Cecily Zamora
The current tax laws are set to sunset on December 31, 2025, with tax hikes expected to come into effect in 2026. The Tax Cuts and Jobs Act (TCJA) of 2017, which was enacted under President Trump's first term, made changes to the tax code that were only temporary. As a result, several provisions of the U.S. tax code for individuals and businesses will expire at the end of 2025, including reduced tax rates, increased standard deductions, and higher estate tax exemption limits. The sunset of these provisions will impact individuals with larger estates and those who utilize itemized deductions. It is important for taxpayers to be aware of the upcoming changes and to consider strategies to optimize their tax savings before the sunset.
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What You'll Learn
The standard deduction will decrease
The standard deduction is a fixed amount that taxpayers can subtract from their income to reduce the amount of taxable income. The standard deduction amount varies depending on the taxpayer's filing status, age, and whether they have a disability. For example, in 2023, the standard deduction was $13,850 for single filers and $27,700 for married couples. The Tax Cuts and Jobs Act (TCJA) of 2017 nearly doubled the standard deduction for all filing statuses, and this change will remain in effect until 2025.
However, it's important to note that the TCJA included a sunset provision, which means that the tax laws are set to change after 2025. While it's uncertain if the standard deduction will decrease, it's possible that the tax laws could revert to the pre-TCJA rules, which had lower standard deduction amounts.
For individuals who plan to make significant charitable contributions, it may be beneficial to do so before the sunset in 2026, as the annual deduction limit for cash contributions to public charities will decrease from 60% to 50% of AGI. Additionally, the current higher estate and gift tax exemption amounts are expected to decrease in 2026, so individuals with larger estates may want to explore ways to take advantage of the current lower brackets.
While the future of tax laws is uncertain, taxpayers can work with financial advisors and tax professionals to prepare for potential changes and maximize their tax savings. It's also important to stay informed about new tax legislation that may be enacted before the sunset provisions take effect.
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The top tax rate will increase
The Tax Cuts and Jobs Act (TCJA) of 2017 lowered the top tax rate from 39.6% to 37%. However, this provision is set to expire on December 31, 2025, and the top tax rate will revert to 39.6% beginning January 1, 2026.
The TCJA made significant changes to the tax code, including lowering tax rates and increasing the standard deduction. While the standard deduction was nearly doubled under the TCJA, it will revert to pre-TCJA levels in 2026. This decrease in the standard deduction will likely result in many taxpayers choosing to itemize deductions again. Additionally, personal exemptions will come back in 2026, providing a deduction of approximately $5,300 per filer and dependent.
The sunset of the current tax laws will also impact individuals with larger estates. The TCJA doubled the estate and gift tax exemption limits, but these exemptions will also revert to lower pre-TCJA levels in 2026. For example, the lifetime exemption from estate and gift taxes for individuals will decrease from $13.99 million in 2025 to around $7.25 million in 2026. This change may cause concern for high-net-worth individuals, including baby boomers who have accumulated substantial wealth over the years.
In preparation for the upcoming changes, individuals can explore strategies to optimize their tax savings and take advantage of the current lower tax rates and higher exemption limits. For example, individuals can consider accelerating income, contributing to a Roth 401(k) or IRA, and utilizing gifting strategies with the guidance of financial and legal advisors.
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Estate and gift tax exemption limits will revert
The Tax Cuts and Jobs Act (TCJA) of 2017 brought about changes to tax laws, including lowering overall tax rates and increasing the estate tax exemption limits. However, these changes were only temporary and are set to expire or sunset in 2025. As a result, the estate and gift tax exemption limits will revert to pre-TCJA levels in 2026.
The TCJA doubled the basic exclusion amount (BEA) for tax years 2018 through 2025. The BEA is the amount that can be excluded from gift and estate taxes. For 2018, the BEA was $11.18 million, and it has been adjusted annually for inflation, reaching 13.99 million per individual in 2025. This means that married couples effectively have a $27.98 million exemption through 2025.
However, in 2026, the BEA is scheduled to revert to its pre-2018 level of $5 million, adjusted for inflation. This reversion will result in a significant decrease in the amount that can be excluded from gift and estate taxes. For individuals and families with significant assets, this means that it may be beneficial to consider gifting funds before the exemption limit decreases.
It is important to note that the IRS has clarified that individuals who take advantage of the increased gift tax exclusion amount between 2018 and 2025 will not be adversely impacted when the exclusion amount drops in 2026. This means that any gifts made during the higher exclusion period will not be subject to additional taxes or penalties when the exemption limit reverts to the lower amount.
While the reversion of the estate and gift tax exemption limits will impact individuals with larger estates, it is just one aspect of the broader tax law changes set to take place in 2026. Other changes include increases in tax rates, narrower tax brackets, and adjustments to standard deductions and personal exemptions. It is always advisable to consult with a financial advisor and estate attorney to navigate the complexities of estate planning and to develop strategies that align with an individual's unique circumstances.
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The child tax credit will reduce
The Child Tax Credit (CTC) is a tax break for families with qualifying children. The American Rescue Plan Act (ARPA) increased the CTC for the 2021 tax year, allowing tax filers to claim up to $3,600 per child under age 6 and up to $3,000 per child aged 6 to 17. This credit was fully refundable, meaning low-income families could qualify for the maximum credit regardless of their earnings. The American Rescue Plan also extended the full Child Tax Credit permanently to Puerto Rico and the U.S. Territories.
However, the legislation that increased the CTC is temporary and set to expire after 2025. After this, the CTC will revert to its pre-TCJA form, and taxpayers will be able to claim a credit of up to $1,000 for each child under age 17. The credit will be reduced by 5% of adjusted gross income over $75,000 ($110,000 for married couples). If the credit exceeds taxes owed, taxpayers will be able to receive the balance as a refund (the ACTC), limited to 15% of earnings above $3,000.
The expiration of the increased CTC is part of the "sunset" of the Tax Cuts and Jobs Act (TCJA) of 2017, which lowered overall tax rates and increased the estate tax exemption limits. This sunset provision means that a large portion of the TCJA rules will automatically revert to the old tax rules in 2026. As a result, tax rates are expected to increase, with most brackets rising by 3-4%. The standard deduction will also shrink, and personal exemptions will return.
The impending sunset of the TCJA has prompted individuals and businesses to consider strategies to take advantage of the current lower tax rates and higher estate tax limits. For example, individuals with significant assets may consider gifting funds to utilize the higher estate tax limits before they decrease in 2026. Business owners may want to delay expenses until 2026 when it could be a higher tax year. Additionally, those considering making significant charitable contributions may benefit from increased deduction limits until 2026.
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The charitable donations tax deduction will decrease
The TCJA preserved the tax deduction for charitable donations and even increased the annual deduction limit for cash contributions to public charities from 50% of AGI to 60% of AGI for the years 2018 through 2025. However, in 2026, this limit will sunset back to 50%. This means that individuals who make significant charitable contributions before 2026 may be able to deduct a larger amount from their taxable income.
The decrease in the charitable donations tax deduction could have a significant impact on charitable giving, particularly from high-income individuals. The new law will introduce a 1% floor on charitable deductions for corporations, meaning only contributions exceeding 1% of taxable income will be eligible for tax relief. This could discourage corporations from making smaller charitable donations and instead encourage larger, more meaningful giving.
In addition to the changes to the charitable donations tax deduction, the sunsetting of the TCJA in 2026 will bring about various other tax changes. For example, personal exemptions will return, adding about $5,275 of deduction per filer and dependent. The standard deduction will also shrink, and tax brackets are expected to increase by 3-4% in most cases.
Overall, the decrease in the charitable donations tax deduction is just one of the many changes that will take place as part of the sunsetting of the TCJA in 2026. It is important for individuals and businesses to stay informed about these changes and seek professional advice to understand how they may be impacted.
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Frequently asked questions
The current tax laws are set to sunset on December 31, 2025.
The tax rates are set to increase in 2026. Most brackets will increase by 3-4%. For example, the 22% bracket will increase to 25%, and the 24% current bracket will increase to 28%.
The sunset of the current tax laws will result in higher taxes for individuals and businesses. The standard deduction will decrease, and more taxpayers will likely itemize deductions. The child tax credit will also revert to the pre-TCJA amount.
Taxpayers should review their estate plans and personal tax situations to optimize their tax savings before the sunset. They may also want to consider accelerating income, making outright gifts, or converting traditional IRA assets to Roth IRA assets.
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