There still is a lot of book ahead in any tax reform coming out of the Trump administration. But taking a page from candidate Trump’s tax plan, it looks that the number of tax brackets will be cut to three from seven, and the top tax bracket, for those with net income of $225,000 for a married couple or $112,500 for an individual, will be reduced to 33% from 39.6%. Other major changes include reductions of corporate tax rates, capital gains taxes and taxes on “pass-through businesses,” that is, sole proprietorships (S corps), partnerships and LLCs, which make up the bulk of taxpaying businesses.
“The proposals are very pro-business,” says Mike Coglianese, founder and principal of Michael Coglianese CPA in Chicago. “[Trump] wants to cut the business tax rate from 35% to 15%, which is amazing. Even if it only goes down by half of that, it’s good for the market.”
Meanwhile on the congressional side, House Ways and Means Committee Chairman Kevin Brady, R-Texas, also has promised big reform, stating that they plan to redesign the IRS into a “21st century organization” as well as cut all corporate taxes, no matter the size of the firm, to 20%. Also, they want to allow businesses “to immediately write off the full costs of new capital investments,” and end the “Made in America” tax that will tax all products sold in the United States at the same rate no matter where produced.
Coglianese believes the promise of tax reform is a main generator of the stock market’s move to all-time highs, “because investors are factoring tax cuts into each company’s bottom line.” A more favorable tax system plus the reduced uncertainty apparently makes for a buoyant market as the S&P 500 stock index is up 11% since the November election.
He outlines key positive changes from the Trump proposal for business and investors, including the reduction in tax brackets and tax cuts for the wealthy:
- Owners of pass-through businesses can elect to be taxed at 15% rather than under individual rates;
- Capital gains and dividends would be taxed under the current preferential rates. Distributions from large pass-through businesses received by owners who elect to be treated at the 15% flat tax would be taxed as dividends;
- Elimination of the 3.8% net investment tax, which currently applies to individuals who make more than $200,000, or $250,000 if married and filing jointly. This tax, which he says was added to help pay for the Affordable Care Act, is in addition to taxes already on capital gains;
- Elimination of personal exemptions, although high earners are phased out currently;
- Itemized deductions would be capped at $200,000 for married filing jointly;
- Business tax would be cut to 15% from 35% while eliminating many business deductions. Rather than taking depreciation over multiple years, businesses also can take an upfront writeoff for an immediate impact.
Regarding the “pass-through” provision, which some pundits have coined the “Trump Loophole,” the Center on Budget and Policy Priorities outlined the cost of such a tax change, stating it would cost $1.5 trillion over 10 years (according to an Urban-Brookings Tax Policy Center analysis), which would account for “about one-fourth of the Trump campaign tax plan’s total cost.”
Further, the CBPP states that “about half of all pass-through income flows to the top 1% of households (those with incomes above $693,500 in 2016); only about 27% goes to the bottom 90% of households.”
Also the CBPP says the provision would “create major new opportunities for tax avoidance. An estimated 40% ($650 billion) of the $1.5 trillion cost would come from high earners reclassifying their non-business wage and salary income as pass-through income to take advantage of the lower rate, according to TPC. In fact, the revenue losses due to tax avoidance would easily exceed the provision’s total tax cuts for the bottom 99% of the population.”
So what should investors do?
That said, Trump policies should be good for growth, states Jeffrey Knight, global head of investment solutions and co-head of global asset allocation for Columbia Threadneedle Investments. In his latest blog, he says the Trump administration’s changes, including tax cuts, deregulation and fiscal stimulus, “will create a new and higher trajectory for both economic growth and inflation …. A higher trajectory for nominal economic growth should in turn bring about a normalization of monetary policy.” The most likely scenario he sees is that this would be good for stocks but “challenging” for bond yields.
Coglianese says “even if only half of these proposals get approved, it would be a great boost to business from Wall Street to Main Street.” He is telling clients to “defer as much income as possible to take advantage of the tax changes when they become effective.”
As stated by Rep. Brady, “tax reform only happens once in a generation,” so it seems the White House and congressional Republicans are planning to go big or go home, and investors should take advantage of the potential changes. Further, several people state that tax reform is the priority action by the GOP Congress, which fears other distractions (like Obamacare) could derail what they believe is the crux of their opportunity of controlling the legislative and executive branches.
— Check out Why the Market’s Great Expectations for Trump Are Overdone on ThinkAdvisor.