Changes to U.S. tax laws on the horizon

Executive summary:

  • The Tax Cuts and Jobs Act of 2017 is set to expire at the end of 2025, meaning significant changes to tax laws are on the horizon
  • Taxpayers will be affected very differently depending on their individual circumstances
  • We believe advisors should be proactively reviewing each client’s tax situation to determine key actions that could help mitigate any impact from the upcoming changes in tax laws.

The Tax Cuts and Jobs Act of 2017 (TCJA) is expected to sunset at the end of next year and there is likely to be a lot of chatter about what the potential changes in tax laws could mean for U.S. taxpayers. So much so, we are going to be writing quite a few blogs about this subject! But first, let’s answer some of the many questions we have been receiving regarding this tax law and its upcoming expiration.

What was the goal of The Tax Cuts and Jobs Act of 2017?

The TCJA of 2017 had two primary goals:

  1. to lower taxes for a wide swath of taxpayers, and
  2. to simplify the annual return filing process.

Broadly speaking, these were accomplished. However, the impact of the changes affected individual taxpayers quite differently.

The TCJA did reduce the tax rates on most tax brackets as well as widen the income levels in many tax brackets. For example, the tax rates on the two middle tax brackets fell from 25% and 28% to 22% and 24%, with the combined brackets widening from $77,400-$237,950 to $77,400-$315,000. This benefitted a large group of Americans.

On the second item, the oft-mentioned goal of getting the often reviled and rarely loved Form 1040 down to the size of a postcard did not happen. What did happen was that many smaller and not broadly used deductions were eliminated or made more limited, and the “standard deduction” was raised.

This resulted in fewer itemized deductions being available, and fewer taxpayers with itemized deductions that exceed the standard deduction threshold. This arguably made the tax filing process more streamlined for a wider swath of taxpayers and made for a higher quantity of simple form submissions.

Why is the TCJA sunsetting/expiring?

This bill was passed as part of a budget reconciliation process; it was not intended to be a permanent change in tax law but rather a temporary change with a sunset/expiration to the changes. If you are wondering why it was done this way, I will not go into the mechanics of how government works as that would take a whole lot of time and effort. But in general, if there is a chance that a bill might meet lethal opposition in the Senate, it can instead go through a budget reconciliation process. The result is a somewhat easier pathway for a controversial bill to be put into effect. However, this also means there is a finite life to the tax laws that get passed this way. In most cases the changes have a maximum 10-year lifespan. That is the case with the TCJA of 2017.

What is the expiration date?

The common belief is that the TCJA sunsets/expires on the last day of 2025, and that is largely true for a significant number of provisions. The reality, however, is that different provisions throughout the bill expire at different times. Ones that have already expired had a much narrower audience that was more corporate/business in nature. The provisions related to individual and small-business taxation that would impact a larger majority of taxpayers and investors are set to expire on December 31, 2025.

To give you an idea of the granularity of some of the provisions in the TCJA: one that is set to expire on December 31, 2027 is related to expensing the cost of replacing citrus plants lost to casualty.

Is the expiration happening all at once, or in stages?

As noted above, not all provisions will expire at once. One can say that there are stages to the expirations in this bill.

But, if the question is more about whether specific provisions expire gradually or in stages, the answer is no. For example, current tax rates will expire at the end of 2025 and all tax rates and income brackets will revert to the levels they stood at (adjusted for inflation) before the TCJA became law.

Are taxes going to go up?

Short answer: Yes.

Longer answer: It's going to depend on each of your clients’ personal situation. Obviously, if their income has declined for any reason and they are in a lower tax bracket, then it’s possible their tax bill will decline. But if their income has increased or if their portfolio value has increased, then it’s likely and probable that their taxes will increase if the TJCA sunsets without an extension.

What are the important tax law changes I need to be aware of?

This is the big question a lot of taxpayers and investors are asking. The answer will depend on each individual situation and how that person was impacted by the TCJA in the first place.

Please refer to this table to see a few key provisions and their impact.

Click image to enlarge

How is this going to affect investment-related taxes?

If your clients have taxable investment accounts, and receive taxable interest, non-qualified dividends, and short-term capital gains, the changes in the income tax tables will likely have an impact on them in that they could be paying even more in taxes.

The capital gains tax rates will not change; if this is where they experience most of their distributions/tax impact from their investments, then the impact will be minimal. Of course, that doesn’t mean you can’t look at ways to reduce the capital gains taxes your clients pay.

If they receive distributions from Qualified Accounts (IRAs, 401Ks, 403Bs, and so on), these distributions are taxed as ordinary income. They will be subject to the adjusted tax table (higher tax rates at lower income levels); therefore, their tax bill will likely increase. Other effects on Qualified Accounts occurred via the implementation of the Secure and Secure 2.0 Actsa (this is a different subject altogether).

Click image to enlarge

*3.8% represents Net Investment Income Tax

Is there anything I can do now to prepare?

Tax rates are still historically low. Considering the level of Federal Debt and budget deficits, it’s most likely that taxes will increase in some manner in the future.

This is a great time to be thinking about how your clients are affected by investment-related taxes and consider how to better integrate Tax Management into their portfolios and investments. Regardless of any future tax law changes, the one thing we can say with near certainty is that taxes aren’t going away. And it’s not likely that they will decrease much, if at all. Being prepared for that and taking advantage of relatively low tax rates now is a strategy that could pay dividends (pun intended) for your after-tax wealth tomorrow.

Is this bill going to get extended/renewed?

This is one of the ‘million-dollar questions.” It’s still quite early in the process; and at the end of the day, it’s all politics. I will caution that right now what you may be hearing is largely campaign rhetoric geared towards driving enthusiasm with specific voter bases. Too much should not be read into these things. The process will begin in the House of Representatives – because that’s where almost all law and budget changes begin. Every seat of the House of Representatives is up for election this year. As such, until a new Congress is in place, discussions on if and what a replacement for the TCJA will look like would be difficult to solidify.

One angle of approach that is possible (please note that possible and likely are not synonyms!) is to look at relatively recent history. When the Bush Era Tax Cuts were expiring, the government at that time took an “extend and punt” approach. This was partly related to the economic crisis we were in and the lack of desire to increase taxes and uncertainty at a time when uncertainty was already a major worry. The other aspect was the government’s focus on managing the financial crisis. A bill was eventually passed that made some of the tax law changes permanent. While today’s situation in the U.S. politically and economically is quite different than back then, my point here is that there is some precedent for tax laws being extended.

Stay tuned on this front and look for future Russell Investments blogs on this topic as we learn more!

Next Steps – Stay Informed

As you contemplate what to do regarding taxes and tax law changes, consider productive proactive action as opposed to rash abrupt changes that could cause more tax pain or investment harm than necessary.

What I mean by this is understand how your clients are invested, what distributions or capital gain realizations they have been experiencing, and how that impacts them from a tax standpoint. Once you establish a strong base of your clients’ personal investment-tax experiences, then you can start to consider how to plan, prepare, and take action.

Russell Investments is your partner and can be an invaluable resource when it comes to Tax Managed investing. Almost 40 years of experience in managing Tax Exempt and Tax Managed assets has created a significant knowledge base of how to accomplish investment goals with after-tax returns in mind. Reach out to us to let us guide you as you help your clients prepare for the potential changes on the horizon.