Back in 2017, congress passed the Tax Cuts and Jobs Act, one of the biggest and broadest tax bills in recent decades. Many people (but not everyone) saw their taxes dramatically drop and benefited from more money back in their pockets. For better or worse, many of those breaks instituted in 2017 will expire after next year. Especially for some business owners, this could mean higher taxes within two years, depending on the situation. Couple this with a presidential election, and you can quickly see why having a plan for your taxes for the next 24 months can be critical.
Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act, or TCJA, changed many of the rules within the income tax landscape. It covered income tax rates, deductions, credits, estate exemptions, business income, state and local taxes, alternative minimum tax, among other areas. Whenever multiple areas of tax law are updated, people will land on both sides of the fence in terms of who benefits and who does not. As the name implies, it is reasonable to say most people benefited from the “Tax Cuts” part of the new legislation.
Perhaps the most memorable change was the decrease in the federal income tax rates. Almost every federal income tax rate decreased by a few percentage points:
| Before TCJA | 10% | 15% | 25% | 28% | 33% | 35% | 39.6% |
| During TCJA | 10% | 12% | 22% | 24% | 32% | 35% | 37% |
While each bracket may have dropped slightly, what is important to note is that the income ranges for some brackets themselves also shifted. Currently in 2024, a family with taxable income just under $201,050 would be in the 22% bracket. Under pre-TCJA rules, that same bracket (being taxed at 25% and not 22%) would likely have ended $189,850. The effects get worse as the income increases: the 24% bracket ends at $383,900 vs. the 28% pre-TCJA bracket ending at an estimated $289,250.
The calculation for “income” more broadly also changed significantly. Mainly related to adjusted gross income, TCJA changed and removed many of the rules around exemptions and deductions:
- Most notably was doubling the standard deduction. In 2017 the standard deduction for a married couple was $12,700 ($6,350 for a single filer). In 2018 under TCJA it doubled to $24,000 (and $12,000).
- The personal exemption was removed, where taxpayers in 2017 could have claimed $4,050 per family member that qualified as a dependent.
- The child tax credit doubled from $1,000 to $2,000.
- The amount of state and local income taxes (SALT) you could deduct was capped at $10,000.
- Most miscellaneous itemized deductions like legal fees and such were eliminated.
There were other changes as well, but altogether altered the calculation of taxable income for many taxpayers.
Where this gets interesting is the fact that in order for Congress to pass TCJA, they imposed a “sunset” for many of the changes within the bill. Simply put, that means many of these changes that went into effect in 2018 will disappear after 2025 and we will revert back to 2017 rules. Congress still has the ability to extend the TCJA provisions, but at the current moment they are set to expire. That means there will be a lot of (likely unfavorable) changes coming in 2026.
What Is Changing?
Everything mentioned above is currently set to expire:
- Tax rates will return to the pre-TCJA levels.
- The standard deduction will likely be cut in half.
- The $4,050 personal exemption will return (but like inflated to somewhere around $5,000).
- The child tax credit will drop back to $1,000.
- Miscellaneous itemized deductions will return and the $10,000 SALT cap will disappear.
Business owners also have a significant problem to address, since most of the changes mentioned to this point have been related to individual tax items. Those who also receive business income, or own property and/or corporations, could see some notably differences as well.
One of the beneficial changes to companies through TCJA was to reduce the corporate tax rate from 35% down to a flat 21%. As it stands, this change was permanent and is not set to revert back to 35%. So, all the C corporations will not see a major change, barring any new legislation. For all the other business owners, namely those with pass through income like an S-Corp or Partnership, may lose access to the qualified business income (QBI) deduction.
The QBI deduction, where business owners can deduct the lesser of 20% of qualified income or 20% of total taxable income, was a TCJA-instituted deduction. It is also set to expire come 2026. For example, if the QBI deduction expires, a business owner who has enjoyed a $40,000 QBI deduction off of $200,000 in qualified income will no longer be able to claim such a deduction. Someone in this situation is likely around the 22% tax rate, which means $40,000 extra in taxable income could produce at least an extra $8,800 in taxes.
Business owners are also losing out on bonus depreciation as well. Since TCJA was enacted, we have enjoyed deducting 100% of the cost of new property in the year we purchased it. If your CPA has ever told you to go buy equipment, cars, furniture, etc. at the end of the year, this is why. Deducting the whole cost could help offset taxes in a higher income year. Unfortunately, this strategy is already phasing out. For 2024 alone you can now only deduct up to 60% of qualified property, and each year hereafter it drops by another 20% until it is completely phased out by 2027.
What Do We Do About It?
With the current regulations in place, the tax landscape could look pretty different for business owners in the next couple of years. If the right proactive measures are taken, it is possible to benefit from these coming changes. Exactly how to save on taxes will depend on the specific situation, but when done right it could mean the difference in thousands of taxes. This is where it my be beneficial to consult with a financial professional to determine the best approach for your situation.
One of the biggest upcoming changes for business owners is the elimination of the QBI deduction. The 20% QBI deduction has likely been one of the largest tax deductions available to owners each year. To plan for the potential lost deduction, it may be worth trying to accelerate any potential income or decrease expenses before the TCJA expires. Since the QBI deduction is a function of income, focusing on increasing revenue for the year may help. Then, at least in some cases, switching to Roth retirement contributions can also help (since traditional retirement contributions reduce taxable income and QBI).
This also means there are new planning opportunities post TCJA. Losing the QBI deduction may be a great incentive to start a retirement plan at your company and take advantage of the massive deductions that you have not previously been using. This could also look like deferring major expenses, investments, and/or depreciation until 2026, when you can write those off (to some degree) and “replace” the QBI deduction you are losing.
Sometimes, something as simple as increasing your savings for taxes throughout the year could help. If it is apparent that taxes will increase, being prepared by saving extra into the savings account for taxes can help from a cash flow perspective. The last thing we want is to be surprised come April 2027 when your 2026 taxes jumped dramatically.
Plan For the (Taxable) Future
These changes, if they happen, are still pretty far away from when you will feel a difference. You have at least a year or two before Uncle Sam will start entering your pocket more. If you wait until then to try and minimize your taxes, it may be too late. Planning ahead and pulling all the levers you can before TCJA expires could help you save thousands in taxes. Many business owners don’t understand their current tax situation, so starting with where you are today and what the next 2-3 years would look like could give you tremendously clarity with your taxes.
TC Falkner 