Clearing the Fog: Anticipating the Impact of the 2025 Tax Cliff

The recent past and the current year, in particular, have been marked by dramatic domestic and international changes. With an electoral year underway, a tax cliff scheduled for 2025, and a global climate more complicated than ever, more changes are a-coming. The direction of these changes is the ‘million-dollar question’ (or trillion-dollar question if we consider the US budget).

Whereas we cannot and will not venture to make socio-economic predictions, we can opine on what we know best: US tax.

Both 2024 and 2025 will be marked by important changes, with 2025 being a fiscal cliff year at the end of which all of the Tax Cuts and Jobs Act (TCJA) provisions are scheduled to expire. To refresh our readers’ memory, some of the TCJA highlights included: redefined individual tax brackets that topped the individual tax rate at 37%, the elimination of personal exemptions and their replacement with higher standard deductions, a state and local income tax deduction capped at $10,000, a deduction for qualified business income (also known as a QBI deduction), and a single corporate tax rate of 21% to name just a few.

One of the changes TCJA introduced in this seven-year period (2018-2025) was the historically high lifetime exemption for gifts and estates, which will peak at $13.61 million in 2025. If allowed to sunset, this estate tax exemption lever will revert to roughly $7 million (as adjusted for inflation).

TCJA provisions included numerous other business-friendly provisions to encourage economic growth for small enterprises and big corporations alike. However, these provisions were and continue to be expensive from a tax revenue perspective. According to the Congressional Budget Office, extending all TCJA individual provisions would cost $3.5 trillion over the next ten years. So the question remains – How would they balance the scorecard if these provisions were made permanent? Certainly, it is a difficult question to answer and highly dependent on who wins the presidential seat this November and what the legislative composition of Congress looks like. There is bipartisan support to maintain the TCJA individual tax provisions for households that make below $400,000. However, this would have to come at the price of raising corporate rates or even eliminating the qualified business deduction. In contrast, extending only the business TCJA business provisions would have a smaller tax revenue impact.

With so much at stake, one of the critical points up for debate in this electoral run is, without a doubt – tax fairness. The Democrat focus remains on raising corporate rates and taxing wealthy individuals to fund several high-impact social programs. On the other hand, the Republican side expressed ‘hopes to cut corporate tax rates to 20 percent, bring more tax cuts for all Americans and reinvigorate America’s energy industry to bring down inflation, lower the cost of living and pay down or debt,’ according to Karoline Leavit, former president Trump’s national press secretary.

If history is any indication, the outcome from these two clashing currents will be a ‘happy medium’ with some of the TCJA provisions being kept in place. For example, whereas we do not anticipate the lifetime exemption to be extended past 2025 at its current level, we see other individual provisions (individual tax brackets, associated tax rates, the postponement of personal exemptions, etc.) as very likely to survive the tax cliff. The qualified business deduction is another provision that may survive the tax cliff.

Given the budget deficit, new tax-revenue-generating sources would need to be identified to ‘finance’ any TCJA deductions, tax rate cuts, or credits that survive the tax cliff. A potential source of revenue for the budget is continuing to raise tariffs on certain imported goods.

Another potential source would be to raise the tax rates applicable to wealthy individuals and corporations.

The current IRS audit trends offer a good indicator of how the Service plans to increase the collection of tax revenues. Below are some highlights from the IRS’ ‘road ahead in 2024 and 2025’ contained in the Service’s Strategic Operating Plan:

• The plan highlights that the IRS will nearly triple audit rates on large corporations with assets over $250 million to 22.6% in 2026, up from 8.8% in 2019.
• The IRS will increase audit rates by nearly ten-fold on large, complex partnerships with assets over $10 million, going from 0.1% in 2019 to 1% in tax year 2026.
• The IRS will increase audit rates by more than 50% on wealthy individual taxpayers with total positive income over $10 million, from an 11% coverage rate in 2019 to 16.5% in the tax year 2026.
• At the same time, the IRS continues to emphasize the agency will not increase audit rates for small businesses and taxpayers making under $400,000, and those rates remain at historically low levels.

Perhaps, with so many variables creating the fog, the focus should not be on the crystal ball but on being well-prepared for various possibilities. This is why we partner with our clients to build sound, efficient and informed tax solutions that withstand the test of time (and audit).