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Business owners could experience a bit of tax sticker shock beginning in 2026.
The Tax Cuts and Jobs Act (TCJA) is scheduled to sunset on December 31, 2025. The act’s expiration means tax laws will revert to approximately what they were in 2017, the year the TCJA was signed into law.
For individual taxpayers, the TCJA has provided a range of benefits. It doubled standard deductions, lowered marginal tax rates, and significantly increased estate tax limits, resulting in lower tax bills for millions of Americans. Business owners, in particular, have enjoyed these provisions while also taking advantage of pass-through deductions to lower their personal taxable income.
If Congress allows these provisions to sunset, it will have significant consequences for taxpayers, especially business owners. Let’s look at three ways your tax bill could be negatively impacted following the act’s expiration.
Impact #1: Tax brackets and marginal tax rates will increase
The TCJA decreased how much taxpayers owe in two ways: by decreasing the marginal tax rate and increasing income thresholds in each tax bracket. Here’s a breakdown of the tax rates and brackets in 2017 vs. 2023:
Filers in the highest tax brackets paid 39.6 percent in marginal tax rates in 2017, compared with 37 percent in 2023. And higher income thresholds in 2023 mean taxpayers can earn more while paying a reduced rate, resulting in significant tax savings.
For example, let’s say you and your spouse take $350,000 as annual pay from your business. This puts you into the 24 percent tax bracket in 2023. This same salary will put you in the 33 percent bracket if rates revert to 2017 levels.
This change doesn’t just affect you; it also affects your heirs. Non-spousal beneficiaries who receive qualified retirement accounts such as a solo 401(k), SEP IRA or traditional IRA) will end up paying more in taxes on their inheritance.
Impact #2: Pass-through deductions will end
The TCJA allows “pass-through” business owners to deduct up to 20 percent of their net business income from personal income taxes. A pass-through business can be a sole proprietorship, partnership, S Corp or limited liability company (LLC).
Removing the pass-through provision means business owners may have more taxable income, especially if they continue taking the same amount from the business as an annual salary.
Impact #3: Estate tax exemption will drop
If you die in 2023, you can leave $12.92 million behind without incurring a taxable event for your estate. (That number doubles to $25.84 million for married couples.) The estate tax exclusion will drop to around $7 million ($14 million for married couples), adjusted for inflation, if the TCJA sunsets. As a result, a sizable chunk of your estate could go to Uncle Sam instead of your designated beneficiaries.
Your heirs may also find their net worth tied up in the business, without the cash flow to pay the required taxes. Since these taxes are usually due within nine months of your passing, your heirs could end up selling the business at a significant discount or to the wrong buyer to cover taxes owed.
Proactive planning options for business owners
While Congress still has time to extend the TCJA or make other changes to tax laws, it’s time for business owners to prepare for tax laws to revert to 2017 levels or even go higher. Here are a few strategies to consider:
Consider converting an IRA to a Roth IRA. If you own a traditional or SEP IRA, you may want to convert it to a Roth while tax rates are lower. You will owe taxes on the conversion in the tax year it’s completed, but the total taxes may be less than they would be after the TCJA expires.
“It’s not just the ultra-wealthy who need to be concerned; marginal tax brackets are set to increase as well,” said Matthew DelPriore, director of financial planning at Fortis Lux Financial. “This could be a good opportunity for clients to convert IRAs to Roths or make Roth contributions in lieu of pretax contributions given the fact that tax rates may be increasing for most filers come 2026.” (Related: The 2026 estate tax question mark)
Get strategic with deductions. You may want to hold off on any large business purchases, capital expenditures, or charitable gifts (either business or personal) until 2026 to maximize your deductions when tax rates increase.
“It is all about tax timing and forecasting your future income to better understand where you are tax bracket wise and how to best minimize the tax bite from Uncle Sam,” said DelPriore.
Reduce your salary and payouts for 2026. If you’re taking distributions from your business, it may be advantageous to reduce how much you’re paying yourself after the TCJA expires.
“Remember: The IRS has a reasonable compensation requirement, which means your salary must be comparable with what someone else doing the same job in your industry would be paid,” said Brian Trzcinski, CEPA, director of business markets for MassMutual. “One rule of thumb is to pay yourself a fixed percentage of the business's profit so that your compensation can adjust according to the performance of your business.”
Consider life insurance as part of your estate plan. Since life insurance proceeds are passed to beneficiaries tax-free, they can be leveraged to offset estate tax liabilities or cover taxes your non-spousal heirs might owe after inheriting a taxable account.
“If estate taxes are due, you may be forced to sell your assets at a significant discount because of the urgency and need for cash to pay the estate tax," said DelPriore. “That’s why I am a fan of life insurance as a part of the estate plan.”
Life insurance provides your heirs with immediate liquidity, giving them time and space to make deliberate decisions about the future of your business. In some cases, your heirs may even use it to buy out other family members who don’t wish to be involved in running the company.
“In closely held family businesses, not all family members get involved in the succession of that business," said DelPriore. “Life insurance can help provide a way to make the non-active family members whole.”
Conclusion
Finding the right solutions can be tricky, especially when we can’t predict what (if any) changes Congress will make before the TCJA expires in 2025. But taking a “wait and see” approach could result in a big tax bill.
Fortunately, we can take proactive steps to address potentially higher future rates. Talk with a MassMutual financial professional today to find out what strategies may work for you, your heirs, and your business.
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