2. The Roth Conversion Window: A Temporary Tax Arbitrage
One of the most powerful "legal loops" available right now is the Roth IRA conversion. Because conversions are treated as taxable income in the year they occur, performing a conversion in 2024 or 2025 allows you to pay taxes on your retirement savings at the current lower rates. Once the money is in a Roth account, it grows tax-free and—more importantly—is not subject to the higher tax rates of 2026 and beyond. This is particularly relevant for those in the current 24% bracket who may find themselves pushed into the 28% bracket overnight.
According to the U.S. Treasury Department, the revenue generated from Roth conversions has increased as taxpayers anticipate the 2026 sunset. For our cross-border clients, we must also consider Canadian tax implications of such a move. While the IRS views a Roth conversion as a taxable event, the Canada Revenue Agency (CRA) generally recognizes the tax-free status of a Roth IRA under the U.S.-Canada Tax Treaty, provided no "contributions" are made while a resident of Canada. However, a conversion counts as a contribution in some interpretations, so precise timing is vital. We use Form 8606 to track these non-deductible contributions and ensure proper reporting to the IRS.
PRO TIP: Don't just convert everything at once. Use a "bracket topping" strategy where you convert only enough to reach the top of your current 24% or 32% bracket. This maximizes the tax arbitrage without accidentally pushing yourself into the current 37% tier.
3. Rescuing the 20% Small Business Deduction (Section 199A)
For our self-employed professionals and small business owners, the expiration of the Qualified Business Income (QBI) deduction is perhaps the most painful aspect of the 2026 sunset. Currently, Section 199A allows eligible sole proprietorships, partnerships, and S-corporations to deduct up to 20% of their qualified business income from their federal taxes. Per the IRS, over 21 million taxpayers claimed the QBI deduction in recent years, saving billions in aggregate.
When this expires, a business owner making $200,000 in QBI will suddenly see their taxable income rise by $40,000. To mitigate this, our team is working with clients to explore "Defined Benefit Plans" or "Cash Balance Plans." These pension-style retirement accounts allow for much higher contribution limits than a standard 401(k)—sometimes exceeding $200,000 depending on age and income. By pumping profits into a Defined Benefit Plan in 2025 and 2026, you can offset the loss of the QBI deduction by significantly lowering your overall taxable income. "The 199A deduction was designed as a temporary stimulus," says many tax policy experts, "and its removal effectively raises the effective tax rate on small businesses by several percentage points."
4. The Estate Tax "Fire Sale": Locking in Lifetime Exemptions
If your net worth exceeds $7 million, the 2026 sunset is a looming crisis for your heirs. Currently, the unified credit for estate and gift taxes is at an all-time high—$13.61 million per individual for 2024. However, the TCJA doubled this amount only through 2025. On January 1, 2026, the exemption is scheduled to drop back to approximately $7 million (adjusted for inflation). This means that for a wealthy couple, upwards of $13 million in protection could evaporate instantly.
The IRS issued final regulations (TD 9884) confirming a "special rule" that allows taxpayers to keep the benefit of the higher exemption even if it later decreases. This means if you gift $12 million now, and the exemption drops to $7 million in 2026, the IRS will not "claw back" the difference upon your death. According to FinCEN and Treasury reports, there has been a marked increase in the utilization of Irrevocable Life Insurance Trusts (ILITs) and Spousal Lifetime Access Trusts (SLATs) as families rush to move assets out of their taxable estates before the 2026 deadline. For our clients with Canadian assets, we must balance this with the CRA’s "deemed disposition" rules at death to avoid double taxation.
5. Cross-Border Optimization: Form 2555 vs. Form 1116
For American expats living in high-tax jurisdictions like Canada, the 2026 sunset creates a unique paradox. As US rates rise, the gap between your Canadian tax bill and your US tax bill shrinks. Currently, many expats use the Foreign Earned Income Exclusion (FEIE) via Form 2555 to exclude up to $126,500 (for 2024) of income. However, as US tax brackets revert to higher levels, it often becomes more advantageous to switch to the Foreign Tax Credit (FTC) via Form 1116.
According to IRS data, the use of Form 1116 has provided a more robust shield for high-income expats because it allows for the carry-over of excess credits. If you pay a 45% marginal rate in Ontario and the US rate moves back to 39.6%, your FTCs will completely wipe out your US liability and leave you with excess credits to apply to other years. However, the expiration of the TCJA also changes the way "standard deductions" interact with these credits. We meticulously model both scenarios for our clients to ensure they aren't leaving money on the table. Per the IRS's own instructions for Form 1116, the complexity of categorizing income (General vs. Passive) becomes even more critical when federal rates are in flux.
Common Mistakes to Avoid
- Ignoring the SALT Cap Expiration: While rates are going up, the $10,000 cap on State and Local Tax (SALT) deductions is also set to expire. This could actually benefit residents of high-tax states like New York or California. Don't assume your total bill will rise until you factor in the return of full SALT deductibility.
- Missing the Gift Deadline: Gifting assets requires legal documentation and often professional appraisals. Waiting until December 2025 to start a complex trust for estate planning is a recipe for failure.
- Overlooking the 3.8% NIIT: Even with bracket changes, the Net Investment Income Tax (NIIT) remains. Many taxpayers forget to calculate this on top of the 39.6% rate, leading to an effective top rate of 43.4%.
Frequently Asked Questions
Will Congress extend the TCJA rates?
It is possible, but highly dependent on the political landscape following the 2024 elections. We advise clients to plan for the "current law," which dictates the sunset, rather than gambling on legislative intervention.
How does the 39.6% rate affect my capital gains?
The TCJA did not significantly change the 0%, 15%, and 20% long-term capital gains rates, though it did decouple the brackets from the ordinary income brackets. These rates are generally expected to remain, but the thresholds for where they kick in will shift.
Does this affect my FBAR filing?
No, the FBAR (FinCEN Form 114) requirements are governed by the Bank Secrecy Act, not the TCJA. The $10,000 threshold remains unchanged. According to FinCEN data, over 1 million FBARs are filed annually, and enforcement remains a high priority regardless of income tax rates.
What happens to the Child Tax Credit?
The Child Tax Credit will likely revert from $2,000 back to $1,000 per child, and the income thresholds for the phase-out will decrease significantly, impacting middle-income families the hardest.
Don't Let the 2026 Sunset Catch You Off Guard
Our team at Zenith Financial Advisors specializes in navigating the complex intersection of US and Canadian tax law. We can help you lock in today's lower rates before they disappear forever.
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