by Chris SwiecickiWhat is the Outlook for Tax Laws in 2025?
I am again both proud and honored to be co-author with Richard Wise on this article, which first appears in the St. Louis Law Journal Blog. Any errors are mine alone. Readers who want the full version, complete with footnotes, should check out the original.
During President Donald Trump’s first administration, Congress passed the Tax Cuts and Job Act of 2017 (TCJA). It is scheduled to sunset on December 31, 2025. If the TCJA sunsets, the relevant tax provisions will expire and the Internal Revenue Code will revert to its pre-2018 status.
If that were to happen, the following changes would occur:
Individual Income Taxes
- The individual income tax rates would increase. Notably, the top tax rate would increase from 37% to 39.6%.
- Individual Standard Deduction: In the calculation of taxable income, taxpayers subtract the standard deduction from their Adjusted Gross Income (AGI). In 2024, the standard deduction was $29,200 for married couples; the pre-2018 standard deduction was $13,000 for married couples.
- Personal Exemption: In calculation of taxable income, taxpayers subtract the number of personal exemptions for themselves, their spouse and dependents from their AGI. The personal exemption under TCJA was reduced to zero; the personal exemption pre-TCJA was $4,150 per person.
- Child Tax Credit: The child tax credit allows taxpayers to reduce their federal income tax liability for each qualifying child. The TCJA set the amount at $2,000. The pre-2018 tax credit was $1,000 per child. Note: this is a dollar-for-dollar tax credit on an individual’s tax return.
- State and Local Tax Deduction (SALT): Currently, taxpayers who itemize their deductions are limited to claiming $10,000 in state and local income and property taxes under the TCJA. Under pre-TCJA provisions, the $10,000 cap did not apply and, hence, taxpayers will be able to deduct all eligible state and local income, sales, and property taxes. Note: the current administration is interested in removing the cap regardless of whether the TCJA is allowed to sunset.
- Mortgage Interest Deduction: Under TCJA, married taxpayers can deduct mortgage interest paid on the first $750,000 of mortgage debt. Returning to pre-TCJA status will increase the $750,000 to $1,000,000.
- Deduction for Pass-Through Business Income: Ordinarily, pass-through business owners are taxed at their ordinary income tax rates on such pass-through income. The TCJA created a deduction equal to 20% of qualified business income. This deduction will expire upon the expiration of the TCJA.
- Capitalization of Costs in a Trade or Business: A business generally must capitalize the cost of property used in a trade or business or held for the production of income and recover such costs through deductions for depreciation. For example, a business acquires a bulldozer for $500,000 with a depreciable life of 10 years. For 10 years, the business can deduct a depreciation expense of $50,000 per year. Under TCJA, a business was eligible to fully expense the purchase in the year the property was placed in service. Accordingly, in year 1, the business could tax a business expense deduction of $500,000. This provision was phased down from 2022 to 2026.
- Estate and Gift Taxation: Estate and gift taxes are levied at a rate of 40% after excluding the applicable exclusion from taxation. For decedents who died in 2024, the exclusion amount was $13,610,000. This exclusion amount was set at $10,000,000 and adjusted annually for inflation. Pre – TCJA, the exclusion amount was $5,000,000, adjusted for inflation, which again will take effect upon the expiration of the TCJA.
What Proposed Tax Changes Are Under Discussion Now?
The new administration has announced that it is looking at some new proposals for changes to tax law.
- Social Security Tax: There are discussions about exempting Social Security benefits from income tax. In fact, at least one member of the U.S. House of Representatives has proposed such legislation.
- Tips: There is talk that the administration wants to exempt from taxation tips paid to retail service providers, although we have not seen any specific details. The consensus is that it would apply to restaurant waiters and waitresses. A sidebar on this topic is how or if this would affect the base compensation paid to such workers. Would management pay the service workers less of a base pay (which is fully taxable) on the prospect that service workers would be able to keep more of their compensation derived from tips? It’s anyone’s guess until the administration issues specific proposed revisions to existing law.
- Overtime: There have been discussions that overtime compensation paid to hourly workers would be exempt from tax. Again, we are short on specifics. Might such an overtime exemption apply only to the 50% overtime payment, or if it would apply to the entire overtime compensation? Would such a change distort the labor market? For instance, would the labor market move to more hourly and non-exempt jobs if an adjustment is not made for salaried employees that are exempt from the Fair Labor Standards Act (FLSA) overtime rules? Would such a tax provision distort the labor market by employers relying more on overtime compensation than by hiring new workers?
In addition to the above considerations, Congress has to consider the estimated revenue effects of each provision under analysis and determine whether there should be corresponding provisions enacted to counter any projected revenue loss.
One takeaway from this article is that the reader should note how a change in tax policy may have a significant impact on the behavior of consumers and businesses. In some instances, tax policy is specifically designed to encourage a change in behavior.
This piece originally appeared in the St. Louis Law Journal blog.
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by Chris SwiecickiPotential Tax Implications of Employment Settlements
Employee settlements are a fact of life for many businesses. The tax implications of those settlements, however, are too often an afterthought. Both parties involved should know the potential tax implications of employment settlements—understanding the tax treatment of settlement payments, their deductibility, and any reporting requirements can help both sides maximize benefits and avoid unnecessary taxes and penalties.
Understanding the Tax Treatment of Employment Settlement Payments
The tax treatment of an employment settlement largely depends on the origin and nature of the claims involved. For instance, if the claimant is suing for wages, the settlement recovery will be treated as wages. This means the amount received will be subject to the same tax considerations as regular income.
The IRS considers all payments for employment claims, including those allocated explicitly to attorneys’ fees, as part of the claimant’s income. This is a crucial point to note as it means that, even if the payment is made directly to the attorney, it will still be considered income for the claimant.
However, certain exceptions exist. For example, the IRS has ruled that payments for attorneys’ fees in specific class action lawsuits aren’t included in class members’ income where there’s no contractual agreement between the members and counsel. Similarly, the IRS has ruled that amounts representing attorneys’ fees paid to settle a lawsuit brought by a union against an employer to enforce a collective bargaining agreement aren’t included in the union members’ income.
Exclusions From Income
There are certain circumstances under which portions of these settlements could be excluded from a claimant’s taxable income. For example, a business owner paying the settlement might wonder whether paying out the settlement is something they can write off at tax time.
Under Internal Revenue Code Section 104, amounts paid to compensate for these damages are generally excluded from income. This type of damages isn’t subject to income tax, which can significantly reduce the claimant’s tax liability.
Like the cost of other business expenses, like equipment and travel, the costs from defending a lawsuit are usually considered costs incurred as part of doing business and are, therefore, tax deductible.
Similarly, if a claim involves a physical injury sustained at the workplace, compensation for that injury could be excluded from income. Regardless of the exact circumstances, the goal is to structure the settlement in the most tax-advantageous way possible.
It’s important to note that these claims aren’t common in employment cases, typically involving wages, discrimination, or wrongful termination disputes. However, the potential tax savings can be significant when they do occur.
Moreover, applying these tax considerations can be complex and depends on each case’s specific facts and circumstances. Therefore, it’s crucial to consult with a tax professional or an attorney knowledgeable about these issues when negotiating and drafting employment settlement agreements.
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Deductibility of Attorneys’ Fees
The tax considerations of an employment settlement don’t only concern the income received from the settlement; they also involve the expenses incurred during the process, such as attorneys’ fees.
The claimant will generally be taxed on the entire settlement amount, including any portion paid directly to the attorney as fees. However, the Internal Revenue Code provides relief under Section 62(a)(20). Claimants are typically entitled to deduct attorney’s fees incurred in claims for unlawful discrimination and many other employment-related claims. These are “above-the-line” deductions taken directly from your gross income.
An “above-the-line” deduction is particularly beneficial because it reduces your adjusted gross income (AGI), which can potentially qualify you for other tax benefits. This differs from “below-the-line” deductions, which are taken from your AGI and subject to various limitations.
Suppose the attorneys’ fees aren’t deductible above the line. In that case, they may still be deductible as a miscellaneous itemized deduction on Schedule A. However, these deductions come with their own set of restrictions. For instance, they are only allowable to the extent they exceed 2 percent of adjusted gross income. Additionally, such deductions aren’t allowable for Alternative Minimum Tax purposes.
It’s important to note that the ability to deduct attorneys’ fees can significantly offset the tax burden of the settlement amount. This is a critical factor to consider when negotiating the settlement and determining the net benefit of any potential settlement amount.
Taxable Wages and Employment Taxes
All settlement payments regarding claims for severance pay, back pay, and front pay are considered wages for employment tax purposes. This means these amounts are subject to the same taxes as regular wages, including Social Security and Medicare.
The IRS asserts that attorneys’ fees for wage claims are wages subject to employment taxes unless the settlement agreement expressly provides an allocation for attorney’s fees. This can have significant implications for the overall tax liability of the settlement and should be carefully considered when drafting the settlement agreement.
Reporting Requirements for Settlement Payments
The tax implications of an employment settlement don’t end with the payment of the settlement amount. There are also important reporting requirements that both parties must adhere to to remain compliant with IRS regulations.
Employers, in particular, bear a significant portion of this responsibility. They’re generally required to file information returns for payments made on behalf of another person. This includes the entire settlement amount, even the portion paid directly to the attorney as fees.
The total amount must be reported as paid to the claimant, regardless of how the payment is divided. This can be done using Forms W-2, 1099-MISC, or both, depending on the nature of the payments. For instance, if the settlement includes back wages, those amounts would be reported on a Form W-2. In contrast, other compensatory damages might be reported on Form 1099-MISC.
Failure to properly report these payments can result in significant penalties. Therefore, employers must understand these requirements and accurately report all settlement payments. As always, when dealing with complex tax matters, it’s advisable to consult with a tax attorney.
Proper evaluation of both the income and employment tax aspects of settlements and the correct reporting of settlement payments is critical to obtaining the best possible result. Failure to properly file a required information return or timely furnish the payee(s) with a correct Form W-2 and/or 1099-MISC may result in a penalty equal to 10 percent of the settlement amount. Therefore, it’s crucial to look before you leap and consider all tax implications before settling employment matters.
As a business law firm, we’re here to guide you through these complex processes and help ensure your business transition is as smooth and advantageous as possible. Contact us to discuss your options with confidence.
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