For more information, please review my summary of the new law here.
Beyond providing a summary of the One Big Beautiful Bill Act (OBBBA), I wanted to provide some initial thoughts to consider when creating a tax plan for 2025 and beyond.
Lots of additional tax torpedoes
Many of the new features in the OBBBA include income based phase out ranges. These phase outs are generally based on modified adjusted gross income (MAGI)1. This creates a dynamic where you lose the value of the benefit/deduction as your income increases. In these scenarios, you will owe tax on the additional income and also pay an additional tax in the form of the lost deduction. This creates a sharp rise (followed by a sharp fall) in the effective marginal tax rate. These situations are generally known as tax “torpedoes”, and do merit some additional attention when it comes to tax planning.
As an simplified example, let’s consider the new state and local tax (SALT) deduction and it’s associated phase out.
Assume Anne and Joe are married and have $20,000 of deductible mortgage interest and $40,000 of deductible SALT expenses. If their AGI is $490,000 (all from wages), then their taxable income is $490,000 – $20,000 – $60,000 = $430,000. This puts them squarely in the 32% marginal tax bracket. So if they earn an extra dollar, they will owe 32 cents of additional federal tax.
But what if their AGI is $510,000 (which is above the start of the phase out range for the SALT deduction)? In this case, they lose 30 cents of the SALT deduction for each $1 of AGI above $500,000. Hence, their lost SALT deduction amount works out to ==> 30% x ($510,000 – $500,000) = $3,000. Their SALT deduction is reduced by $3,000, so they can only deduct $37,000 instead of $40,000. Looking again at taxable income yields $510,000 – $20,000 – $37,000 = $453,000. At first glance, it appears they are still in the 32% marginal tax bracket. But if you increase their income by $10, then your taxable income actually increases by $13 (the $10 of additional income + $3 of lost SALT deduction. Take a look at this table with all of the numbers:
The true marginal tax rate is 41.6% (or 1.3 x 32%). Many taxpayers fail to consider these higher tax rates. Sometimes they are unavoidable, but it’s important to be aware of them.
Before OBBBA, the main tax torpedoes included:
- Taxable Social Security
- Effect of additional income on qualified dividends and long-term capital gains
- Medicare IRMAA
- Net investment income tax (NIIT) and additional medicare tax
- ACA premium tax credit
- QBI deduction for certain businesses
Any new OBBBA provision with a phase out range will introduce a new torpedo. In fact, these additional torpedoes will add siginifcant complexity to tax planning for the next few years at least.
Most people will still use the standard deduction
The higher state and local tax (SALT) deduction limit garnered much attention during the legislative process. All else equal a $40,000 SALT limit will help many high earning taxpayers in high tax states such as California or New York. However, most people will continue to use the standard deduction simply because they won’t have enough itemized deductions to exceed the standard deduction. This is especially true for retirees who don’t have a mortgage (or have one with a low borrowing rate) and who live in low to moderate tax states. Strategies such as bunching charitable deductions or qualified charitable distributions (QCDs) will remain valid and useful for many taxpayers.
Social Security income is still subject to tax
To be clear, the new senior deduction does NOT eliminate taxes on Social Security benefits. It will help somewhat, but retirees will need to keep a close eye on how things like Roth conversions effect their true marginal tax rate. For example, a Roth conversion could still increase the amount of your Social Security benefits that are taxable and make the Roth conversion less attractive (tax torpedo).
Potential tax planning ideas for 2025
Here is a quick list of rough ideas to consider when you start tax planning for 2025 (as always, be sure to consult a tax expert prior to taking any action on these):
- Itemizers with plans to make large charitable contributions may consider accelerating gifts into 2025. The 0.50%-of-AGI floor will reduce the value of charitable contributions starting in 2026.
- Residents of high tax states such as California, New York, or New Jersey or high earners should drill down on their potential SALT deduction. These folks will be the most likely to itemize deductions over the next few years.
- Non-itemizers should keep in mind the new above-the-line charitable deduction. For example, if you make weekly donations to your church or send small cash donations to your local food bank, keep track of them for tax time so you don’t miss out.
- Electric vehicle buyers may consider buying before the end of September to capture the credit. It’s possible that manufacturers will reduce their pricing after the credit is gone, but there’s no way to be sure. My sense is you need to use it or lose it. The same logic applies if you plan on installing solar panels or energy efficiency improvements to your home.
- Any parents or grandparents should make full use of the expanded flexibility of 529 accounts to cover the expanded list of costs and programs. If your state offers any tax benefits for 529 contributions, it can make sense to route any out of pocket expenses through a 529 (i.e. make a contribution and then immediately reimburse yourself) to capture the state tax benefits. For example, Virginia offers a state tax deduction for residents who make 529 contributions, so Virginia parents with a child in private school can route up to $20,000 per year through a 529 account and pocket tax savings of $20,000 x 5.75% = $1,150 without any significant market/investment risk, just a few minutes of administrative hassle. But be sure to check the rules for your specific 529 plan before taking action.
- Adults seeking a new credential for work or a career change will also want to consider if using a 529 account to fund the costs can help save some tax dollars.
- In their current state, the new Trump accounts are lackluster. By all means, go ahead and capture the $1,000 seed funding or allow your employer to make contributions… that’s free money after all. But be sure to do your due diligence around these new accounts and the available investment options before committing additional capital. It’s possible that 529s, Roth IRAs, or even a regular brokerage account could offer better results over time.
- If you might be eligible to deduct auto loan interest, be sure to account for that when you’re car shopping. Taxpayers in a high tax bracket could see scenarios where the after-tax financing rate is attractive.
- Business owners should talk with their CPA/tax advisor in the near future. OBBBA included many business provisions which require careful attention and planning.
1) For the vast majority of tax payers, OBBBA’s definition of MAGI will be the same as the standard AGI amount on your Form 1040.
