What GOP Tax Outline Means for Advisors and Clients

The broad outline excludes details but still there are items that advisors should start thinking about

The latest Republican tax reform plan is a mixed bag for advisors’ clients.

Those living in high-tax states such as California, New York and New Jersey could face a net tax hike rather than tax cut if the deduction of state and local income taxes from the federal income tax bill is eliminated, as suggested in what the White House and Treasury Department are calling the “Unified Framework for Fixing Our Broken Tax Code.”

The framework doesn’t specify which deductions will be erased but rather indicates which ones won’t be, although that could change: "In order to simplify the tax code, the framework eliminates most itemized deductions, but retains tax incentives for home mortgage interest and charitable contributions," the framework says.

Given the historical antipathy of many Republicans to the state and local tax deduction, analysts expect it is back on the table.

New Jersey taxpayers could be especially affected by this change because it, like other high-tax states, would have difficulty raising taxes, and the Garden State is currently operating with a budget that is “deeply out of whack,” says Matt Fabian, partner of Municipal Market Analytics. (Moody’s has downgraded New Jersey’s debt 11 times since Chris Christie became governor in 2010).

At the same time, many wealthy taxpayers in New Jersey and every other state would no longer be subject to the Alternative Minimum Tax, which has precluded them from deducting state and local taxes, says Matt Sommer, vice president of the Retirement Strategy Group at Janus Henderson Investors, adding that any impact is still uncertain.

The lack of specific information on the plan — it is just a framework — makes it difficult for advisors to recommend any specific strategies yet.

“While the proposed tax plan looks to chainsaw the current federal income tax brackets from seven down to three, there is not any information provided on where each bracket begins and ends,” says Jon Ulin, CFP, managing principal of Ulin & Co. Wealth Management in Boca Raton, Florida. 

He recommends against “any big changes before year end regarding income or expenses reported for this calendar year, or to make a Roth conversion from an IRA — as there is no way yet in knowing if you may be better or worse off in 2018 and beyond. “

Sommer agrees. "It is too soon for advisors or clients to take any action regarding the GOP tax reform proposal as it still has a long way to go and many of the details need to be filled in.”

Among those things he’s watching is whether the tax plan is done through budget reconciliation and whether the 10-year sunset applies in order to make the numbers work "because then pretax retirement contributions could be limited or eliminated outright. Those scenarios will require a revised financial planning playbook.”

Using the budget reconciliation process requires a simple majority vote for passage, but in that case the plan would need to be revenue neutral over 10 years or include a sunset provision whereby the changes would expire before the 10-year window closes.

Despite the uncertainty about the proposed tax plan, Dean Mioli, director of investment planning at the SEI Advisor Network, recommends that advisors tell clients to accelerate deductions and deferred income for tax year 2017 because those deductions and deferrals would be worth less if tax rates are cut and the standard deduction is doubled for future years, which are both included in the tax plan framework.

But he suggests that investors check with their tax advisor before making any changes.

There are also investment and economic implications of the tax plan framework. As it stands now, the proposed tax framework would add about $1.5 trillion to the U.S. budget deficit over 10 years if no other offsetting changes were made, pushing the debt-to-GDP ratio up to about 95% from around 85% currently and increasing 10-year Treasury yield by about 40 to 50 basis points, says Mark Zandi, chief economist at Moody’s Analytics. “None of that will result in stronger growth, just winners and losers.”

Among the potential winners are companies that could repatriate overseas profits if the proposal to switch from a global to a territorial tax system is adopted, as outlined in the framework. Companies could then use those repatriated assets to increase stock buybacks or dividends or reinvest more funds to growth the business, which could help stock prices.

Zandi doesn’t expect the current proposal will pass as is, and he gives greater odds for corporate tax cuts over other tax cuts.

Municipal bonds could also benefit from increased demand because taxpayers no longer able to deduct local and state income taxes from their federal tax returns may be looking for more tax-preferred investments. The interest on many municipal bonds are exempt from local, state and federal taxes. At the same time, the federal tax deduction would be worth less if individual tax rates are lowered.

"There are so many cross currents,” says Zandi about the proposed tax framework. “The distributional effects are very uncertain … and they didn’t give us enough information to figure that out.”

 He doesn’t expect the current proposal will pass as is and sees better odds of cuts in tax rates for corporations and pass-through entities. “At best there are even odds that anything gets through.”

Despite the uncertainty about the tax plan, advisors can use it “as an opportunity to engage their clients by letting them know they are staying current and on top of things,” says Douglas A. Boneparth, president of Bone Fide Wealth LLC in New York.

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