With the new year in full swing, it is an appropriate time for clients to revisit personal matters and for those involved with businesses to revisit their business-related issues as well.
Implications of Tax Cuts and Jobs Act (TCJA)
A significant issue surrounding the Tax Cuts and Jobs Act (TCJA) is the expiration of many tax provisions at the end of the calendar year 2025, commonly referred to as the "Sunset." Much of the financial press has concentrated on the potential impact of the Sunset on the federal estate tax exemption amount. The current federal estate tax exemption is $13.99 million per person for 2025. If the Sunset occurs, this exemption will be reduced to approximately $7 million per person starting in 2026.
Estate & Income Tax Plans for the Future
In addition to estate tax changes, there are a number of income tax changes that will be impacted by the Sunset. The top individual income tax rate will increase from 37% to 39.6%. Additionally, the $10,000 exemption for the deduction for state and local taxes will expire.
Although it is premature to determine what Congress will do, it is advisable to consider how to address potential estate tax liability through transfers to family members or charities in calendar year 2025. High-net-worth clients who have not yet utilized the existing estate tax exemption should act promptly to utilize the exemption available in 2025, rather than delaying further. If Sunset occurs, clients who do not act may miss the opportunity to transfer significant value under the existing exemption amount.
Regarding income tax planning, consider whether there is a benefit to accelerate income in the calendar year 2025, if possible.
Congressional Uncertainty & Impact on Tax Policy
Of course, all of this depends upon what Congress and the new administration will pursue relating to tax policy in calendar year 2025. In May 2024, the nonpartisan Congressional Budget Office estimated that extending all of the provisions of TCJA adds $4.6 trillion to the deficit over 10 years (2025-2034). Even with Republican control of Congress, the narrow majority may lead some Congressional members to express concerns about the deficit impact of extending all provisions of the TCJA. This situation then leads to "pay for" discussions where tax measures would need to be offset by corresponding tax increases or spending reductions. All of this leads to great uncertainty as to the future of tax planning beyond 2025. Before the change in administrations, the Office of Tax Analysis in the Treasury released its estimates on January 10, 2025, detailing the tax breaks scheduled to Sunset.
Treasury's first scenario estimated that if all of individual and estate tax provisions to TCJA are extended for an additional ten years, that cost would equate to a $4.2 trillion price tab. The $4.2 trillion estimate would rise to as much as $5.5 trillion depending on which business tax provisions of TCJA are extended.
Review Buy/Sell Agreement
Those persons who have active businesses and buy/sell agreements should review those agreements to confirm that the valuation mechanism reflects the current value of the business. Additionally, they should review the buy/sell arrangement itself. A review of the arrangement has taken a more prominent role in light of the Supreme Court's decision last year regarding valuation of a business for estate tax purposes when business-owned life insurance was payable to the corporation to effectuate a buy/sell agreement. This type of arrangement is referred to as the "redemption agreement". The case is Connelly v. United States. In this unanimous decision, the United States Supreme Court held that corporate-owned life insurance on the life of a deceased shareholder, acquired for the purpose of redeeming the deceased shareholder's stock, increased the value of that stock.
In this particular case, two brothers entered into a buy/sell agreement. The buy/sell agreement was funded with life insurance owned by the corporation. The Internal Revenue Service, in valuing the business, increased the business' valuation by the amount of life insurance that was payable to the corporation.
There are two approaches for a buy/sell agreement among business owners. The first is the redemption or entity purchase agreement, where the business itself is obligated to purchase the deceased owner's stock. The alternative is what is referred to as the "cross purchase agreement," where the obligation to purchase is among the business owners and not the business. In this case, an agreement funded by life insurance will not increase the value of the deceased's ownership by including the life insurance the value of the business entity when the insurance proceeds are payable to the entity itself.
Update Beneficiary Designations
This is also the appropriate time for reviewing beneficiary designations. This relates to any assets that pass by way of beneficiary designations such as pension plan benefits, IRAs, annuities, and life insurance. Not only is it imperative that there be a primary beneficiary designated in any such account but also do not overlook contingent beneficiary designations as well.
New Rules for "Catch-Up" Contributions
Finally, a new rule in the qualified plan area, a "catch-up contribution." This new rule permits individuals attaining ages 60-63 in 2025 to make a catch-up contribution of $11,250 to an employer plan, such as a 401(k) plan.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
