Overview of the TCJA and its impending expiration
Behold! The end is nigh for the Tax Cuts and Jobs Act! Over seven years ago, the Tax Cuts and Jobs Act (TCJA) transformed the tax code and led to major tax breaks for high-net-worth taxpayers. After seven years, taxpayers might not remember the major transformation wrought by the TCJA, and its pending expiration on December 31, 2025, will shock many unprepared for the return of the pre-2018 tax code.
The political landscape
Additionally, this year’s presidential election will feature two competing visions to resurrect the TCJA. On one side, President Joe Biden proposes extending many of the TCJA’s tax breaks for taxpayers making under $400,000 annually while allowing tax breaks for those over $400,000 to expire and raising other taxes above pre-2018 levels. On the other side, former President Donald Trump proposes making the tax breaks in the TCJA permanent and increasing others. As the time to pass the TCJA in 2017 after the 2016 election illustrated, taxpayers and financial advisors will not know what the tax code will be until near the Act’s last day.
Importance of early planning
Given the TCJA’s uncertain future, taxpayers and advisors must begin short and long-term charitable planning now. 18 months is a brief time to plan considering asset donations take time to complete.
Key comparisons between TCJA and pre-2018 law (for individual taxpayers):
| TCJA | Pre-2018 | |
|---|---|---|
| Highest marginal tax rate | 37% (40.8% with NIIT) | 39.6% (43.4% with NIIT) |
| Estate tax exemption | $27.22 million for husband/wife | $10.98 million (2017) |
| Business income deduction | 20% deduction for qualified inc | No deduction |
| Itemized/standard deductions: | •Increased standard deduction •No personal exemptions •SALT limited to $10,000 •Limitation on mortgage interest •Limit for cash gifts – 60% of AGI •No miscellaneous deductions | •Lower standard deduction •Personal exemptions •No SALT limit •Increased mortgage interest •Limit for cash gifts – 50% of AGI •Miscellaneous deductions |
Source: Tax Cuts and Jobs Act: A comparison for businesses | Internal Revenue Service (irs.gov)
President Biden’s proposal for his second administration
Among his proposals include:
- Raising top marginal rate to 39.6% for married couples making over $450,000
- 25% minimum income tax on billionaires
- Capital gains taxed at 39.6% for millionaires
- Limits step-up in basis for estates to $5M ($10M married)
- Increasing Net Investment Income Tax (NIIT) from 3.8% to 5% for incomes over $400,000
- Closing the carried interest loophole
- Limit deferral of gains on like-kind exchanges to $500,000
The political fight over TCJA’s future
The political fight over the future of TCJA will be long, brutal, and full of uncertainty. Much depends on whether one political party controls the House, Senate, and Presidency or a split government. All the major tax bills (Bush, Obama, and Trump) happened when one party controlled government. The national deficit, national debt, government spending, and the economy will all inform lawmakers, but more so than any other time, deep political divisions between the parties and members within parties will add more uncertainty to any tax legislation.
There is also a bigger appetite among the electorate to tax the wealthy currently than in previous tax bill debates. For advisors and their clients, the mantra should be: “Hope for the best, prepare for the worst.” They should expect reform around wealthy taxpayers, such as a higher marginal tax rate, reduced estate tax exemptions, and limited deductions.
Smart tax strategies for different taxpayer groups
The TCJA expires on December 31, 2025, so who should advisors target for charitable planning?
Passthrough entity owners
The expiration of the TCJA will bring increased tax rates and reduced deductions for the self-employed and passthrough entity owners, which include owners of partnerships, LLCs, S-corporations, and PTPs.
For example, a taxpayer with $500,000 ordinary income from passthrough entities will pay $148,000 tax under TCJA but pay $198,000 under pre-2018 law. Investors in passive income investments should consider divesting before January 1, 2026,whenmore of their income will be taxed at a higher rate. Owners who long contemplated retirement or selling their business but hesitated to pull the trigger might be persuaded to soon by illustrating how the TCJA’s expiration will affect their tax bill. While many business owners will enjoy capital gains rates on the sale of their ownership, some businesses will generate significant ordinary income recapture. When assets are sold, ordinary income recapture will reclass capital gains as ordinary income with certain ordinary income-producing assets (unrealized receivables, inventory, accumulated depreciation on capital equipment). Ordinary income recapture on a sale will cost more after the TCJA expires. Discussions around donating ownership shares should begin now. 18 months is a brief time to donate the shares, perform due diligence on buyers, and complete a sale agreement, and taxpayers must donate and sell shares on or before December 31, 2025.
Estate and gift planners
The 2024 estate tax exemption under the TCJA is $27.22 million for a married couple, more than double the pre-2018 exemption of $10.98 million. Only 0.1% of taxpayers pay any federal estate tax under the TCJA. Lowering the exemption means more estates will be subject to estate tax. The Great Wealth Transfer will also begin. An estimated $70 to $90 trillion will pass from one generation to younger generations. Wealthy estates might be targeted as revenue-raisers, and Congress might compromise on the exclusion to pay for tax cuts elsewhere. Assuming the new exclusion falls somewhere in between the two tax laws, those estates within that range should be targeted for estate planning. Establishing a split-interest trust such as a charitable remainder or charitable lead trust mitigates the taxable estate by removing some assets from the estate. Clients can also add language to their wills leaving testamentary transfers to charity or a donor-advised fund (DAF). Assets left to or set aside for charity are eligible for an estate charitable deduction, lowering the taxable value of the estate.
Itemizers
The expiration of the TCJA will mean the return of itemized deductions. The TCJA raised the standard deduction to a level where 90% of taxpayers filed with the standard deduction compared to 70% pre-2018. When the TCJA expires, the standard deduction will return to pre-2018 levels and more taxpayers will itemize deductions. The end of the TCJA will also bring back unlimited state and local tax deductions (SALT, which is currently capped at $10,000), the 50% AGI limit on cash contributions, and the return of itemized deductions, such as tax preparation and investment advisory fees, subject to a limit of 2% of AGI. There will now be a greater incentive to give when the tax deduction for charity returns for some taxpayers. Clients living in or subject to income tax in high-tax states will be a target for post-TCJA charitable planning. The cap on SALT will be removed and these clients will eagerly return to itemizing deductions to reduce taxes. Clients who held off on major charitable giving due to these limits or were in a different life phase will be giving more. Now opportunity exists to talk to our clients in high-tax states about a charitable giving plan to maximize their itemized deductions after 2025.
Owners of real estate
An interesting standout of President Biden’s tax proposal is the limit on the deferral of gain like-kind exchange to $500,000. Popular among real estate investors, the current like-kind exchange rules allow for a real property owner to trade his property for other real property, and the gain on the trade can be deferred until sold. Property owners can utilize like-kind exchanges to postpone gain indefinitely. The proposed limit of $500,000 gain deferral might come to a huge tax shock to owners of highly appreciated real property. There might be enough lobbying pressure to keep current like-kind exchange rules. Advisors should consider a change to the rules and identify those clients with appreciated real property in a seller’s market for a giving plan.
Reminders for charitable planning
- Gifts must be completed on or before December 31, 2025, to be subject to TCJA rules.
- Donated property subject to a debt will result in a partial bargain sale to the donor.
- To avoid the IRS assigning the income from a donated business interest to the donor, there must be no signed final agreement between buyer and seller in place at the time of the gift.
Benefits of using donor-advised funds
Charitable planning with a donor-advised fund (DAF) works in any tax environment emerging after 2025. Congress could extend the TCJA’s increase to the standard deduction past 2025. In this scenario, a DAF allows a donor to bunch charitable donations into one year to utilize itemized deductions. Alternatively, itemized deductions might return. Annual gifts to a DAF will give donors a charitable deduction in each year of contribution to add to their other itemized deductions. In either scenario, particularly helpful with year-end gifts, the donor receives a charitable deduction and can delay the selection of charitable grantees to the following year.
Opening and regularly contributing to a DAF now not only provides tax-deductible benefits to the donor, but the DAF can be named as a beneficiary of an estate. By targeting estates falling between the two possible exemptions, estate planning advisors will remove assets from the estate before changes to the estate tax. Donors name their family and loved ones as grant advisors to the DAF either upon its establishment or as successors, which will establish a legacy during and after the donor’s life.
Political candidates and the media will extensively cover the expiration of the TCJA and political fight over its future. Both political parties agree tax cuts should be extended for most taxpayers. If a divided government emerges after the 2024 election, expect some revenue to be raised from the wealthy through income or estate taxes. Uncertainty in the tax code after December 31, 2025, presents great opportunities for advisors to introduce or revisit charitable planning with clients.
Frequently Asked Questions (FAQs)
What is a donor-advised fund (DAF)?
A charitable giving vehicle that allows individuals to make a donation to a public charity, receive an immediate tax deduction, and then recommend grants from the fund over time to their preferred charities. This flexibility enables donors to plan their charitable giving strategically, ensuring their contributions align with their philanthropic goals and financial plans. Discover more benefits about DAFs.
How can I help my clients maximize their charitable deductions?
- Bunching donations: Advise clients to bunch their charitable giving or combine multiple years’ worth of donations into one year. This can help exceed the standard deduction threshold, allowing them to itemize deductions for that year.
- Donate appreciated assets: Encourage clients to contribute appreciated securities such as stocks, mutual funds, or real estate. This strategy can help them avoid capital gains taxes while providing a larger charitable deduction based on the asset’s fair market value.
- Use a DAF: Recommend donor-advised funds to clients. These funds allow clients to make a large, tax-deductible donation in one year while distributing the funds to charities over time, providing strategic flexibility.
- Timing: Ensure clients make donations before December 31 to secure deductions for the current tax year. This includes checks, credit card donations, and electronic transfers.
- Tax-efficient estate planning: Assist clients in incorporating charitable giving into their estate plans to maximize tax benefits and fulfill their philanthropic goals. This can include setting up charitable remainder trusts, charitable lead trusts, or including charitable bequests in their wills.
What Are the Deadlines for Charitable Contributions?
To ensure your clients’ charitable contributions are deductible for the current tax year, keep the following deadlines in mind:
- Cash contributions: Must be made by December 31. This includes checks, credit card donations, and electronic transfers. For checks, the donation date is when the check is mailed.
- Non-cash contributions: Donations of property, such as stocks or real estate, must also be completed by December 31. This may involve additional steps, such as transferring ownership, so start the process early to ensure it is finalized before the deadline.
- DAF contributions: Contributions to DAF must be completed by December 31 to qualify for a tax deduction in the current year. Ensure any asset transfers or cash donations are processed by the DAF provider in time.
