The Tax Cuts and Jobs Act of 2017 – Preparing for the sunset

Executive summary:

  • The Tax Cuts and Jobs Act of 2017 is expected to "sunset" in 2025 which could usher in several tax changes
  • Among the provisions that could expire are the cuts in income tax rates and the child tax credit; there may also be changes to capital gains taxes
  • We believe the best way to mitigate the impact of these changes is to plan for them
  • Tax-smart investing strategies can help lower the potential impact of rising taxes

Anticipation is one of those mental states that can result in either relief, or disappointment. We may anticipate the results of a test, for example, and feel relieved if the results are good, or disappointed if they are not.

This definition of "anticipation" is a great way to think about the potential expiration of the Tax Cuts and Jobs Act of 2017 (TCJA). Are we going to experience relief, or disappointment? That is not going to be answered until a new law is signed (or not) to replace the TCJA.

In the meantime, we are likely to experience some anxiety as the process unfolds, as negotiations occur, as different proposals and tax law changes are put forward. Fear may kick in too, on worries about tax rates and other changes and how they may impact us as taxpayers and investors individually and collectively.

What's the best way to deal with these mixed emotions? Well, understanding the key sections of the tax law that may change will at least let you plan for them. And that could alleviate the fear and anxiety you may be feeling. Let's take a deep dive into seven key areas of the tax law that changed in 2017 and could change again in 2025 as the TCJA sunsets (or not) and see how we can prepare for what may happen.

The Tax Cuts and Jobs Act of 2017 (TCJA) – Expiration forthcoming

Tax Cuts and Jobs Act table

Source: Russell Investments

Income Tax Rates

Income tax rates 7 brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37% several tax bracket income levels expanded in 2017 7 brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6% income brackets revert to lower 2017 levels (adjusted for inflation)

This is the category that is most likely going to impact the broadest number of taxpayers. With the expiration of the TCJA, a vast majority of the tax rates on different tax brackets will move upward. Although the income levels assigned to the different brackets will move lower, they will not return to the level they were at before 2017 due to inflation adjustments.

These changes could have a meaningful impact on certain investments and planning for them is important. Items such as taxable interest, non-qualified dividends, and short-term gains are taxed at the ordinary income level. With a potential increase in these tax rates and lower income hurdles to trigger a higher tax rate, it may be necessary to look at how investors have structured their portfolios and the types of income received.

For example, many investors have found that with the higher interest rates we've seen recently, more taxable interest is being paid than in previous years. If an investor is receiving a lot of taxable interest, it would be wise to make adjustments to their taxable income stream because the tax cost for that investor will increase in 2026 if the TCJA does expire and isn't replaced by a new law.

Capital Gains Tax Rates 

Long-term capital gains and qualified dividends 0%, 15%, and 20% tax rates 0%, 15%, and 20% tax rates

There's some good news in this category as rates did not change with the passage of the TCJA and are not scheduled to change with the expiration either.

Does this mean investors can breathe a sigh of relief? Sort of. Be aware that there have been suggestions in corners of Washington D.C. that there is room for the tax rates on capital gains to increase. This is going to be a watchpoint for us here at Russell Investments. Capital gains tax rates continue to be relatively low, which benefits investors. But policymakers may consider this a potential area of interest to increase tax revenues.

Standard Deduction 

Standard deduction $14,600 for Single, $29,200 for Married Filing Jointly (MFJ) $6,350 for Single, $12,700 for MFJ (plus adjustment for inflation)

Most U.S. taxpayers benefited from an expansion of the standard deduction. As a refresher of how this expansion came to be: several studies over the last two decades (Simpson-Bowles was a more recent one) proposed a simplification of the tax-filing process. This was a goal of the TCJA. To do this, the standard deduction was increased to a level where many taxpayers who previously chose to itemize deductions on their tax returns would not need to anymore as they wouldn't meet the standard deduction threshold. In addition, several specific itemizable deductions were adjusted, such as the SALT (State and Local Tax) deduction, which we will get to momentarily.

The simplification was arguably a success as there was a significant drop in the number of itemized tax returns taxpayers submitted each year.

This could very well disappear in 2026. If it does, we may see: 1) a reduction of the standard deduction to pre-TCJA levels (adjusted for inflation) and 2) a return of or an increase in the number of many/most of the individual itemizable deductions that were impacted by the TCJA. Many taxpayers today benefit from the increased standard deduction and enjoy the simplified filing process.

State and Local Tax Deduction (SALT) 

State and Local Income Tax Deduction - Real estate, personal property tax and state income tax $10,000 Maximum cap for taxpayers Cap removed

Talk about a "SALTy" subject (pun intended!). This is a subject that we receive a lot of questions on – both from advisors and clients in the highest tax states.

The impact on taxpayers is mixed. The limit on the SALT deduction substantially increased tax revenues and allowed for a broader reduction in tax rates (see item 1 above). It is likely that this deduction and the overall tax rates are going to continue to be connected if there is a replacement for the TCJA. While it could be a net positive for certain higher-income taxpayers in high tax states if the SALT limitations go away, it likely will be a net negative impact for most taxpayers in the lower-tax states. Stay tuned.

Mortgage Interest Deduction 

Mortgage Interest Deduction Limited to $750,000 of "acquisition" debt Limited to $1M of "acquisition" debt plus $100k in home equity debt

The TCJA reduced the amount of interest an individual can deduct from a mortgage from $1 million in "acquisition debt" down to $750,000, and largely eliminated the ability to deduct home equity loan interest.

An expiration of the TCJA would see the level of interest deduction increase, which will be a net benefit for individuals considering moving into a new residence since average home prices have increased substantially since the TCJA passed into law. And having a return of the Home Equity interest deduction up to $100,000 in balance will be a net positive for individuals looking to use that to finance home improvements, the purchase of a vehicle, etc.

Child Tax Credit 

Child Tax Credit $2000 per child, $500 for other dependents; phaseout at $200k/$400k single/MFJ $1000 per child under 17; phaseout at $75k/$110k single/MFJ (plus adjustment for inflation)

Kids are expensive – speaking from experience! If the TCJA expires, this one will be a net negative for a lot of families as the credit drops from $2,000 per child to $1,000 per child. And the income level at which one can claim the credit drops by about half from the $200K/$400K single/MFJ (married, filing jointly) level it is at today.

Estate Tax Exemptions 

Estate Tax $13.6M exemption; inflation indexed $5M (plus adjustment for inflation)

The Estate and Gift Tax Exemption is currently at a healthy level. But the TCJA expiration would reduce the exemption level by about 50%, causing a lot of stress among advisors and investors alike. That is a very large number and leaves many savers, small business owners, landowners, and farmers, among others, exposed to significant tax bills that may be passed on to their heirs.

Planning is critical to take advantage of the exemption as it stands today. Bringing together a complete picture of all the assets an investor/family owns will help to increase the understanding of how close or far they are from these thresholds. (For 2024 the estate and gift tax amount stands at $13.61 Million). And then, once you know and see that the levels may/will be hit, it's time for the next-level planning meeting to decide how to approach the situation.

One option may be to establish an Irrevocable Grantor Trust, and then use the gifting exemption to fund the Trust with the assets. While that may lead to a reduced step-up of cost-basis benefit later, it could allow a generous gifting exemption now. But as with all complex tax and legal matters, it may be prudent to use the expertise and advice of legal and tax professionals.

Net Investment Income Tax (NIIT)

This tax is not related to the TCJA, and yet it still generates a lot of questions. This tax was enacted through the ACA/HealthCare Bill. In essence it is a 3.8% tax surcharge on income received not through employment (i.e. investment and passive income). It is applied to income over $200K/$250K single/MFJ.

As much as it is a subject of annoyance for many investors, we are not likely to see it go away. There were already a few attempts to change or eliminate it, to no success. We can hope that it is part of the discussion on future tax law changes, but we shouldn’t hold our breath on this one going away (I do hope I am wrong though).

Upcoming tax law changes - Next steps

Stay informed and be prepared. As someone said to me recently: "The circus is about to start." My response: "The circus never stopped; this is just going to be another circus sideshow!"

It is going to be very hard to predict the direction the tax law discussions will take, never mind the details and nuances, until after the 2024 election and the 119th Congress is seated. In the meantime, we should plan for any eventuality.

This is the moment to review your clients' tax Form 1040 to see how their investment income is being taxed. Help them adjust their investment mix to minimize taxes – today's and tomorrow's.

And your clients should begin to plan their estate and potential legacy: this is the most immediate of the planning items as the potential reduction of this exemption is arguably the largest item.

Russell Investments can be your resource in this project. With almost 40 years of tax-managed investment experience and knowledge, we can help you guide your clients through the uncertainty of the next few years of potential tax changes.