Understanding the 2026 Tax Sunset: Implications and Impact
As the country’s debt burden grows and we prepare for another presidential election there is a debate looming in DC that will have a significant impact on most Americans financial strategy. Between now and the end of 2025 Congress will have to vote to extend the 2017 tax cuts or they will expire (“sunset”) subjecting most to higher taxes.
Let's delve into what this term means, its implications, and the potential impact.
What is the 2026 Tax Sunset?
The term "tax sunset" refers to a provision in the tax code that sets an expiration date for certain tax cuts or changes. In the case of the 2026 tax sunset, it specifically pertains to the changes introduced by the Tax Cuts and Jobs Act (TCJA) of 2017.
The TCJA represented one of the most significant overhauls of the U.S. tax code in decades. Among its key provisions were lower individual and corporate tax rates, an increase in the standard deduction, and changes to various deductions and credits.
However, many of the individual tax provisions under the TCJA were temporary and scheduled to expire after 2025. This includes the individual tax rate cuts, the increased standard deduction, and various other tax breaks.
Some of the key provisions scheduled to sunset, unless Congress acts to extend them are:
1. Individual Income Tax Rates: The TCJA reduced individual tax rates across various income brackets. These lower tax rates are set to expire after 2025 and as a result most taxpayers will see at least a 3% bump. Individuals with taxable income over $150,000 and joint filers over $300,000 will likely see larger increases.
2. Increased Standard Deduction: The standard deduction for individuals and married couples filing jointly was nearly doubled under the TCJA. If the higher standard deduction is allowed to revert to its pre-TCJA levels after 2025 then the itemized deductions (ie. medical expenses, state and local taxes, mortgage interest and charitable contributions) become more important.
3. Medical Expense Deduction Threshold: The TCJA temporarily reduced the threshold for claiming the medical expense deduction from 10% to 7.5% of adjusted gross income (AGI). This lower threshold is scheduled to revert to 10% after 2025. Planning on having an expensive procedure? You may want to have it done before 2026.
4. State and Local Tax Deduction Limitation: The TCJA introduced a $10,000 cap on the deduction for state and local taxes (SALT). This limitation applies to the combined total of state and local income taxes, property taxes, and sales taxes. If the cap is not extended then those living in higher tax states will benefit, particularly homeowners with higher incomes.
5. Deductions for Mortgage Interest: The TCJA modified the deduction for mortgage interest by reducing the amount of mortgage debt eligible for the deduction and eliminating the deduction for home equity loan interest in certain cases. These changes are set to expire in 2026. With interest rates higher than what they have been in recent decades any tax relief for borrowers would help improve cash flow.
6. Child Tax Credit Expansion: The TCJA increased the Child Tax Credit from $1,000 to $2,000 per qualifying child and expanded eligibility for the credit. Additionally, a portion of the credit became refundable. If not extended those with children under the age 17 and taxable income under $200,000 individual, $400,000 married filing jointly will see their taxes increase.
7. Estate and Gift Tax Exemption: The TCJA doubled the estate and gift tax exemption to $11.18 million per individual (adjusted annually for inflation). This increased exemption is set to revert to pre-TCJA levels after 2025, unless Congress acts to extend it. We estimate that if the exemption is reduced it will land around $7M for individuals and $14M for couples, subjecting a lot more people to the 40% estate tax. For those who currently have, or expect to have, an estate subject to the tax there is time sensitive opportunity to take advantage of the higher gift tax exemptions in 2024 and 2025 to reduce the size of your taxable estate.
Potential Congressional Action
While the TCJA provisions are currently set to expire in 2026, it's important to note that Congress has the authority to extend or modify these provisions before they sunset. Whether Congress chooses to extend the tax cuts, make them permanent, or enact new tax legislation remains to be seen and will likely depend on various economic and political factors. Just so happens there is an election this year, no doubt this will be a focal point on the debate circuit!
How to Plan
As taxpayers prepare for potential changes to the tax code, it's essential to stay informed and adapt financial strategies accordingly. Some of the ways we are helping clients are running tax projections to prepare for different scenarios, setting up gifting strategies to reduce estate taxes and strategically managing distributions from taxable and tax-deferred accounts.
While the future of tax policy is uncertain, careful planning and vigilance can help navigate the evolving tax landscape.