Opinion: Preparing your portfolio for higher tax rates

Taxpayers only have this year and next to take advantage of the lower tax rates enacted by the Tax Cuts and Jobs Act of 2017. On December 31, 2025, barring an act of Congress, the current personal tax rates are scheduled to sunset and revert to the higher pre-TCJA rates in 2026. It’s a possibility worth planning for.

First, for background, let’s explore a couple of key items.

The American income tax system is a progressive system, meaning that the first dollar you make is taxed at a lower rate than the last dollar you make. The current tax rates for 2024 are 10%, 12%, 22%, 24%, 32%, 35% and 37%. The rates are scheduled to revert to the pre-TCJA tax rates, which are 10%, 15%, 25%, 28%, 33%, 35% and 39.6%.

In 2017, the Joint Committee on Taxation estimated 46.5 million Americans itemized their deductions when the standard deduction for married filing jointly was $12,700. In 2018, after TCJA, roughly 18 million Americans itemized. The standard deduction for 2024 is $29,200 for married filing jointly, adjusted for inflation. The personal exemption and other items are set to reappear along with the reduction of the standard deduction.

Finally, the estate tax exemption is scheduled to be reduced by roughly 50%. The estate tax exemption is the maximum amount an individual can leave at their death and not pay federal estate tax. In 2024, the exemption is $13.61 million per person, up $690,000 over 2023. The federal estate tax is also a progressive system reaching a rate as high as 40%, according to the IRS.

Given that backdrop, here are some ideas to discuss with your tax adviser ahead of the potential rate increases:

1. Consider maximizing contributions to Roth IRAs, Roth 401(k)s and Roth conversions. The earnings on Roth IRAs grow tax-free and are withdrawn tax-free, provided the Roth has been established for five years and the account owner is older than 59 1/2. The tradeoff for the tax advantage is that there is no tax deduction in the year when the contribution is made. However, this could be an attractive proposition if tax rates are lower today than they will be in the future.
2. Accumulate a reasonable amount of capital losses. Although there will likely be a negligible change in capital gains rates upon the crossover into the 2026 tax year, managing capital gains and losses upstream ahead of the sunsetting could help with income distributions in future years. The IRS allows $3,000 in capital losses to offset any type of income each year for single filers and those married filing jointly. Losses in excess of $3,000 are carried forward to offset gains in future years. As an example, realized capital gains are included in the formula to determine how much of retiree’s Social Security benefits are taxable, if any. Both capital gains and the taxable portion of Social Security benefits could lead to a higher adjusted gross income. Some deductions hinge on adjusted gross income. Therefore, if more individuals will be itemizing their deductions beginning in 2026, a lower adjusted gross income could be beneficial. .
3. Consider reducing the value of traditional IRAs at these potentially lower tax rates. Traditional IRAs are taxed at ordinary income rates, which are set to go up in 2026. Therefore, reducing the values of IRAs at these potentially lower tax rates could result in saving money in the long run if tax rates go up. Reducing traditional IRA balances could be done with Roth conversions at any age, making withdrawals without a penalty once you’ve reached age 59 1/2, or giving funds directly to charity without tax consequences if you are age 70 1/2 or older. The age for required minimum distributions from traditional IRAs has increased to 73 for those who reach the age after December 31, 2022, according to the IRS.
4. If your estate runs the risk of exceeding the potentially lower exemption amount, work with your estate planning team to consider techniques to remove assets from your taxable estate. On November 26, 2019, the IRS clarified the regulation that individuals who have taken advantage of the higher exclusion amount will not be penalized if the exclusion amount drops back down.

Work with your financial professionals to take control of your goals and have a plan for the possibility of higher tax rates in the years ahead.

Andy Drennen is a certified financial planner and senior portfolio manager at Simmons Private Wealth in Springfield. He can be reached at andy.drennen@simmonsbank.com.