Major legislation affecting government spending and the tax code passed Congress and was signed into law over the July 4th weekend. Much of the surrounding news coverage and commentary may lead our clients to wonder if they now face a whole new world and to ask whether it is necessary to overhaul their financial plans and adopt new strategies to avoid tax pitfalls.
We want to reassure them that the plans we have built for them will change little, if at all. In fact, now that we know with greater certainty what the tax laws will be next year and beyond, their plans rest on more solid ground than before.
While we continue to review the details of the new law, so far we have not come across anything novel or unexpected. We see no major departures from the tax environment of the past seven and a half years. Tax planning for almost all our clients in the years ahead will be similar to what it has been in recent years.
Further, we now can more clearly identify those elements of tax planning strategies within our control and the opportunities they present. We know what the tax rates will be, at which levels they will apply, and what kind of moves no longer need to be considered.
Prior to the bill’s passage, uncertainty loomed over our tax planning discussions with clients. The previous change to the tax code, which went into effect with the 2018 tax year, was a temporary measure due to expire at the end of 2025. Absent any replacement, the law would have reverted to what had been in place prior to 2018. For most of our clients, that would have meant more complicated tax returns.
In the face of that uncertainty, we took to showing our clients two different scenarios: (1) what would happen if the laws in place since 2018 did sunset and revert to the status quo ante; and (2) what would happen if Washington acted to keep elements of the law in place, which we anticipated was likely. A plan with fewer assumptions is a more solid plan, especially when those assumptions depend on anticipating how hundreds of politicians will act. We can now put aside our political predictions and concentrate on plans for the scenario and tax code we know will obtain.
For clients in states with high income and property taxes, it may once again be advantageous to itemize deductions, because the updated tax law now allows up to $40,000 of state and local taxes to be deducted, but only through the 2029 tax year. We expect that many of our clients will find that what they currently pay in state and local taxes, added to their home mortgage interest paid, will exceed even the enduring, large and simple standard deduction that served them well for the past eight years. But the larger state and local tax deduction will not be available for higher income taxpayers.
For taxpayers who do not itemize, the standard deduction continues to be attractive, increasing next year to $31,500 for married couples filing jointly, and to $15,750 for singles.
The new law includes other changes to what can be deducted from income before taxes, and these changes will merit close attention. Some deductions will be available only for the next few years and then expire. The deductibility for charitable giving will be subject to new tests based on their size relative to the donor’s overall income.
Discussions and debate about the bill were marked by grandiose promises and dire warnings, wild exaggerations and misrepresentations from all sides. We hope that passage of the bill can put the most extreme of those to rest and that we can focus on what is codified into law. (Regrettably, important terms in the bill, like “tips”, “overtime”, and “customary” are left for the IRS to define later.)
One of the most spectacular boasts in the run-up to the bill’s enactment was that Social Security income would not be taxed at all. The new law does not explicitly bring this about, but it does introduce a new additional $6,000 deduction available to certain filers age 65 and older (a group that closely matches Social Security recipients). This effectively means more of their Social Security income will not count as taxable income. This special deduction will remain only through 2028.
In our opinion, one of the best things about the new law is that it allows us to anticipate tax implications further into the future. Provisions that had been due to expire remain in the code without any end date. We have seen this referred to as making these provisions “permanent.” We find this representation misleading and prefer to describe the current and continuing provisions as “indefinite.” Subsequent legislation can change things, which may happen if the political landscape shifts and majority control of the branches of government passes between parties. As long as that remains a hypothetical development, we will rely on the law in place, not on speculation about what kind of legislation might happen years from now.
On a practical level, what we show our clients will look cleaner. The projections we present to clients about the size, composition, and sources of their incomes and how it will be taxed will be determined by what we know the tax code will be. It was frustrating to us because it was confusing to clients to have to lay out different possible versions of the world before even discussing choices available. There will still be decisions to make, but we now can anticipate the immediate and real tax consequences of those decisions.
What kind of decisions, for example, are we talking about?
- determining the right location for different investments, whether in qualified retirement accounts or in taxable brokerage accounts.
- choosing between taking retirement income now and paying a certain tax rate or waiting until being required to take more income later and risk having to pay a higher rate.
- identifying opportunities to diversify out of concentrated positions in a single stock and minimize taxes on the capital gains.
Affecting all these decisions is the year in which clients elect to begin collecting Social Security.
This is the kind of planning we offer our clients. The new legislation makes some of these questions easier to address. What remains as important as ever is helping our clients answer these questions wisely.