Americans have enjoyed favorable tax rates in the recent past, along with other tax incentives like the increased standard deduction, the high estate tax exemption threshold or the expanded child tax credit. These are just a few of the items set to expire in 2025.
Today, an individual making $250,000 (married filing jointly) would fall within the 24% marginal income tax bracket as opposed to the same income level in 2017 would fall within the 33% marginal bracket. Even 33% seems low when you realize that America has had a top marginal tax rate over 70%. Keep in mind this was before the changes to the laws which eliminated many of the tax write-offs which were allowed back then as well. Lower tax rates (compared to historical standards) combined with the exponential growth of the government deficit spending, indicate an increase in taxes are soon to follow. Unfortunately this could affect you no matter what income tax bracket you fall under. Even with this in mind, there will be some surprises if proper planning is not used.
Many of us have made pre-tax retirement contributions under the assumption that they will be taxed at a lower rate when they retire. That may be true for some, but there will be cases where the income taxes will be higher due to individuals taking the required minimum distributions from these plans and as a result end up in a higher tax bracket. With the impending changes, the time between ages 59 ½ and 72 will become a pivotal period for tax planning to minimize tax liability related to your pre-tax retirement plans.
One strategy might be doing a Roth conversion. This would allow an individual to transfer tax-deferred retirement assets such as a Traditional IRA, SEP or Simple IRA into a Roth IRA. Also, some employer plans may allow for in-plan conversions to a Roth as well. Keep in mind, these conversions will be recognized as a taxable event and be taxed in the year of conversion, since they were done on a pre-tax basis. So, planning is key.
Another big change is with the estate tax exemption. This may be considered one of the most important impending changes Americans will face under the current administration. Currently the exemption is $11,700,000/person, so a taxable estate could be avoided if their estate is under this amount. Thus, the vast majority of people could have nothing to worry about, but when the current tax provisions expire at the end of 2025, this exemption is scheduled to revert to the old rules which is $5,000,000/person (but adjusted for inflation factors). This could potentially even be lowered to $3,500,000 depending on whether some of the current tax proposals get through Congress. Any portion of an estate exceeding these amounts may be hit with a 40-45% estate tax on the excess. Taxable estates with retirement plans will not only pay an estate tax, but there will also be an income tax to pay when the money is withdrawn by the trust or beneficiary. There is an itemized deduction to help prevent some of the double taxation issues, but only if you itemize your deductions on your personal returns. Anyone with an estate currently exceeding these numbers should be reviewing options to help minimize these taxes.