Potential Tax Changes: 2025 and Beyond
Taxes are a part of American life, and they come in all different forms: Income tax, capital gains, excise tax, sales tax, and on, and on. The income tax system as we have come to know it today was introduced as the sixteenth Constitutional Amendment in 1913, but taxes have been collected for as far back as man kept records. These revenues are used to fund the country and our respective states. Key programs like Social Security and Medicare, national defense along with public services like roads, national parks, emergency services, and public schools are all funded by your tax dollars. In general the tax code remains similar year to year, while there are recurring adjustments to the tax rate tables accounting for inflation or the upping of contribution limits to a 401(k) or individual retirement accounts (IRAs), periodically there are significant shifts in legislation, the last one enacted in 2017 with the Tax Cuts and Jobs Act (TCJA). In an effort to get enough bipartisan support to pass, several provisions were written in as temporary and are set to expire in 2025. Some of those changes are likely to be rather consequential, affecting a wider swath of the tax paying population.
Which are the most significant expiring provisions in 2025 and 2026?
Standard deduction: The TCJA increased the standard deduction and eliminated personal exemptions except for those over the age of 65 or blind though they are no longer referred to as exemptions per se. For example, if the TCJA expires as under current law, the standard deduction for a married couple will be approximately $16,525 in 2026, roughly half the size of the current level which would likely be around $30,725 in 2026. A good estimate would put the personal exemption at about $5,275. When enacted there was a dramatic decrease in taxpayers itemizing deductions impacting things like charitable contributions and due to the capping of mortgage interest expenses based on the maximum amount of $750,000 in borrowings. In 2017, 31 percent of all individual income tax returns had itemized deductions, compared with just 9 percent in 2020 according to taxpolicycenter.org.
Individual income tax rates: The TCJA lowered marginal income tax rates throughout the majority of the income distribution. As an example, the TCJA cut the top marginal tax rate from 39.6% to 37%. These rates will increase to pre-2017 levels if the TCJA expires. If the provision does expire, it will result in a tax increase for roughly 62% of taxpayers.
State and local tax (SALT) deduction: The TCJA placed a $10,000 cap on the deductibility of state and local taxes (SALT). States with relatively high income taxes and property taxes may mean larger itemized deductions. For those people in states that do not assess an income tax, taxpayers would be able to deduct sales taxes. This has become a highly politicized issue, with individuals benefiting high-income taxpayers in high-tax states, Like Nj< NY, CA and MA, deeply “Blue” states standing to see the biggest potential benefit to a return to the older system. For example, a married couple with $30K in state income taxes and $20K in property taxes, aside from any medical, charitable or interest deductions would see their deductions increase nearly 66% when compared to the standard deduction.
Alternative minimum tax (AMT): The TCJA increased the AMT exemption amounts and raised the income levels at which the exemptions phase out. The result of this…fewer taxpayers liable for the AMT. If this provision of the TCJA does indeed expire, the 2026 AMT exemption for married couples filing jointly will be approximately $110,075, compared to about $140,300 if some action is taken to extend the provision. Those same individuals in the “high tax” states will likely see this issue creep back into their calculus.
Estate taxes: The TCJA doubled the estate tax exemption. If this provision expires the exemption which was likely to be around $14.3MM per person in 2026 and $28.6MM for married couples, will likely be about half that number. With a tax rate of 40% the impact could be substantial for those affected and after a long bull market in both stocks and real estate more and more people are likely to be exposed to the vaunted “death tax.” Many states have their own estate taxes with several using the Federal levels as a guidepost, though many have lower limits. As an example, in Massachusetts, the estate tax kicks in at $2 Million, while in New York the threshold is $7MM. In California, New Jersey and Colorado, there is no estate tax.
Child Tax Credit: The TCJA increased the tax credit for any child under seventeen from $1,000 to $2,000, and that is not adjusted for inflation. The maximum credit that can be refunded increased from $1,000 to $1,400 per child in 2018; that is adjusted for inflation and is set at $1,700 in 2024. The TCJA also increased the income thresholds at which the credit phases out. The child tax credit will fall back to $1,000 if the TCJA expires, which would make the real value of the credit about 25% lower than it was in 2017. This is a significant drop that will impact the tax returns of millions of families nationwide. This credit applies to individuals whose income is less than equal to single filers with incomes of $200K or lower and $400K for those filing married joint returns.
Deduction for small business income: One of the more significant provisions in the TCJA provided a 20% deduction for qualified pass-through income (section 199A) for sole proprietorships, partnerships, and S-corporations. If the TCJA expires, this deduction will no longer be available. The impact for small businesses is likely to be significant. Many states have also enacted pass through entity tax provisions (PTET), that allow small business owners to pay state taxes through their entity as an expense, thereby creating a dollar-for-dollar deduction on one’s Federal return. Much like the passthrough going away, this would reduce net income and possibly influence hiring or capital expenditure decisions.
Dating back to Arthur Laffer’s famed napkin illustration, referred to as the “Laffer Curve,” there is an optimal state or nirvana when it comes to raising the necessary revenue to fund this great nation, while still providing powerful incentives to work hard and innovate. Too low of a tax rate, one of the real objections to trickle down economics, would see not enough money funding important programs and wealthy individuals acquiring more assets after their essential expenses have been met, while rates that are too high will choke entrepreneurship and reduce motivation for trying to “get ahead.” Here are some of the key considerations:
Potential Benefits
- Increased Investment and Business Activity: Lower taxes for businesses can increase their profitability, allowing them to invest in growth, create jobs, and pay higher wages. Businesses are more likely to spend when they are more profitable and pay less in taxes.
- Higher Consumer Spending: If individuals pay lower taxes, they have more disposable income, potentially boosting demand for goods and services. Consumer spending is a main driver of the US economy.
- Encouraging Entrepreneurship: Lower taxes can encourage people to start businesses, which may drive job creation and innovation.
- Competitiveness: Lower corporate taxes can make a country more attractive for foreign investments and can stimulate economic growth. When multinational corporations add jobs through job sites like factories or regional centers, they can be a growth engine for states.
Potential Downsides
- Reduced Public Services: Lower taxes often mean less revenue for the government, which can result in cuts to essential services like education, healthcare, and infrastructure. This not only affects those receiving those essential services, but also will often result in a scaling back of the workforce.
- Higher Debt: If tax cuts are not balanced by spending cuts, they can lead to higher government deficits and debt, which may create long-term economic challenges.
- Diminished Economic Stability: Some public investments, like infrastructure and social safety nets, contribute to long-term economic stability. Reducing these to accommodate lower taxes can hurt economic resilience over time. Social Security and Medicare are two of the most talked about programs falling into this category.
We are all willing to pay our fair share and it makes this country truly the greatest in the world and very much a destination. It seems that some changes may very well be afoot, some necessary as we deal with enormous deficits and debt levels, but calibrating tax policy is an ongoing process and for those of us taxpayers, it requires knowledge of the playing field and proactive approach to navigating whatever the future holds.
Sources:
www.IRS.gov
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