When people think of sunsets, they often imagine a romantic walk along a beach in the evening. However, in the context of the Internal Revenue Code (IRC), the word “sunset” has a very different meaning. In tax law, a sunset is an expiration date for a specific tax provision set by the law when it is enacted or amended.

The Tax Cuts and Jobs Act of 2017 (TCJA) introduced many changes to U.S. tax law. However, many of these changes included sunset provisions that will cause them to expire at midnight on January 1, 2026, unless Congress acts to extend them.

For individuals with larger estates, including high-net-worth and ultra-high-net-worth business owners, the sunset of the current estate and gift tax provisions presents a significant tax risk. Business owners have substantially grown their wealth through skyrocketing home values, employment stock options, inheritances, and business sales. For this demographic, it’s no wonder that estate taxes have quickly become a top concern.

The TCJA doubled the 2011 estate and gift tax exemption of $5 million, which is adjusted for inflation to slightly over $11 million for single filers and $22 million for couples. In 2023, the federal estate and gift tax threshold was $12.92 million per individual and $25.84 million for couples. These numbers have been further adjusted for 2024, with the exemption increased to $13.61 million for individuals and $27.22 million for couples. However, in 2026, the estate and gift exemption will revert back to pre-TCJA levels, effectively reduced by half, and is expected to be around $6.8 million per individual and close to $14 million for a married couple.

If business owners do not address this risk, 40% of their taxable estate above the exemption will be at risk of being handed over to Uncle Sam. Fortunately, estate and tax planning can minimize or eliminate this risk entirely at a relatively low cost.

More concerning is the immediate impact the sunset will have on the cash flow of business owners. Many business owners are more concerned with the immediate profitability of their business than legacy issues.

With the enactment of the TCJA, significant changes were introduced to the U.S. tax landscape. One prominent change was the reduction of the corporate tax rate from 35% to 21%. Additionally, the TCJA introduced IRC Section 199A, designed to bring S Corps and other pass-through entities in line with the C Corporation tax rate. IRC Section 199A generally allows taxpayers, excluding C Corporations, to claim a deduction related to their qualified business income (QBI). QBI is typically derived from trade or business activities.

Under this provision, eligible taxpayers can obtain a 20% deduction on their QBI, effectively reducing their tax liability. This benefit primarily applies to entities such as partnerships, S Corporations, and LLCs. Many of our clients have benefited from the 199A deduction. However, with the TCJA set to sunset on December 31, 2025, Section 199A is set to expire, ending this tax advantage.

In contrast, the reduced corporate tax rate of 21% will not expire, prompting a reevaluation of entity choice for taxpayers. While it was advantageous to structure businesses as partnerships, S Corporations, or LLCs for income tax purposes due to the benefits of Section 199A, the impending sunset of this provision might lead taxpayers to reconsider their entity choice.

The importance of business entity choice is compounded by the top marginal tax rate increasing from 37% to 39.6% with the tax sunset.

For business owners unaware of the tax bill increase already on their horizon, advisors should be bringing these key risks to their attention. At Guardian Tax Consultants, we work with business owners and their financial advisors to identify and mitigate tax risks. Many tax mitigation strategies are available to reduce the impact of this tax sunset, including adding additional entities to a business enterprise structure. Connect with us to learn about tax mitigation strategies that will help business owners today and after the tax sunset in 2026.

Sources

• IRS: Tax Cuts and Jobs Act Provisions that Sunset
• IRS: Estate and Gift Tax Changes Under the TCJA
• IRS: Qualified Business Income Deduction