On Thursday, November 2nd, members of the US House of Representatives revealed an overview of their proposed tax bill.
Tax Reform Proposal
The plan announced on Thursday is only a proposal. This must pass the Senate to become law, and there may be changes to this proposal when all is said and done. However, now that we are starting to get specific proposals, we can begin to identify the important points to determine which of our clients may need to take action.
We have not had a chance to fully analyze the proposed changes, and we are not tax advisers. But as fiduciaries, we feel it is important to present highlights of the proposal so our clients can begin to understand potential changes of tax reform, both positive and negative, and to begin conversations with their tax advisers about their best course of action.
The link below is to the House of Representatives Ways and Means Committee summary report of the proposed legislation. We do not view this link as an objective view of the proposal, but rather provide it as a reference for those who would like to view the source.
Proposed Individual Tax Changes
From an initial glance, there are no obvious winners and losers from this plan. The tax code is ridiculously complicated, and this plan may serve to simplify things a bit. But whether it will result in a reduction or increase of an individual’s net tax costs appears to be very dependent on how many itemized deductions a household takes.
Here are the notable changes:
- Individual tax rates lowered for low- and middle-income Americans to Zero, 12%, 25%, and 35%; keeps tax rate for those making over $1 million at 39.6% (see the chart below).
- Standard deduction increases from $6,350 to $12,000 for individuals and $12,700 to $24,000 for married couples.
- Home mortgage interest deduction remains the same for existing mortgages and maintains the home mortgage interest deduction for newly purchased homes up to $500,000, half the current $1,000,000
- State and local taxes (including property taxes) deducted up to $10,000
- Alternative Minimum Tax repealed
- Child Tax Credit increases from $1,000 to $1,600
- Child and Dependent Care Tax Credit preserved
- Earned Income Tax Credit preserved
- 401(k)s and Individual Retirement Accounts unaffected
- Capital Gains rates remain unchanged
What could this mean?
Before taking action on anything with tax implications, consult your tax adviser.
LARGE PURCHASES: Large purchases, such as homes, boats, etc, may have a bigger positive tax impact on certain people if purchased in 2017.
PROPERTY TAXES: A proposed cap of a $10,000 deduction of property taxes may have a very large impact on our clients, especially given home values and property tax rates in the Austin area. Travis County allows for people to pre-pay property taxes for multiple future years.
MORTGAGE INTEREST: The proposal would cap mortgage interest deduction for a home value at $500,000, down from $1,000,000. It appears that existing mortgage balances may be grandfathered.
Again, this is not law and these are only proposed changes. We will continue to monitor this and have discussion with our clients prior to year end regarding potential implications of your individual situation.
Proposed Corporate Tax Changes
The biggest beneficiary of the reform bill appears to be large corporations. Particularly those with large retained earnings overseas.
Highlights of the potential business/corporate tax reform:
- Corporate tax rate lowered to 20%, down from 35%
- Tax rate on business income reduced to no more than 25%
- Individual wage income distinguished from “pass-through” business income
- Allows businesses to immediately write off the full cost of new equipment
- Multinational companies would, generally, no longer pay taxes on their active foreign income.
- Interest Deduction capped at 30% of cash flow
All in all, it appears to be a net positive for companies, with the exception of those carrying high debt loads. See the next chart for an overview of the proposed business changes.
Potential Market Impact
This tax reform proposal is not news to the market. In our view, much of the potential impact may already be priced into stocks at this point.
The chart below shows the performance of the two baskets of stocks relative to the S&P 500. The top part of the chart is the Goldman Sachs high-tax basket of stocks. These stocks are the companies within the S&P 500 that have the highest net tax rate.
Following an initial surge after the 2016 election, high tax stocks have struggled to keep up with the overall market. The same is true for companies that do not have overseas exposure, specifically small-cap stocks.
The bottom part of the chart shows the Russell 2000 performance against the S&P 500. The Russell 2000 is an index of smaller company stocks that almost exclusively do business within the United States, and therefore have little if any earnings held overseas.
Again, these stocks surged after the election, but have struggled to keep pace for most of the year.
Part of this relative performance can be attributed to changes in currency. The US dollar has weakened most of this year, so larger companies with overseas operations have benefited from the currency appreciation of their overseas earnings.
But some of this could be from the market having doubts about the President’s ability to get a tax reform bill passed.
Our internal market signals have been showing improvements in small and mid-sized companies the past two weeks. We continue to monitor the market’s reaction to these developments.
Our view is that one should not attempt to anticipate how the market will react to the potential legislation. Instead, adhere to strict signals which ultimately include movements attributable to tax reform.
From our initial analysis, this tax reform is best viewed as a corporate tax cut, with some simplification of the individual tax code. We do not view this proposal as an individual tax cut.
We suggest our clients take this same view, and should not expect meaningful tax relief come April. It could easily mean an increase in tax liability for many of our clients.
Disclaimer This presentation is for informational purposes only. All opinions and estimates constitute our judgment as of the date of this communication and are subject to change without notice. > Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. The investments and investment strategies identified herein may not be suitable for all investors. The appropriateness of a particular investment will depend upon an investor?s individual circumstances and objectives. *The information contained herein has been obtained from sources that are believed to be reliable. However, IronBridge does not independently verify the accuracy of this information and makes no representations as to its accuracy or completeness. IronBridge does not provide tax advice.