What If We Go Back to Old Tax Rates?
Key Points – What If We Go Back to Old Tax Rates?
- Analyzing the Impact of the Tax Cuts and Jobs Act of 2017
- Comparing 2017 and 2021 Tax Brackets
- Differences Between CPI and Chained CPI
- Breaking Down Changes in Deductions and Exemptions
- Previewing the end of the TCJA in 2026
- 4 minute read
What If We Go Back to Old Tax Rates?
A few years ago, the Tax Cuts and Jobs Act of 2017 was signed into law by President Donald Trump. The law was arguably the most significant change to the tax code in years. Because the legislation was so unpopular with Democrats, the Republican authors of the bill wrote in a sunset provision for most of the changes affecting individuals (the corporate tax law changes were made permanent) to work within budgetary constraints.
The sunsetting is scheduled to take place after 2025. That means if there is no additional legislation passed between now and the end of 2025, much of the law will be reversed, and we’ll go back to many of the same tax laws we had prior to 2018. Since we can’t predict what will happen with potential future legislation, let’s take a few minutes to discuss what would happen if the TCJA was allowed to sunset as scheduled.
Tax Rates
One of the most significant changes to individuals was the change in tax brackets and rates on ordinary income. New rates and brackets were introduced in 2018, and those changes will be reversed. The brackets are and have been adjusted for inflation each year. We won’t necessarily have the same brackets we had in 2017, but the rates will be the same. Let’s compare the 2017 (pre-TCJA) brackets with the tax brackets used in 2021.
Speaking of Inflation…
The TCJA also included a major change to how inflation will adjust the tax brackets year by year. In the 1980s, the tax brackets were made to adjust annually by the consumer price index (CPI), an index tracked by the Bureau of Labor Statistics that is designed to measure the change in prices of consumer goods and services. The TCJA made it so the tax brackets will adjust by Chained CPI instead of CPI. The Bureau of Labor Statistics has a good video on their YouTube channel explaining the difference between traditional CPI and Chained CPI. You can watch that if you want to have a good understanding for how tethering the tax brackets to Chained CPI will impact you.
Differences Between CPI and Chained CPI
FIGURE 1 | Source: Y Charts
A 2013 article from the Congressional Budget Office spoke to the impact by saying “The chained CPI-U results in lower estimates of inflation than the traditional CPI does. CBO expects that annual inflation as measured by the chained CPI-U will be about 0.25 percentage points lower, on average, than annual inflation as measured by the traditional CPI.”
Translated to English – the tax brackets will not grow as “fast” in the future. Therefore, someone who was near to going into the next tax bracket and receiving regular increases to their income may wind up in the next higher tax bracket sooner. Of note, the tethering of the tax brackets to Chained CPI is a change that will not sunset after 2025.
Deductions and Exemptions
There was also a major change to deductions. Pre-TCJA, the standard deduction for a single tax filer was $6,350 ($12,700 for married filing jointly). The TCJA greatly increased the standard deduction, and in 2021, the deduction for a single tax filer is $12,550 (or $25,100 for married filing jointly). Several changes reduced or eliminated many deductions for taxpayers who itemized their deductions.
For example, state and local taxes (SALT) capped at $10,000. For taxpayers in states with high tax rates, this change greatly reduced the income deduction they could claim on their tax return. The TCJA also reduced the amount of mortgage interest that could be deducted by only allowing the interest on the first $750,000 of mortgage debt to be deducted, reduced from a limit of $1,000,000 prior to TCJA.
The TCJA also eliminated personal exemptions, which is a deduction taken by the taxpayer, his or her spouse, and their dependents (in 2017 the personal exemption amount was $4,050). With the sunsetting of the TCJA at the end of 2025, we can expect a reduction in the standard deduction, removal of the SALT cap, and return of the personal exemptions.
Gift and Estate Tax
The TCJA effectively doubled the amount of the lifetime exemption of assets that passed on tax-free. That means the amount of lifetime gifts you can give while avoiding the gift tax is $11.7 million in 2021. For a married couple, that amount that can be given tax-free from both spouses is $23.4 million.
In the last 20 years, the exemption amount has only gone up. It has increased from about $500,000 to where it stands today. That all changes when the TJCA expires in 2026, as the lifetime exemption amount reduces to about $6 million ($12 million for married couples). You can bet that families with assets that total several million or that are on track to leave behind significant wealth to their beneficiaries will use estate planning techniques that have been out of fashion in recent years. Such strategies include using certain types of irrevocable trusts to avoid estate tax.
These changes may have positive, negative, or mixed impacts on your personal financial plans. Fortunately. we have an idea of what changes are coming, and we can plan for when they come into play. It does, however, require some effort to run these projections in your personalized financial plan. If you’d like to speak with one of our CPAs or CFP® Professionals on how the sunsetting of the Tax Cuts and Jobs Act of 2017 may impact you and your family, please get in touch with us.
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.