In 2017, President Trump and a Republican Congress passed the Tax Cuts and Jobs Act which is expiring at the end of 2025. On Tuesday, December 12, 2023, David John Marotta appeared on Radio 1070 WINA’s Schilling Show with Rob Schilling to talk about planning for the end of this act.

Here is an outline of the discussion:

0:00 Introduction to the Tax Cuts and Jobs Act and the 2026 Tax Cliff on Horizon
4:54 Alternative to the current tax system
9:26 Estate tax changes and controversies
14:36 Recommendations for the next three years

After over a decade of broken promises and rising costs, our need for a more sustainable tax system is acutely felt.

You can listen to the audio here:

Rough Transcript:

Rob Schilling: The Shilling Show resumes and welcomes to the program David Marotta, the president of Marotta Wealth Management and a long-time guest on this program. He’s online at MarottaOnMoney.com and today I would say grab your wallets, but that won’t do any good because there’s money about to be forcibly extracted from you.

David Marotta, welcome back to the Shilling Show. Always good to have you with us; we’re really glad that you could be here today. Alright, so we had something called the Tax Cuts and Job Act. Most of these acts I can’t stand, but this one actually had some good things in it. So tell us about what it does and has been doing for the past couple of years.

David John Marotta: The Tax Cuts and Jobs Act is sometimes called the Trump tax. He put it in place his first year in office, and it reduced taxes across the board. In order for it to pass the Senate and their budgeting requirements, it had to have a zero effect on long-term taxes. So, they had to have it sunset after a certain number of years. It was planned that it would go through his second term, which didn’t happen, so now it’s planned that it will sunset at the end of 2025 and there will be a new tax regime in 2026. But, it’s actually not a new tax regime as it reverts back to the old taxes.

A lot of people saved a ton of money on their taxes by having this Tax Cuts and Jobs Act in place, but taxes are going up at the end of 2025. So taxes are low for the next three years, and relatively speaking it’s been one of the lower tax regimes that we’ve had in place. In 2026, someone who earns $94,000 will pay more taxes than someone this year earning $383,000. It’s a huge gap in the tax code that is gonna be filled between $94,000 and $383,000, and you only have three more years to take advantage of it.

This means you have three years to do Roth conversions, which is the primary recommendation, because you get to decide when you want to increase your taxes. You will never get to decide when you want to decrease your taxes. The way that the tax regime works is you postpone all of these taxes by filling up your traditional IRA account, and then later on you find out that it was a terrible mistake because you’re getting taxed for more money than you got a tax deduction for.

That’s the long-term planning that we try to do it Marotta Wealth Management. We have a tax team of four people who work around the clock doing tax analysis for people. One tax analysis takes about two weeks for a single client because we’re trying to make sure that our qualified clients get a tax analysis every year. This involves doing their taxes in mock every year until age 100, and it shows interesting changes in the tax code. I’ve learned a ton from it.

My tax analysis before this was a back of the napkin calculation, and I was right about 40% of the time, which I’m very proud of considering the circumstances. What we found is that there’s all kinds of strange oddities, and now I found my estimation is a lot better, but I’m also not surprised by some of the the tax analysis that we do anymore.

Consider the question: should I try to fish for ACA (Affordable Care Act) subsidies or do big Roth conversions this year? That’s a trade-off, and there’s a correct answer for that. If I wait to delay my social security and I also wait to do any Roth conversions, that means more of my social security gets taxed in retirement. And if more of my Social Security gets taxed, I could be in the 43% tax bracket with a very low income. So in addition to there being loopholes in the tax code, there are also what CPAs would call tax torpedoes where you’re getting sunk simply because you obeyed a normal progression. Now, your IRA required minimum distributions are causing you to get your social security taxed, or get a Medicare surcharge, or any of the other crazy ways the government has of taxing us in addition to the tax code tax brackets.

Rob Schilling: You know David, every time we have this conversation I get mad and something you said really ticked me off. Not against you, but the fact that you have to have four people working around the clock to figure this stuff out. How much better would it be for us if we just had a simple straight-forward system? But, I don’t even know if that’s calculable. It seems to me the amount of productivity that would be regained and the amount of money that would be recaptured by going to something like a checkbox system would be so beneficial to the economy. Do we even have a way to figure that out?

David John Marotta: It is amazing how much effort is put into the tax code from CPAs to financial planners, and it really unfortunately happens because the 16th Amendment allows Congress to tax our wages. If Congress couldn’t tax our wages they’d have to raise that revenue some other way, and any other way would be preferable, but the best I’ve ever seen is what Europe has gone to, which is a value added tax. 

A value added tax is where I tax the product that I produce and I get to deduct all the taxes I’ve paid on the materials to buy it. With a value added tax, none of our income would matter to the federal government. This would also do away with all Roth’s if we ever got there, but that’s a price I would gladly pay to have a simplified tax code where we just tax consumption. Consumption is something you’d like to be low. You don’t want savings to be low, and that’s what they’re taxing now. You don’t want revenue or income to be low, you want those to be high, and so you should just tax the things you want to be low.

My dad would always say, tongue in cheek, that the best way to eliminate poverty would be just to tax it. If you tax poverty, poor people couldn’t afford to be poor so they’d go out and earn some money. That’s sort of the approach of why taxing consumption is the best way of doing it. Simply taxing consumption with no exemptions and taxing everything that’s produced would be one way to have a flat tax.

Rob Schilling: I think the other thing that people miss is the impact of lower taxes versus higher taxes. I look at this on the local level and you have the decision makers, who in this case are all Democrats, and they say they want to raise the meals tax and the hotel tax. That’s just putting the burden on people who are traveling. What they don’t tell you is that when the government takes that money, the travelers cannot spend it in the community. That’s money taken out of the economy and put into this worthless government that’s just going to squander it. But again, people don’t see that and they get tricked by these illusions and deceptions of local governing officials.

David John Marotta: I was reading some clickbait on how these Hollywood entertainers and athletes had gotten into money troubles. I was amazed at the number of times they simply failed to set aside enough money to pay their taxes and then got into tax trouble. I thought to myself, if we had a consumption tax, you can’t get into tax trouble because you pay the tax as you spend the money. Even the Beatles were facing great Britain’s 95% tax rate, and they wrote a song about it, “Taxman.” All of this is just to say that the more money you make, the more you pay. If you think about a Hollywood actor, one year they get millions of dollars for some film and they’re in the highest tax bracket. But, the next two years they may not work or get anything at all. We have this great progressive tax system and it’s like having a big red hot iron at some income, and then no one wants to go to that income.

If you think about it, Roth conversions are one way that you can help smooth out your income a little bit or at least preload the tax up front. If you can get most of your money into Roth, you can be in the 10% tax bracket and have incredible wealth. We have clients who have finished their Roth conversions now after many years and have millions of dollars in a Roth, yet they are in the 10% tax bracket.

Rob Schilling: That is remarkable. Now, we’re going to talk about the death tax, the estate tax. It’s one of the most egregious taxes that we have. I remember being a kid learning about this tax and thinking, how dare they tax you on your death and take money away from you, your family, and your posterity. So let’s talk about the estate tax and where it is now and where it’s going.

David John Marotta: Currently the estate tax exemption, the amount of estate tax which is not saddled on you when you die, is at $12.9 million, which is a large number. I realize most people don’t have $12.9 million, but small business owners do.

Rob Schilling: And it’s not always that they’re sitting on $12 million in cash. This is wrapped up in the business value and equipment or the farm right?

David John Marotta: Right, and you read about the taxes these days and they say “only” over 300 farms every year are subject to this tax. They’re very proud of this because there’s only 300 family farms that get subject to this tax. I remember hearing a story where a family had prepared for the inheritance, and when their grandfather died, they were able to pay the tax. A few years later Papa died, and they couldn’t pay the tax. They got hit again just a couple of years later. They were intending to begin building the money back up to pay this tax. And poor son, he’s not only lost his father but he loses the farm because he’s got to sell off a big portion of his land just to pay the tax.

If you think about it, big agriculture doesn’t have to pay this tax because they don’t have someone who dies. So it’s just benefiting one set of people rather than benefiting another set of people, and I think people would prefer having family farms exist.

Rob Schilling: This is the rhetoric that we hear all the time out of the federal government elected officials: we want to protect the small businesses and families, and how evil big corporations are. But it sounds like this policy and others are doing exactly the opposite.

David John Marotta: Yes, so take for example a $13 million farm barely hit with any estate tax today. In three years, they would owe an estate tax of two and a half million dollars, because the estate exemption is being cut in half. And it could always go down even lower than that. If you look at the estate tax, it affects less than 1% of revenue in the government. They can get their revenue from other places, but they like it because it’s a tax on rich people. But, family farm owners or family business owners get hit by it. It’s not a fair tax. The tax rate for the estate tax and capital gains should be zero, but instead they have these exempted limits. Most capital gains are avoided, but only because some very twister rules are used simply to try to avoid them.

If I have money that’s in a stock, ETF, or mutual fund that’s highly appreciated, I just hold on to it until I die. If I wanted to sell, I would sell it today if it’s in a traditional or Roth IRA. If it’s in a taxable account, we have some incredible mathematics we have to go through just to figure out if it goes over some hurdle table where we can get a better return in something else rather than the current position. It locks capital in place.

I remember I was looking at properties, and there was one property that was owned by a 94-year-old woman and she didn’t want to sell it. I don’t know why it was listed, because she wanted to get rid of it but she couldn’t sell it because then her heirs would have to pay this massive capital gains tax. If they just waited until she died, then they wouldn’t have to pay this because you get a step up in cost basis.

The Democrats’ solution to this is to not get a step up in cost basis and to just gouge everyone. Again, most of the capital gains is just inflation. There is a rate of inflation such that paying the capital gains tax means you’ll have lost after-inflation money. So you’ll pay the tax on the inflated value, and then you’ll have less capital than you started with simply because inflation is so high. Last year it was so high it was almost there, unfortunately. It’s less today, but paying the capital gains tax on inflation is just cruel.

Rob Schilling: We’ve got just a little over a minute left to wrap all of this up. We’re dealing with tax uncertainty, and there are certainly legislative options, so we don’t know what’s going to happen. How do we proceed in an environment of uncertainty?

David John Marotta: I think the best planning is to assume that Congress will do nothing. Congress has proven itself very good at doing nothing, and so that’s probably the best option. If it does nothing in three years, we’re going to have the standard deduction get reduced, AMT will come back, and phase outs will come back. It will get a lot more complex.

I would, and that’s what we’re recommending to our clients, simply take advantage of the next three years to do as large of Roth conversions as you can. But, there’s an optimum Roth conversion. If you do too much Roth conversion, you might push yourself into a higher tax bracket. On the other hand if you have a large taxable account, pushing yourself into a higher tax bracket could very well be worth it simply because you get to pay the tax early and reduce your taxable account. Unfortunately because of capital gains, dividends, and interest being taxed onto a taxable account, they are growing at a rate that is one and a half to two percent less than normal growth because you have to pay the tax every year. It’s like having a one and a half to two percent drag on that portfolio.

Rob Schilling: He’s online at MarottaOnMoney.com. David Marotta, a depressing conversation, but an important one nonetheless. Thank you so much.

David John Marotta: Yeah, thank you so much for having me.

Photo by Blake Verdoorn on Unsplash. Image has been cropped.