the potential to impact most taxpayers. The current top marginal rate of 37% is set to increase to 39.6% in 2026, and people who are currently in the marginal 22% and 24% tax brackets may find themselves in the marginal 25% and 28% tax brackets after 2025. To add to the complexity, income levels per bracket are scheduled to be different pre- and post-TCJA. A married couple with $200,000 in taxable income could move from the 22% tax bracket on their marginal income all the way to the 28% marginal tax bracket.

To estimate the impact the expiration of the TCJA could have on your taxes, we can refer back to how the law impacted taxes when it was first implemented in 2018.  We will use some real-life examples of the difference between 2017 and 2018 taxes for three taxpayer scenarios.  In each case, the taxpayer’s total income remained roughly the same between the two years.

Taxpayer A:

• Married couple.
• Earned total income of $337,839 in 2017 and $309,220 in 2018.
• Since the 2017 tax law allowed for higher itemized deductions, their taxable income was $295,518 in 2017 and $285,220 in 2018 — a difference of only about $10K. The 2017 tax law permitted higher itemized deductions for this couple, many of which were no longer allowed in 2018.
• Despite the higher itemized deductions, this couple was subject to the alternative minimum tax in 2017. The AMT is a second way to calculate your taxes, and you must pay the higher of the regular and AMT tax amounts. This couple paid over $5,000 in AMT in 2017.
• Their total federal tax bill in 2017 was $77,543 as compared with $54,854 in 2018, on taxable income that was only about $10,000 less than in the prior year.
• This couple paid 23% of their total income in federal income taxes in 2017 and only 17.7% in 2018.

Taxpayer B:

• Married couple.
• Earned total income of $440,922 in 2017 and $461,529 in 2018.
• Their total federal tax bill in 2017 was $118,951 as compared with $106,091 in 2018, a reduction of $12,860. They were also subject to AMT in 2017.
• This couple paid 27% of their total income in federal income taxes in 2017 and 23% in 2018, despite higher income in 2018.

Taxpayer C:

• Married and retired.
• Total income was $95,686 in 2017 and $103,843 in 2018.
• Their total tax bill in 2017 was $7,257 as compared with $6,108 in 2018.
• This couple paid 7.6% of their total income in federal income taxes 2017 and 5.9% in 2018, once more despite higher income.

The following chart summarizes the above examples:

Please note that the chart shows each client’s effective tax rate, which is the total federal tax divided by total income.  The effective tax rate is not the same as the marginal tax rate, which is the rate you will pay on an additional $1 of income.  The marginal tax rate is also known as your “tax bracket,” and these are the rates you see in tax tables.

The taxes any given taxpayer will pay in the future will continue to be highly dependent on the character of income (wages vs self-employment income vs capital gains and qualified dividends) and on itemized deductions (charity, mortgage interest and medical expenses can still result in higher itemized deductions).

Whatever happens with upcoming tax legislation – whether Congress and the President allow the TCJA to expire and the tax law to revert back to 2017 law or some or all of current tax law is retained – we will continue to monitor and prepare our clients for the outcome.  There are steps you can take before 2026 to take advantage of historically low tax rates.  Our advisors have been reviewing client situations to find where it makes sense to make Roth conversions, moving taxable income into tax-free accounts each year in anticipation of higher tax rates in the future. We also look at timing of charitable contributions including those to donor-advised funds (DAFs), as well as ongoing gifting strategies. There may also be cases where harvesting tax gains could be advantageous in 2024 and 2025.  These are just a few of the strategies that we are considering for clients as we approach this time of tax uncertainty.

Just because you are retired does not mean you should not be concerned with tax bracket changes! Taxes in retirement can be just as important as when you are working.

If you want to know if there is action you can take to potentially reduce your lifetime taxes no matter what happens with tax legislation, please reach out to our team.