Preparing for Tax Changes: Strategies for 2023 and Beyond

As we approach the end of 2023 and inch ever closer to 2025, it is time to start preparing for tax provisions that are set to expire. Of course, no one can predict which provisions might be extended or revised by Congress.

This looming expiration at the end of 2025 has implications for tax planning and estate management that may require preparation now – don’t wait until New Year’s Eve 2025 to get started.

Higher income, reduced deductions

Section 199A Qualified Business Income (QBI) Deduction for Pass-Thru Entities

The QBI deduction was introduced under the Tax Cuts and Jobs Act (TCJA) of 2017. It allows owners of sole proprietorships, partnerships, S corporations, and some trusts and estates to deduct up to 20% of their business income from their taxable income. This deduction provides substantial tax relief to these businesses, which are known as pass-through entities because the income passes through to the owners' tax returns. The relief provided to pass-through entities was designed to be similar to the overall reduction in corporate tax rates provided under the TCJA.

The QBI deduction is temporary and is set to expire at the end of 2025. If it expires, independent contractors and small business owners could face a tax increase, which would impact their financial planning and cash flows. If the QBI deduction expires, business owners should evaluate their entity selection with their advisors and consider the possibility of conversion to a C-Corporation.

Lifetime Transfer Exemption for Estate and Gift Taxes

The lifetime gift and estate tax exemption doubled under the Tax Cuts and Jobs Act of 2017, but the increased exemption is also set to expire at the end of 2025. This potential change should prompt individuals to consider setting up trusts or other estate planning vehicles now.

For individual taxpayers who die in 2024, up to $13,610,000 of the decedent’s gross estate at death, decreased by lifetime taxable gifts, will be excluded from the imposition of federal estate tax (an increase from $12,920,000 for individuals dying in 2023). A married couple can together shield up to $27,220,000 in asset transfers without having to pay any federal estate or gift tax (an increase from $25,840,000 in 2023).

Individual taxpayers can make gifts up to $18,000 per gift recipient (up to $36,000 per recipient for married couples) in 2024 without using any of their lifetime estate and gift tax exclusion.

Tax Bracket Adjustments

With the top tax rate potentially increasing from 37% in 2023 to 39.8% in 2026, consider ways to accelerate income into the years 2023-2025.

Another option to consider is converting pre-tax retirement funds to Roth IRAs to take advantage of lower rates now.

Alternative Minimum Tax (AMT)

The AMT, which was curtailed under recent tax reforms, is expected to impact more taxpayers again beginning in 2026. Planning for this tax can be complex, and taxpayers should consult with a professional to minimize its effect.

Child Tax Credit

The enhanced Child Tax Credit will be reduced to $1,000 per child with a lower income phase-out limit, affecting family tax planning.

Standard Deduction

The standard deduction, which was nearly doubled by the TCJA, is expected to decrease almost by half, adjusted for inflation starting in 2026. This change will likely make itemizing deductions more appealing for many taxpayers.

Section 174 Research and Development Costs

Upon the sunset of Tax Cuts & Jobs Act, research costs will again be fully deductible in the year the expense is incurred. However, this transition may require an application for change in accounting method, so business owners should consult their tax preparers.

Deductions and exemptions increase

Itemize or Standard Deduction?

The return of the 2% floor on itemized deductions and a reduction in the standard deduction amount necessitate a reevaluation of whether to itemize or take the standard deduction.

With the sunset of TCJA, taxpayers will again be allowed deductions such as unreimbursed employee expenses, tax preparation fees, and investment fees (subject to limitations).

Investigate alternative ways to deduct expenses. For example, legal and accounting fees can still be deductible elsewhere on your return if they pertain to a trade or business you conduct within the tax year.

Consult with a financial planner or tax advisor to understand how the return of the 2% floor could impact your financial situation and to strategize accordingly.

State and Local Taxes (SALT)

The state and local tax (SALT) deduction limitation is a cap on the amount of state and local taxes that taxpayers are allowed to deduct from their federal income taxes. Under the Tax Cuts and Jobs Act (TCJA) of 2017, the SALT deduction was capped at $10,000 for both single filers and married couples filing jointly. This limit includes state and local property, income, and sales taxes. This cap was implemented in 2018 and is currently scheduled to expire at the end of 2025, at which point the SALT deduction would increase. However, AMT and other restrictions apply.

This may create an opportunity to accelerate income into 2025 when state taxes may be fully deductible in 2026.

Mortgage Interest Deduction

The cap on the mortgage interest deduction, currently set at $750,000 of acquisition debt (unless you have a pre-12/16/17 loan) is slated to increase to loans of up to $1,000,000 after 2025. At the same time, deductions for home equity loan interest are expected to be reinstated.

Personal and Dependent Exemptions

Personal and dependent exemptions, which were eliminated by the Tax Cuts and Jobs Act (TCJA) for tax years 2018 through 2025, are scheduled to be reinstated. Before the TCJA, taxpayers could claim a personal exemption for themselves, their spouse, and each of their dependents, which was $4,150 per person in 2017.

Action Steps for 2023

Since many of the strategies, particularly those related to estate planning, require legal work and time to implement, it is crucial to begin the planning process now.

With these potential changes on the horizon, individuals and businesses should work closely with their tax advisors to ensure they are in the best possible position as we move closer to 2025. The key is to plan proactively with your advisors so that you benefit from current laws as well as from any potential changes to the tax law.