Is Your Tax Advisor Telling You to Pay Taxes Now? Maybe They Should.
Impacts of Proposed Tax Legislation and Looming TCJA Sunsets
Tax advisors like those of us at Adams Brown typically advise clients on a variety of strategies to minimize taxes, using such tools as deferring income, accelerating expenses, changing accounting methods and expensing rather than capitalizing business costs. Our clients expect this kind of advice, and it is in a tax accountant’s DNA to provide it. This year may be different. This year, depending on your circumstances, the message may be: Pay your taxes now.
Current tax rates for individuals and corporations are the lowest we have seen in several decades because of the Tax Cuts and Jobs Act (TCJA) passed in December of 2017. But that may change soon. President Joe Biden’s proposed spending programs will need revenue generators. Various provisions have been proposed and come and gone, including increases in capital gains tax, increases in individual and corporate tax rates and estate and trust taxes. Proposed changes to the federal tax code would raise tax rates on high-net-worth individuals as well as corporations. The tax proposals are currently bogged down in partisan negotiations. The provisions seem to change daily, if not hourly, and it’s anyone’s guess what will emerge from Congress by the end of this year.
But when it comes to tax planning in 2021, three important factors are worth considering:
- Politically, the next two months may be the last chance for Congress to act before the 2022 mid-term elections. Congress typically avoids making major changes in tax law during election years, and the Democrats – who currently hold slim control in both houses – may not have majorities after the mid-term elections.
- The massive amounts of government spending pumped into the economy (six major bills that total $5.3 Trillion) will come with a price tag. How Congress decides to be fiscally responsible is largely along party lines.
- Even if Congress does nothing to change the tax code, current tax rates – which are the lowest we have seen in a long time – will expire at the end of 2025, and pre-2018 tax rates will prevail again. That’s because many provisions of the TCJA were written to sunset after December 31, 2025. In other words, those provisions – including today’s low tax rates – will revert to what they were before the TCJA took effect.
The bottom line is that tax rates will likely increase for some taxpayers in 2022 if Congress produces a tax bill before the end of this year. Even if Congress does not change the tax code this year, tax rates are scheduled to increase in 2026.
While 2026 may sound like a long way off, it really isn’t. That’s why engaging in some long-range tax planning this year will be so important. You may need to consider strategies that will have you increasing taxable income now but will hedge against higher rates in the future.
Consider the following chart that describes current favorable provisions of the TCJA and what will happen to them in 2026 under the sunset schedule:
|TCJA Expiration Dates|
|Individual Rate Cuts||Final year||Gone|
|§199A QBI Deduction||Final year||Gone|
|AMT Exemption Increase||Final year||Gone|
|$10,000 SALT Cap||Final year||Gone|
|Estate Gift Exemption Increase||Final year||Gone|
|100% Bonus Depreciation||100%||80%||40%||20%|
Moreover, if individual rates return to pre-2018 levels, many taxpayers who are considered middle-class will see tax increases. For example, under TCJA current rates, a married couple can have up to $172,750 in taxable income at a 22% marginal tax rate. Before TCJA, that same couple would be taxed at a marginal rate of 25% on $153,100 and 28% on the additional $19,650. The current top tax rate for married couples with taxable income over $628,301 is 37%. A couple with income over $470,000 currently has a top rate of 35%. The Pre-TCJA rates will be a top rate of 39.6% on this same income level. Couple this with the potential sunsetting of the Qualified Business Income tax deduction for small business owners , as well as imposing a 3.8% surcharge tax on pass-through business income, an effective tax rate increase is currently scheduled on the horizon.
We will keep you informed about the status of tax legislation. In the meantime, if you would like to discuss tax planning strategies during these uncertain times, contact your Adams Brown advisor.