The Politics Of Investing

For The Tax Cuts And Jobs Act, An Early Sunset

Planners need to act quickly

by Chris Bogren

Chris Bogren is Vice President, Advanced Planning for Jackson National Life Distributors LLC (JNLD). Visit www.jackson.com.

On January 1, 2026, many of the provisions in the Tax Cuts and Jobs Acts (TCJA) will revert to pre-TCJA levels. Without proper planning, these changes could have negative effects on many clients, especially those with high incomes or high net worth. Many hyperbolic nicknames such as the “great sunset,” “estate tax cliff” or “2026 tax trap” are popping up to describe the upcoming TCJA sunset, but the main point is the same: without proper planning, it may be an extraordinary event that could affect many Americans’ tax bills.

Overview Of Tax Cuts And Jobs Act

When the TCJA was originally passed in 2017, lawmakers built into the bill an automatic “sunset” or reversion to pre-TCJA levels for many of the key changes. At the time, the 2026 horizon seemed distant, and optimism led planners and investors to believe these changes would become permanent. However, the TCJA is in its twilight, and no progress has been made to extend these changes beyond 2025. The results of the 2024 elections will have a major impact on the direction of potential changes to the TCJA. As each week passes, it is becoming more likely the sunset in 2026 will happen, at least in some form. For many clients, now is the time to start preparing for major tax and estate-planning consequences they could potentially face.

Estate And Gift Exemption Reduction

In 2024, the estate and gift exemption is $13.61 million per person, or $27.22 million per married couple at the federal level. This means an individual can gift or leave behind (or a combination of the two) just over $13 million for heirs without facing the dreaded federal estate tax. Anything over that $13.61 million is subject to a hefty 40% tax. Most Americans are not affected by this tax because the exemption is so high — or if they are, they may have already taken steps to mitigate the amounts subject to the tax. However, on January 1, 2026, this $13.61 million (indexed) will automatically be reduced to $5.6 million, indexed for inflation. This could result in the final number landing somewhere between $6 million and $7 million per person, or $12 million to $14 million per married couple once the exemption is reduced. If a person does not use their full exclusion through gifting before this time, they will forfeit the difference between the old amount and the new.

In short, without proper planning, many Americans will go to sleep on December 31, 2025, without an estate tax problem and wake up on January 1, 2026, with a significant one.

How Irrevocable Trusts Can Help

With this issue looming, the funding of irrevocable trusts could spike over the next two years. Trusts can be an effective estate tax-reduction tool for those who may be suddenly thrust over the estate tax threshold. To use the higher exemption now, trust grantor(s) can gift assets such as, cash, investments, property or even business assets, into a trust up to the current exemption, without the sting of gift taxation. This effectively removes the assets from the estate and allows the assets to grow estate-tax-free. As of now, once the exemption amount falls in 2026, assets previously gifted to an irrevocable trust are outside of the grantor’s estate and not subject to the then-reduced estate tax exemption. The more those assets appreciate inside the trust, the bigger the federal tax bill avoided. NOTE: The estate tax strategy above does not apply to revocable trusts.

It is important to remember the two main types of irrevocable trusts: grantor irrevocable trusts and non-grantor irrevocable trusts. Once funded, both trusts remove assets from an estate, which is important to alleviate the effects of the impending sunset. A trustee is named to manage the assets and distributions pursuant to the governing trust documents. The major difference between the two is where the tax liability flows on investment gains or other income generated inside of the trust.

With a grantor irrevocable trust, the income taxation is the responsibility of the grantor while they are alive, whereas in a non-grantor trust, the trust is responsible for the tax bill at trust tax rates. From an income tax perspective, grantor trusts may cause an unwanted tax bill for the grantor. In the alternative, non-grantor trusts are subject to highly compressed trust tax rates. Trust grantors face a decision up front as to whether they want to be responsible for the taxes on assets they cannot use or enjoy or whether they want the growth of trust assets to be reduced by onerous trust tax rates.

Trust planning can be beneficial for a myriad of reasons, and many different types of trusts can be used to accomplish the goals of the grantor(s). However, income tax issues can be a major obstacle. There are a variety of ways to overcome the tax hurdles related to trusts. For example, a trustee can purchase an annuity inside of an irrevocable trust for the tax deferral it could potentially provide.

Let’s say Grandma Diane chooses to fund a generation-skipping trust for the ultimate benefit of her granddaughter, Olivia. Diane funds this trust now to get assets out of her estate, but she does not want the growth to be eroded by trust tax rates, or to receive a tax bill every year on the growth. Therefore, working with her attorney and financial professional, Diane chooses to purchase an annuity as one of the investment vehicles in the trust to avoid paying taxes on growth of those assets until money is withdrawn. By naming Olivia as the annuitant, Olivia becomes the measuring life on the policy, meaning a death benefit is not triggered until Olivia passes away, essentially creating multigenerational tax deferral. This is just one of many ways to incorporate a trust-owned annuity into estate planning, and as more of these trusts are created in the run up to the TCJA sunset, the need to find tax-efficient strategies will grow.

Reversion To Pre-TCJA Tax Brackets & Planning Techniques

The other looming issue that will affect more than just high-net-worth persons is the reversion to the pre-TCJA tax brackets. Many people saw a decrease in their tax bills due to the changes in tax brackets as well as the increased standard deduction from $6,500 to $12,000 for single filers and $13,000 to $24,000 for those married filing jointly. Additionally, the income threshold for capital gains was decoupled from ordinary income, which benefitted many high earners. However, reverting to previous tax brackets and standard deductions will increase tax liability for many Americans. For those adversely affected, this increase will come as an unwelcome surprise and leave many wondering why their tax refunds are lower (or why they owe more taxes after filing), and how to counteract these changes.

By moving money into non-qualified annuities, clients can invest uncapped amounts for retirement, without the same required minimum distribution requirements of qualified accounts, while still enjoying tax deferral...

Fortunately, clients can mitigate some of these increases with thoughtful planning techniques. The first of these is using the power of tax-deferred accounts. Many people are already setting money aside in qualified plans and IRAs. By increasing contributions, they may be able to minimize the impact of the tax changes by reducing their adjusted gross income. In maximizing contributions, not only are clients able to save more for retirement, but they are also potentially able to reduce income taxes along the way. Of course, there are limits to the amount that can be socked away inside these tax-qualified accounts. For clients who are making the maximum allowable retirement-plan contributions and are further investing into non-qualified accounts, the use of a non-qualified annuity may be a good fit. By moving money into non-qualified annuities, clients can invest uncapped amounts for retirement, without the same required minimum distribution requirements of qualified accounts, while still enjoying tax deferral. Clients with non-qualified annuities can experience account growth while avoiding an annual tax bill on those non-qualified accounts — which can be especially important during prime earning years. Once retired, most people find themselves in lower tax brackets and can use those funds at that time or leave them as a legacy to heirs.

Another opportunity may lie in performing Roth IRA conversions. Many taxpayers are paying a lower income tax rate under the TCJA than they will after the TCJA sunset. Those taxpayers may consider converting a portion of an IRA or qualified plan, or even the entire amount, from pretax dollars to tax-free dollars. Keep in mind, this will cause a taxable event in the year(s) of conversion, but this may be a worthwhile strategy for the opportunity to pay taxes at a potentially lower rate (if tax rates and the account value continue to climb) and allow that money to grow tax-free going forward. In the future, the Roth account can be used to supplement retirement or be left to heirs who may withdraw those funds tax-free.

Conclusion

With the sunset on the horizon, it may be an opportune time to address the potential changes with clients and discuss how they may be negatively impacted. With proper planning, some or all of the negative consequences from this legislation may be mitigated. However, that planning can take time to implement, so making clients aware of potential issues is a critical first step.

 

 

1 Tax Cuts and Jobs Act, Conference Report to accompany H.R. 1, December 15, 2017.
2 IRS provides tax inflation adjustments for tax year 2024 – Internal Revenue Service
3 Ibid.
4 Martin Schamis, Kiplinger, “What to do Before the Tax Cuts and Jobs Act Provisions Sunset,” June 13, 2023.
5 EideBailley, “Estate and Gift Tax-Estate Planning Now and for the 2026 Double Exemption Sunset,” May 17, 2023.
6 Julia Kagan, Investopedia, “Irrevocable Trusts Explained: How They Work, Types, and Uses,” September 27, 2023.
7 Note that trustees may try to avoid trust tax rates in non-grantor trusts by passing income out to trust beneficiaries, but this may create issues with unwanted income/taxes and/or reduce the growth of trust assets.
8 Martin Schamis, Kiplinger, “What to do Before the Tax Cuts and Jobs Act Provisions Sunset.” June 13, 2023.
9 IRS, “Topic 556, Alternative Minimum Tax,” August 16, 2023.
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