What if TCJA Isn’t Extended?

May 14

By Roger McEowen, Professor of Agricultural Law and Taxation, Washburn University School of Law

Overview

Tax legislation that went into effect in 2018 is set to expire at the end of 2025. For many, this could have a significant impact starting in 2026. Do you have a plan in place if the tax law changes dramatically at that time?

Tax Rate Increase

If Congress allows the 2017 tax law (the Tax Cuts and Jobs Act (TCJA) to expire, how might it impact you? For starters, tax rates will increase.

For example, those currently in the 12 percent federal bracket will see a 25 percent increase in their tax rate.

Currently (for 2024) the 12 percent bracket for married persons filing joints applies to taxable incomes from $24,200-$94,300.

So, for instance, a married couple with $75,000 of taxable income would see their tax bill raise from about $8,560 to approximately $10,500.

Standard Deduction and Child Tax Credit

In addition, the standard deduction will be reduced (essentially cut in one-half), but personal exemptions will be restored.

Also, the child tax credit will be reduced from $2,000 per qualifying child to $1,000, the $500 credit for a dependent that doesn’t qualify for the child tax credit will be eliminated, refundability of the child tax credit will be reduced and the credit will be eliminated entirely for some families due to old income phase-out ranges being restored.

For homeowners, the current limit on the mortgage interest deduction will be removed.

Government Health Insurance

The 2017 law removed the penalty for not getting government health insurance, but that will be restored starting in 2026, as will the deduction for state and local taxes.

In addition, the lower limit on charitable deductions will be reinstated.

For businesses that aren’t corporations, the 20 percent deduction on business income will go away.

Corporate Tax

The TCJA also permanently reduced the corporate tax rate from (essentially) a top rate of 35 percent to 21 percent and allowed for immediate expensing for shorter-term capital investments (although the provision is currently 80 percent for 2023 and is phasing down).

If individual rates that apply to partners in partnerships or shareholders of S corporation become greater than 21 percent, rethink whether it makes sense to convert to a C corporation (hint – it likely won’t).

Qualified Business Income Deduction (QBID)

This 20 percent deduction for business income is set to expire after 2025. If it does business income, for example, that subject to a 24 percent rate would no longer be taxed at an effective rate of 19.2 percent. It would be taxed at 24 percent.

The QBID is a big deduction for farm and ranch businesses that are not C corporations.

Bonus Depreciation

First-year bonus depreciation is scheduled to become zero starting in 2027 if the Congress does nothing. So, qualified asset purchases should be made before that time.

The earlier the better, bonus is in the midst of a phase-down and is 60 percent this year (down from 80 percent last year and 100 percent for 2022).

Tax Planning for Higher Rates

If you believe that tax rates will rise, certain standard strategies should be considered:

Delay incurring deductible expenses (such as business expenses and/or charitable deductions) until the year with higher rates.
With the standard deduction scheduled to drop after maximize retirement contributions to reduce taxable income and lower tax liability. Those over age 70 and ½ can donate to a charity (such as the Rural Law Program at Washburn University School of Law) directly from an IRA via a qualified charitable distribution.
Convert a traditional IRA (perhaps over time) to a Roth account.
Contribute to an education savings account (Sec. 529 plan) to get tax-free growth and tax-free withdrawals for qualified educational expenses.
Harvest capital gains before individual income tax rates go up.
Harvest capital losses after rates go up.
Contribute to a health savings account to reduce taxable income and withdraw contributed funds tax-free for medical expenses.
Instead of a health savings account, enroll in a health sharing arrangement (if eligible). There is no need for a high-deductible health insurance policy and the cost-savings can be enormous.

Estate Tax (and planning)

The estate tax exemption will be essentially cut in half, (from about $14 million in 2025 to about $7 million in 2026).

For larger estates, making gifts now might make some sense. Especially gifts of income producing property to family members in lower tax brackets.

The marital deduction is unlimited (and not anticipated to change) so gifts up to the exclusion amount could be made without tax and (according to the IRS) those outright transfers would not be pulled back into the estate at death subject to a lower exemption amount.

Another strategy would be to transfer assets to an irrevocable trust (thereby removing the assets from the estate) with an ability to access income distributions (this requires careful drafting).

A variation of this approach is for the grantor to retain the right to a series of annuity payments for a specified time with distribution of trust assets to the beneficiaries after the expiration of the annuity.

Conclusion

It might be time to start thinking about the changes that could occur starting in 2026 and putting a good plan in place to handle what could happen.

If you operate a business, think of higher taxes as an additional cost that needs to be managed. While it’s not known what the Congress will do and if something is done it may not be until late in 2025 (or even early 2026), it doesn’t hurt to be proactive.

Janet Bailey