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Investors Beware: Tax ‘Volatility,’ Regulatory Upheaval on Horizon

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As the new Trump administration and a new Congress take control in Washington, advisors can expect widespread easing of the regulatory reins around such areas as retirement, tax and investing policies.

Debates are in full swing regarding the fate of the Department of Labor’s fiduciary rule on retirement accounts, who would become the new chair of the Securities and Exchange Commission as well as the anticipated full-frontal focus by the Trump administration and Congress on tax reform – both individual and corporate.

Even ways to reform entitlement programs like Social Security were being floated by lawmakers before year-end, with House Ways and Means Social Security Subcommittee Chairman Sam Johnson, R-Texas, introducing legislation that he argued will permanently save Social Security – by cutting benefits.

In introducing his bill in early December, Johnson said that his “common-sense plan is the start of a fact-based conversation” about how to save Social Security, and he urged other lawmakers “to also put pen to paper and offer their ideas about how they would save Social Security for generations to come.”

As for tax cuts, Trump and the Republican-led Congress have vowed to pass tax reform in 2017. As Andy Friedman of The Washington Update points out, Trump’s campaign materials call for a top individual tax rate of 33% on ordinary income (down from close to 40%) and a top tax rate of 20% for capital gains and dividends (down from close to 24%). Both Trump and Congress “would repeal the 3.8% surtax on investment income instituted under Obamacare,” he adds.

While the effective date of tax reform is uncertain, Friedman, a former tax attorney, believes lower tax rates would apply retroactively to the beginning of 2017. “Rates early next year could reflect the full rate reduction, or a reduction to somewhere between the old and new rates,” he said. 

Either way, “investors would be well advised to plan for lower taxes next year,” Friedman counsels, and investors should “redouble their efforts to defer income into 2017 and accelerate deductions into 2016.”

For instance, he continues, “investors could defer the exercise of employee stock options until January, and prepay 2017 state taxes and charitable contributions in December.”

But lower tax rates won’t last forever, Friedman warns, as congressional procedural rules are likely to require that the lower rates “sunset” in 10 years. “Before then, a Democratic Congress – or any Congress concerned about outsize deficits in future years – could raise tax rates again. Thus, investors must plan for ‘tax volatility’ – the concept that over time tax rates ebb and flow,” Friedman said.

Investors, therefore, “should maintain liquidity in both taxable and tax-deferred accounts and in taxable and tax-free investments. That way they can withdraw funds from one or the other depending on whether it makes sense to pay taxes that year (and if so whether to pay at ordinary income or capital gains rates),” Friedman adds. “Preparing for tax volatility allows an investor to take advantage of tax changes, whichever way they might go.”

As for corporate tax reform: “It’s coming,” said Greg Valliere, chief global investment strategist for Horizon Investments. The top corporate rate will plummet from 35% to about 20%, he said in a recent commentary, “but there are lots of close calls on specific provisions. There’s already fierce lobbying over issues like ‘border adjustability,’ which would reward U.S. exporters and punish importers.”

Any business tax reform will put the U.S. tax code in sync with codes in “most of the developed world,” Valliere said, as a reform bill “will adopt a ‘territorial’ system that would only tax the profits of U.S. firms’ business in this country, a dramatic reform that should eliminate tax inversion deals that have seen U.S. companies relocate around the globe.”

However, Valliere notes that such reform “could be complicated by the hottest theme in corporate taxation – border adjustability – which would tax goods on where they are consumed rather than their exports.” As to the SEC, ex-U.S. attorney Debra Wong Yang, a partner at law firm Gibson, Dunn & Crutcher’s Los Angeles office, is said to be Trump’s top pick to lead the agency.

SEC Chair Mary Jo White announced that she would resign at the end of the Obama administration in January, a decision she made prior to the election. She told lawmakers in recent comments that the agency will not propose a uniform fiduciary standard rule before her departure.

Republican SEC Commissioner Michael Piwowar will reportedly become acting chairman once White departs.

Hmm, Trump Voters Support DOL Fiduciary Rule – and Dodd-Frank

Trump transition officials along with members of Congress have vowed to repeal, delay or curtail DOL’s fiduciary rule. But a December report of Trump voters by the GroverParkGroup found that while the majority of Trump supporters want fewer regulations, they support keeping the Dodd-Frank Act intact, and they also want the new administration to leave the SEC alone. Sixty-five percent said they supported keeping DOL’s fiduciary rule in place.

Industry officials have urged advisors to comply with DOL’s rule by its April effective date.

Rep. Jeb Hensarling, R-Texas, chairman of the House Financial Services Committee, has promised to advance his Financial CHOICE Act in the next Congress, which is designed to roll back Dodd-Frank. Hensarling has said Trump supports the bill.

While all eyes will be on Andrew Puzder, Trump’s choice to be the next Labor secretary, regarding fiduciary rule changes, Duane Thompson, senior policy analyst at fi360, opines that the assistant secretary of Labor’s Employee Benefits Security Administration who replaces Phyllis Borzi “may have an even greater influence on pension regulations and any modifications” to DOL’s fiduciary rule.

While implementation of the rule will continue to take center stage in the new year, advisors are also anticipating new anti-money laundering rules for advisors from Treasury’s Financial Crimes Enforcement Network. However, it remains to be seen “where that ends up with a change in administrations,” notes Skip Schweiss, head of advisory advocacy for TD Ameritrade Institutional.  

Schweiss is also waiting to see if the SEC moves to finalize the plan requiring RIAs to adopt and implement written business continuity and succession plans, which has already gone through a comment period. Whether the agency will require advisors to receive third-party audits also remains up in the air. “I don’t expect that [proposal] to go anywhere,” Schwiess said, as both Piwowar and Commissioner Kara Stein, a Democrat, are opposed to it.

A few months before White’s departure, she had this to say about third-party exams and a uniform fiduciary rule: SEC commissioners are currently reviewing staff recommendations on a rule to require “independent compliance reviews” for advisors, or third-party exams, as well as a “detailed outline” on a uniform fiduciary duty rule for brokers and advisors which is “before the commissioners for their consideration.”

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