Big Changes May be Coming to the Tax Laws in 2026. Here is What You Need to Know Now.
By John H. Robinson, Financial Planner (May 28, 2024)
The Tax Cuts and Jobs Act of 2017 (TCJA) ushered in sweeping changes to the federal tax code. However, to conform with federal rules for budget reconciliation, the law was slated from the outset to sunset on December 31, 2025, at which time the 2017 rules (indexed for inflation) will be reinstated. Although a few of the provisions in the TCJA have been permanently extended by separate acts of Congress, many of the key provisions of the Act are slated to go away, and consumers would do well to use 2024 and 2025 to optimize their tax planning.
Financial Planning Hawaii and Fee-Only Planning Hawaii clients can expect to hear much more detailed guidance from me on this topic over the next 18 months, but here is the “cliff notes” summary of the most significant changes in the offing and their planning implications.
#1 Marginal Income Tax Rates Will Return to the Higher 2017 Rates with Brackets Adjusted for Inflation. The TCJA lowered individual tax rates to 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The 2026 rates are slated to return to 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
Implication - The prevailing tax planning guidance is that consumers should consider using 2024 and 2025 to fill up the lower brackets with distributions/conversions from retirement accounts (IRA, 401(k), 403(b), etc.) to avoid paying a higher tax rate on distributions in the future.
#2 The Standard Deduction Amounts will be Halved, Personal Exemptions will be Restored to $2,000 per taxpayer and each dependent (to be phased out at higher income levels), and Disallowed/Restricted Itemized Deductions will be Restored. Most notably the $10,000 limit on state and local tax deductions will be eliminated, the unrestricted deductibility of up to $100,000 of home equity loan interest will be restored, and the limit on mortgage interest will be increased from loan amounts of $750,000 to $1,000,000.
Implication – Millions of Americans will return to itemizing their federal tax returns. The return of these deductions will also mean that charitable contributions will be much more impactful in lowering tax payments.
#3 Several Miscellaneous Itemized Deductions that Were Eliminated by the TCJA will be Restored. These include the deduction for investment advisory fees, tax preparation, and legal fees, to the extent that the sum of these fees exceeds 2% of adjusted gross income.
Implication – Since the TCJIA, I have been encouraging clients to pay advisory fees proportionately from their different account types in order to pay as much as is legally allowable from pre-tax assets. With the reversion, it may once again behoove taxpayers to pay advisory fees from after-tax accounts.
#4 Owners of passthrough businesses, such as partnerships and S corporations, as well as sole proprietorships, may currently claim a deduction of up to 20% of QBI. Beginning in 2026, the Sec. 199A QBI deduction no longer will be available. The IRS Section 168(k) Bonus depreciation on qualified property will expire for new property placed in service after 2026.
Implication - These changes eliminate some of the major pass-through benefits of Sub-Chapter S corporations. Business owners may wish to consult with their tax or legal advisors to determine if it may be wise to convert to a C-corp.
#5 The inflation-adjusted estate and gift tax exclusion limits that were doubled Under the TCJA will be halved when the Act sunsets. The 2017 estate and gift tax basic exclusion amounts of $5,490,000 (per person) and $11,180,000 (per couple) are now $13.61 million (per person) and $27.22 million (per couple) and will be adjusted again in 2025. Thus, in 2026, it is reasonable to project the estate tax exclusion limits to be roughly $7 million per person and $14 million per couple beginning in 2026.
Implications – Irrevocable Life Insurance Trusts may come back into vogue for people whose estates may exceed these thresholds. NOTE: Some advisors are pitching more complex estate planning strategies aimed at preserving the current high limits. Consumers should be aware of the potential risks, costs, and complexities that implementation of these strategies may bring.
#6 Tax-free distributions from 529 College Savings Plans to pay for private secondary school tuition will no longer be permitted. The ability of 529 plan account holders to make tax-free distributions of up to $10,000 per year to pay for private school tuition was a popular provision of the TJCJA that has not been extended.
Implications - 529 Plan owners may wish to take advantage of this benefit in 2024 and 2025. Note: There is bipartisan support to make this provision permanent, but it has not happened yet.
CONCLUSION
In sum, the purpose of this missive has been to raise awareness of the significant changes to the tax code that are coming when the Tax Cuts and Jobs Act sunsets on December 31, 2025. These changes will impact nearly every American taxpayer. While I will dive deeper in the coming months into quantifying the impact and interpreting who may benefit and who may not, I believe the change requiring the most immediate attention is the reversion to higher marginal tax brackets. I urge all FPH clients to start reaching out to their CPAs (and to me) to discuss whether it makes sense to fill up their lower marginal tax brackets (i.e., 22% or 24%) with IRA distributions or (partial) Roth conversions this year and next.
Of course, Congress may put aside party and inter-party differences to extend or make permanent certain provisions of the TCJA, I would not bet my tax dollars on that happening.
RELATED READING:
Tax Planning for the TCJA’s Sunset (Tax Advisor)
John H. Robinson is the owner/founder of Financial Planning Hawaii and Fee-Only Planning Hawaii. He is also a co-founder of fintech software maker Nest Egg Guru.
