Preparing for the great sunset: What you need to know if tax code provisions expire

The hot equities and housing markets have contributed to a surge in U.S. household wealth during the pandemic.

According to the Federal Reserve, household wealth grew by $19 trillion to $137 trillion during the pandemic, increasing American household net worth by 16%. Baby boomers, the first generation of retirement savers, saw their nest eggs grow sharply over the past few years. In addition to being flush in cash and growing their wealth, baby boomers have benefited from selling their homes at peak prices. For this demographic, it’s no wonder that taxes have quickly risen to the top of their concerns.

There has been a great deal of tax uncertainty as the Biden administration continues to explore tax policy changes. What might be more certain and should be on everyone’s radar is the great sunset looming with the expiration of the Tax Cuts and Jobs Act (TCJA).   

Sunsets are provisions of the tax code that expire at a specified date. With the TCJA, Congress chose to make many of the individual provisions temporary to limit the revenue cost of the TCJA to a level consistent with the overall constraint on the 10-year revenue loss in the Congressional Budget Resolution. Moreover, to comply with Senate budget rules under the process used to pass the tax act, there can be no increase in the federal budget deficit after the 10th year.

The TCJA made significant changes to individual income taxes as well as estate and gift taxes. For individual taxpayers, almost all these provisions expire or “sunset” at the end of 2025, while most business provisions are permanent. Without additional tax policy changes, the tax year of 2026 will be a big shock to many U.S. taxpayers and will especially hit boomers hard as many settle into retirement with big taxable nest eggs. 

What expires with the sunset? Here are the most notable sunset provisions.

Income taxes and deductions

For individual taxpayers, the top individual, estate and trust income tax bracket goes back up to 39.6% from the current rate of 37%. The TCJA also repealed personal exemptions, but increased the standard deduction of which this year is $25,900 for joint filers and $12,950 for single taxpayers. For families with dependents, it replaced the dependent exemptions with an increased child tax credit, by doubling the maximum per child credit amount and extending it to higher-income families by substantially increasing the income thresholds for the benefit phase out.

The TCJA removed the phaseout for the overall allowable itemized deduction impacting higher income filers with AGI above certain thresholds, but also changed the structure of several major itemized deductions. Under prior tax law, those who itemize could claim deductions for all state and local property taxes (SALT) and the greater of income or sales taxes (subject to various limits on itemized deductions). TCJA limited the itemized deduction for total state and local taxes to $10,000 annually, for both single and joint filers, and did not index that limit for inflation.

The mortgage interest deduction also changed. Prior to the TCJA, taxpayers could deduct interest on mortgage payments associated with the first $1 million of indebtedness incurred to purchase (or substantially renovate) a primary and secondary residence plus the first $100,000 in home equity debt. For taxpayers taking new mortgages after the effective date, TCJA limited the deductibility to the interest on the first $750,000 of home mortgage debt and suspended the deductibility on home-equity loans unless they are used to buy, build or substantially improve the taxpayer’s home.

Alternative minimum tax

TCJA retained the individual AMT but raised both the exemption levels and the income threshold at which the AMT exemption phases out to $1 million for married individuals and $500,000 for others. The exemption amounts and phase out thresholds continue to be indexed for inflation.

Charitable giving

In general, a tax deduction for charitable donations was preserved. In fact, for 2018 through 2025, the annual deduction limit for cash contributions to public charities increased from 50% of AGI to 60% of AGI, and will sunset back to 50% in 2026. (There was also an increase to 100% of AGI for cash contributions to qualifying charities as part of COVID relief acts for 2020 and 2021.)

Estate and gift tax

For many boomers, the sunset of the current estate and gift tax provisions provides the greatest gloom. TCJA doubled the estate and gift tax exemption to $11.2 million for single filers, $22.4 million for couples, and continued to index the exemption levels for inflation. This year, the federal estate and gift tax threshold increased to $12.06 million per individual, $24.12 million for couples. In 2026, the estate and gift exemption will revert to pre-TCJA levels, effectively reduced by half, and expected to be in the ballpark of $6.5 million per individual or $13 million for a married couple.

The sunset of the estate and gift exemption will have a significant impact on many boomers. For families with a net worth exceeding $24 million it is important to shore-up their estate plans and where possible take advantage of the high exemption amount using estate and gifting strategies. The IRS has provided clarity on how significant gifts will be accounted for prior to 2026 when a death occurs in 2026 or later. In general, you benefit if you gift more than the estate and gift exemption amount expected for 2026. For example, if an individual gifts $12 million now and the gift and estate exemption becomes $6.5 million in 2026, they have moved an additional $5.5 out of their estate tax-free. This gets complex really quickly and should only be done with the guidance of your expert estate attorney and accountant.        

For boomers in the position of having a taxable estate above $13 million now or by 2026, due to years of saving, healthy retirement accounts, home values that have skyrocketed, employment stock options, inheritances or even a sale of a business will now be looking forward, or better said, not looking forward to an impending federal taxable estate. Estate planning will become equally important to these families as their wealth grows and they experience additional wealth events.

It’s also important to mention that if you live in a state with a state estate tax or inheritance tax, you likely already have cause for estate planning. There are a host of estate and gifting strategies to explore. Again, due to complexity, utilize the guidance of your expert advisers including your attorney and accountant.       

Of course there is the potential of new tax legislation before the sunset in 2026. With that said, waiting to see what will happen may put you at risk of running out of time to put a prudent and thoughtful plan in place. Working together with a team of advisers, such as your financial adviser, your attorney and your tax adviser to put a holistic plan in place understanding both the tax provisions today and in 2026 will help make any sunset what it should be, great.

RBC Wealth Management does not provide tax or legal advice. All decisions regarding the tax or legal implications of your investments should be made in consultation with your independent tax or legal adviser.

RBC Wealth Management, a division of RBC Capital Markets, LLC, registered investment adviser and Member NYSE/FINRA/SIPC.

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