Write Off the Sunset: Planning Around the OBBBA

I would like to thank Vivian Yang, Associate Director in our Tax Department,  for her contributions to this article. 

Much of the financial planning discourse since 2017’s Tax Cuts and Jobs Act has been about preparing for contingencies should its signature lowering of federal income tax rates and near doubling of estate tax exemptions sunset at the end of this year. The One Big Beautiful Bill Act enshrines the tax landscape cultivated by the TCJA, with ever so slight modifications and annual indexing for inflation in the years ahead, infusing a greater degree of certainty into planning conversations. The lowest federal income tax bracket will remain at 10%, the highest at 37%, and the unified estate and gift tax exemptions get a boost to $15 million per person.

But with this clarity comes a fresh wave of confusion around new policy, much of which was introduced on a provisional basis to be reassessed after 4-5 years. We will all be waiting with bated breath for the IRS to issue further guidance on the new, controversial elements of this bill. Perception of beauty is famously subjective, and David opined extensively in this Friday Dividend Cafe, but the bill is incontrovertibly big, and there are ample opportunities for us to consider even as we are just beginning to excavate. So, what’s new, what’s staying the same, and what requires peeling back a layer of political varnish to get to the actionable substance?

A Quick Primer:

You’re going to encounter tax jargon both here and in other breakdowns of the bill that may or may not be familiar or comfortable.

All eligible taxpayers can claim “above the line” deductions (i.e., IRA and Health Saving Account contributions, student loan interest, and half of one’s self-employment taxes), which reduce one’s gross income, regardless of whether “below the line” they elect to take the standard deduction (an amount all taxpayers are entitled to write off, as set by the federal government each year) or itemize based on an approved list of common expenses (i.e., charitable gifts, state and local taxes, and mortgage interest), should the aggregate of those items exceed the standard amount.

Whereas deductions reduce how much of your income is taxable, credits are applied to directly reduce the final tax bill dollar for dollar, so they pack a big punch.

The Allure of the Standard Deduction:

The standard deduction nearly doubled under the TCJA, which made it less practical for many taxpayers to consider itemizing. With the passage of the OBBBA, the standard deduction is elevated to $31,500 for joint filers and $15,750 for single filers, plus an additional $1,600 for married individuals and $2,000 for single individuals who are over age 65.

When the TCJA capped the state and local tax (SALT) deduction at $10,000, charitable giving was forced to do a lot of heavy lifting. (Note that there was also a principal limit on which mortgage interest could be deducted under the TCJA, which will continue in perpetuity at $750K for joint and $325K for single filers with the OBBBA.) But this opened the door for a handful of impactful approaches that now remain in play, most notably a “bunching” strategy in which one can make large charitable gifts every other year and alternate with the standard deduction to maximize deduction power. Donor Advised Funds are an invaluable tool through which a large deductible gift can be made, based on a taxpayer’s income level for that year, and deployed to favorite charities in subsequent years.

Changes to Being Charitable:

The OBBBA adds a new element to consider in charitable planning, but how potent is it? A permanent above-the-line charitable deduction of $2,000 for joint filers and $1,000 for single filers will now be permitted, and the itemized below-the-line charitable deduction is subject to a 0.5% floor of Adjusted Gross Income, or one’s income after above-the-line deductions have been accounted for. For example, if one’s AGI is $500K, the portion of their charitable giving that can be included in itemized deductions is everything over $2,500.

If you are someone who makes charitable gifts but not at the level where it would make sense to itemize, you can now take advantage of the above-the-line deduction for a portion of your annual giving. Conversely, for those considering sizable gifts that would be part of a larger itemized list below the line, a small sliver of your Adjusted Gross Income can no longer be deducted, though for most, this will be offset by the new allowance above the line. This will provide a nice top off for those who utilize the standard deduction, but it is more of a new nuance to understand than a fresh window of opportunity.

SALT in the Spotlight:

There has been loud chatter about raising the state and local tax deduction, amplified by key holdouts in Congress from high-tax states who felt that a $10,000 SALT cap disproportionately impacted their constituents. The below-the-line SALT cap is now raised from $10,000 to $40,000 per year, but is subject to a phase-out for high earners. In 2030, it is scheduled to revert back to $10,000. And while this increase will temporarily give more wiggle room to some looking to itemize, those with state and local taxes high enough to take advantage of the new cap are high earners who will begin to see it phase out with Adjusted Gross Incomes beyond $500K. For those above $600K, the SALT deduction remains firmly unchanged at $10,000. So, even though SALT is receiving extensive coverage, one cannot qualify this as seismic enough of a shift to be a heavy hitter in a deduction strategy.

Notably, however, the pass through entity taxation (PTET) workaround, which effectively allows business owners in high tax states to pay state taxes through an entity and deduct them federally, was unaddressed by this bill and can continue to be utilized as a means of circumventing a SALT limitation.

Promises Made, Promises Kind of Kept:

No tax on Social Security, no tax on tips, and no tax on overtime were signature promises of Trump’s 2024 campaign, as well as deducting auto loan interest, and the administration is already working overtime to spin the form they take in this bill.

The Social Security Administration sent an email to current benefit recipients claiming that “the bill ensures nearly 90% of Social Security beneficiaries will no longer pay federal income taxes on their benefits.” This is a misleading characterization since the underlying tax treatment of Social Security remains unchanged. However, US seniors above 65 will be granted a $6,000 per person above-the-line deduction from 2025 to 2028, phasing out for high earners. A moderate to low-income couple in retirement may be able to stack a $12,000 deduction above the line on top of an increased standard deduction below the line to receive meaningful tax relief for the Social Security benefits that make up the bulk of their income. For higher earners, the deduction would be phased out, and their benefit is still up to 85% taxable, so no substantial change.

Meanwhile, up to $25,000 in tip income and up to $12,500 in overtime compensation per person will be deductible above the line from 2025 to 2028, phasing out for high earners. This will present some logistical challenges and require some clearer guidance to implement, and many individuals who receive cash tips do not always declare all of those funds to begin with. This is another one of those changes that will only be in play for the next several years, so time will tell how impactful it is deemed to be and whether it is worth expanding and extending before it expires.

The ability to deduct up to $10,000 in auto loan interest above the line is also in effect from 2025 to 2028 and only applies to new automobiles with final assembly in the US as part of President Trump’s push to bring manufacturing back to the United States. Very few will be able to utilize this, and, as David touched upon in his overview, incentivizing consumer debt on a depreciating asset is antithetical to the growth-focused tenets of a long-term financial plan.

Trumping the Trump Account:

Never one to miss a branded opportunity, Trump is rolling out the Trump account, a tax-deferred vehicle which the government will prefund with $1,000 for children born between 2025 and 2028. Additionally, families can make non-deductible contributions up to $5,000 per year. Companies can even chip in up to $2,500 for an employee’s eligible child, though it is unlikely that this will become a highly utilized benefit. The funds must be invested in a broad stock index and used by the recipients after age 18 for higher education, job training, small business investments, or a home down payment. Qualified distributions will be taxed as long-term capital gains, whereas distributions for any other purpose will be treated as ordinary income and subject to a 10% penalty if withdrawn before age 18.

Other than $1,000 in free money, the tax-deferral benefits are not as robust as other saving alternatives, such as 529s or IRAs. The terms for using the funds are slightly broader for Trump accounts than 529s, but the ability to make larger contributions along the way and, in some instances, deduct at the state level still point to the 529 as a more advantageous option. Contributing to an IRA or a Roth IRA for a child requires that they have earned income, but both are more favorable than the Trump account due to a long time horizon for appreciation and greater flexibility in investment choices.

Credits Come and Credits Go:

The Tax Cuts and Jobs Act doubled the Child Tax Credit (CTC) temporarily and made it available to more families by shifting the phase-out thresholds. With the OBBBA, the CTC is increased permanently to $2,200 per child for 2025, to grow annually with inflation, and is phased out for high-earning families. Other credits, such as those that rewarded implementation of clean energy initiatives or subsidized marketplace health coverage under the Affordable Care Act, are scheduled to expire this year and were not extended by the OBBBA.

Credits can go a long way in reducing income tax due. Continuing to grow the Child Tax Credit is a big win for families with children, and it was inevitable that credits tied to policies on which opposing parties disagree would take a hit. The ACA subsidies are calculated based on where a taxpayer falls relative to the federal poverty line, and it was previously viewed as an impactful tactic in the years between retirement and Medicare enrollment to keep income low and apply these credits to save significantly on the cost of marketplace care.

Giving Estate Planning a Little Lift:

Prior to the passage of the OBBBA, the lifetime federal estate and gift tax exemption sat at $13.99 million and was scheduled to be slashed in half, where it lived pre-TCJA. However, since retroactive gifts up to that exemption would not be walked back and deemed taxable with a reversion to old levels, estate planning leaned heavily on irrevocable gifts and highly scrutinized vehicles like the Spousal Lifetime Access Trust to lock in the higher exemption should the sunset occur.

The new bill raises the exemption permanently to this higher level and gives it a slight lift to $15 million per person, alongside the generation-skipping transfer tax exemption. This will prevent many wealthy families from being exposed to federal taxation, as well as allow those engaging in multi-generational estate planning to take a deep breath and avoid implementing hasty strategies.

The OBBBA Impact:

In digesting a bill that boasts its size in its title, Americans may be struck by how so few of the new policies could affect them. For many, the largest impact from the bill is not what will change but what will stay the same. New guidance on deductions and depreciation will be gleefully employed by business owners, cuts to Medicaid will not be felt fully for a few years, and most will find that the OBBBA marks merely an extension of the status quo. Had the TCJA sunset, Americans at all income levels would have surely felt the hit. Before writing off the bill’s other impacts, meet with your financial, tax, and estate planning teams to reexamine your picture with fresh eyes. There is an opportunity for some big beautiful financial clarity that may have felt elusive with the sunset looming.