Navigating the Uncertainties of the Tax Landscape

We are constantly hearing about new tax proposals in the media. So, while we will always have taxes, that’s for sure – we are often left with the uncertainty of what the tax landscape will actually look like down the road. This is always exacerbated in a presidential election year. Even when the Oval Office is filled and the new Congress is established where the “new” tax code will land is still in flux until it isn’t. We think that if either party takes control, there will be sweeping tax reform. If Congress and the Presidency are split, we could end up with compromised legislation.

In any operational or long-term investment decision, you have to consider taxes; however, they should not be the only driver of the business decision. Does this expenditure help my business become more profitable? Should I sell this investment because I have maximized my expected return and could utilize the net proceeds for other investments? Should I implement my succession plan? What assets have a high probability of appreciation over the years?

Let us focus on what we do know with absolute certainty today about taxes. When the clock strikes midnight on December 31, 2025, tax liabilities will increase for many business owners, and the amount of wealth that can be transferred tax-free will change dramatically due to expiring provisions of the Tax Cuts and Jobs Act (“TCJA”}. While there are several provisions that sunset, we will focus on a few key ones that will have the most significant impact.

The top tax rate for individual taxes will revert to 39.6% from 37%, and all rates and brackets will revert back to the 2017 amounts adjusted for inflation. This, coupled with the expiration of the qualified business income deduction of 20%, could raise a taxpayer’s effective tax rate by 10%. For example, taxable income of 1,000,000 from a passthrough entity for an individual in the highest tax bracket will see an increase of taxes of about 100,000. This does not account for the impact of expiring bonus depreciation and interest expense limitations that will drive up the taxable income. Bonus depreciation has been declining by 20% each year and will be zero for property placed in service in 2027 (60% in 2024 and 40% in 2025). The typical year-end tax planning point is to defer income and accelerate expenses where possible. However, coming into 2025, it may make sense to do the opposite and pay some tax at the “lower” rates. Place extra scrutiny on year-end accruals and lower cost or market inventory adjustments. Rather than deferring compensation, it may make sense to take that compensation now. Tax planning and determining the timing of estimated tax payments will be essential to manage cash flow as there will likely be significant shifts in income taxes even when book income might remain in line with previous years.

With estate and gift taxes, the TCJA doubled the exemption from 2018 to 2025. For 2024, it is $13,610,000 per spouse. In 2026, it reverted to roughly $6,000,000, adjusted for inflation per spouse. Keep in mind that many states have separate exemption amounts. The Massachusetts exemption is currently $2,000,000. Estates exceeding that amount are subject to state estate taxes.

There is no clawback provision for those who gift before the sunset but pass after the sunset. Also, a donor cannot use part of their exemption now and preserve the balance for later use. For example, if an individual makes a gift of $7 million in 2023 and passes away in 2026 when the exemption exceeds $7 million, the individual’s estate has no remaining exemption. If you are married, consider having one spouse make a large gift to utilize their exemption to get “at least one bite of the apple.”

With an appropriate valuation of assets completed, the value of the transferred assets can be discounted by the application of well-established factors, and the amount of assets that can be transferred via the increased exemption amount is substantially expanded. Common discount factors include lack of marketability, lack of control, and restrictions on subsequent transfers. Despite repeated threats of the “loophole closing,” valuation discounts withstand IRS scrutiny. Leveraging transfers through valuation discounts provides opportunities to transfer undivided partial interests in real estate and family businesses, including recapitalization of voting and non-voting stock. Focusing on assets expected to appreciate significantly in the future allows growth to occur outside of your taxable estate.

If you have been considering transferring wealth, this process should absolutely start now. As we approach the end of 2025, the professionals involved with valuing assets, preparing the appropriate documents and filing the appropriate tax returns will be increasingly busy impacting turnaround times and the ability to complete it all on time.

While the certainty of taxes remains a constant, the landscape in which they operate is ever-changing. As we approach significant shifts in tax legislation, particularly with the sunset of critical provisions of the Tax Cuts and Jobs Act, business owners and individuals alike must stay informed and proactive. Strategic tax planning, timely decisions, and leveraging available exemptions and deductions can help mitigate the impact of these changes. By focusing on what we can control and preparing for what lies ahead, we can navigate the uncertainties of the tax landscape with greater confidence and clarity.