Your Tax Bracket May Increase After 2025. Here's How It Could Affect Your Investments.

What Happens After 2025?

When the TCJA was signed into law, it lowered individual income tax rates, provided a larger standard deduction, and limited certain deductions such as the state and local tax (SALT) deduction. However, many of these provisions were temporary. At the end of 2025, unless Congress acts to extend or make permanent these tax cuts, the law will revert to the pre-2018 tax brackets and rules. This means:

1. Higher Marginal Tax Rates: The current tax brackets, which range from 10% to 37%, will likely increase, with the top bracket potentially returning to 39.6%.
   
   
2. Reduction in Standard Deduction: The standard deduction, which was nearly doubled under the TCJA, would likely shrink, leading to more taxable income.
   
   
3. Capital Gains and Dividend Tax Rates May Also Be Affected: While the long-term capital gains and qualified dividend tax rates weren’t directly reduced by the TCJA, higher ordinary income could push more individuals into higher capital gains tax brackets.
   
   

How Could These Changes Impact Your Brokerage Account?

A brokerage account, also known as a taxable investment account, is one in which you invest in stocks, bonds, mutual funds, ETFs, or other securities. Unlike tax-advantaged accounts such as IRAs or 401(k)s, the earnings from investments in brokerage accounts are subject to taxation every year based on the type of income the account generates—dividends, interest, and capital gains.

Here’s how the potential tax bracket changes after 2025 could affect your taxable brokerage account:

1. Capital Gains Taxes

If you sell an investment in your brokerage account for a profit, that profit is known as a capital gain. Capital gains are taxed differently depending on whether the gain is short-term (held for less than a year) or long-term (held for more than a year). Long-term capital gains are taxed at a lower rate, but these rates are still tied to your income tax bracket.

Currently, long-term capital gains tax rates are 0%, 15%, or 20%, depending on your income level. If the TCJA expires as scheduled, the higher income tax brackets could push more investors into the 20% capital gains tax rate. For high earners, the top rate could even exceed 20% when accounting for the 3.8% net investment income tax (NIIT) that applies to certain investment income.

For example, under the current rules, if you're a married couple filing jointly with an income of $550,000, you fall into the 37% tax bracket and pay 20% on long-term capital gains. After 2025, if the top income tax bracket increases to 39.6%, you might find yourself paying the 3.8% NIIT on your capital gains as well. This makes tax-efficient strategies, such as holding investments for longer periods to take advantage of lower long-term capital gains rates, even more important.

2. Qualified Dividends

Dividends from stocks and mutual funds in your brokerage account are another area of concern. Qualified dividends are taxed at the same rate as long-term capital gains, but ordinary (non-qualified) dividends are taxed at ordinary income tax rates.

If your tax bracket increases after 2025, the tax you pay on dividends could increase as well. For instance, if you’re in the 22% tax bracket today, your qualified dividends are taxed at 15%. However, if you move into a higher bracket after the expiration of the TCJA, your dividend tax could increase, reducing the net income you earn from your investments.

3. Interest Income and Ordinary Dividends

Unlike qualified dividends and long-term capital gains, interest income and ordinary dividends are taxed as ordinary income. If you hold bonds, CDs, or mutual funds that pay out ordinary dividends in your brokerage account, these income streams will be taxed at your regular income tax rate. With tax brackets likely to rise after 2025, this type of income will become more heavily taxed. Investors with significant fixed-income investments in their brokerage accounts should be aware of this potential tax hike.

What Can You Do to Mitigate the Impact? 

While the expiration of the TCJA is still over a year away and may get extended, it’s never too early to start planning. Here are a few strategies to consider to minimize the potential tax impact on your brokerage account:

1. Tax-Loss Harvesting

Tax-loss harvesting involves selling investments at a loss to offset capital gains from other investments. By strategically realizing losses, you can reduce your taxable income for the year. This can be an especially effective strategy if you anticipate being in a higher tax bracket after 2025. Realizing losses now, while tax rates are lower, could provide a significant benefit by reducing your capital gains exposure.

A way to maximize this strategy is a separately managed account. With this type of account, you can own a market index directly by purchasing every underlying stock. By doing this, you can sell stocks that are down to offset the gains of stocks that do well. This is more tax efficient than holding an ETF that holds a basket of stocks to mimic an index.

2. Hold Investments for the Long Term

Given that long-term capital gains are taxed at a lower rate than short-term gains, it may make sense to hold onto investments for more than a year to benefit from the lower rates. This is especially true if your income might push you into a higher bracket after 2025. Minimizing turnover in your portfolio can help reduce your overall tax liability.

3. Diversify into Tax-Advantaged Accounts

While brokerage accounts offer flexibility, tax-advantaged accounts like Roth IRAs, traditional IRAs, and 401(k)s provide tax deferral or tax-free growth. By diversifying your investments across different account types, you can manage when and how your income is taxed. For example, contributing more to a Roth IRA (which offers tax-free withdrawals in retirement) could be a good strategy if you expect higher taxes in the future.

If you earn too much to contribute directly to a Roth IRA, consider a backdoor Roth IRA or contributing to a Roth 401(k) if your employer offers that option.

4. Maximize Deductions and Credits

If the standard deduction decreases and itemized deductions become more favorable after 2025, it might make sense to revisit your deduction strategy. Charitable donations, medical expenses, and mortgage interest could become valuable deductions again. By maximizing these deductions, you can reduce your taxable income and minimize the impact of higher tax brackets.

Approaching Next Year 

As we approach 2025, it’s important to keep an eye on how changes in tax law could affect your finances, especially when it comes to your brokerage account. The expiration of the TCJA could result in higher taxes on your capital gains, dividends, and interest income, making tax planning even more essential. By taking steps now, such as tax-loss harvesting, holding investments for the long term, and diversifying into tax-advantaged accounts, you can reduce the potential impact of higher taxes on your portfolio.

At Allworth Financial, we’re here to help you navigate these changes. Our team of experienced financial advisors can work with you to create a tax-efficient investment strategy tailored to your unique goals. Contact your Allworth advisor today to learn more about how we can help you prepare for the future.