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Watch Out for This Tax Bomb: Jamie Cox

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When it comes to income tax, much of President Joe Biden’s Build Back Better plan is comparable to stuffing lumps of coal into taxpayers’ Christmas stockings, according to James A. Cox III, managing partner of Harris Financial Group.

For example, here’s a provision that would go into effect immediately: “You [can no longer] create entities and slide money through an S corp to avoid the 3.8% [Medicare surtax]. You can’t S corp your way out of [it],” says Cox in a recent interview.

He also explains his views on the expansion of the wash-sale rule to cover all assets and says its “bye-bye to backdoor Roth conversions” and to a rule that would cap IRA accounts at $10 million.

A Wall Street Journal expert panelist, Jamie Cox, 46, has keen insight into issues of the economy and financial regulation, about which he regularly engages in policy calls and meetings with legislators.

In the interview, he contends that there’s “a tax bomb brewing” because “an enormous number” of taxpayers are receiving Advance Child Tax Credit payments to which they’re not entitled. 

“When they file their taxes,” he says, “there’ll be a lot of surprises.” 

Cox launched his Richmond, Virginia-based LPL Financial practice with two partners in 2006 after a decade of working as a financial advisor. The group has about $900 million in assets under management, and its clients have included Philip Morris, Progress Energy and Verizon.

ThinkAdvisor interviewed Cox on Nov. 17. He was speaking by phone from his home in Midlothian, Va.

Addressing rising inflation, he opined, “Central banks have this big task ahead of them in the next six to nine months to thread the needle between watching the pandemic-related inflation pressure abate and not allowing a labor shortage to precipitate real inflation.”

Here are highlights of our conversation:

THINKADVISOR: What should advisors know about Advance Child Tax Credit payments, which, in President Biden’s American Rescue Plan, were expanded in 2021 and end this month?

JAMIE COX: There’s a little bit of a tax bomb brewing: An enormous number of taxpayers are receiving Child Tax Credit payments who don’t qualify for them [income exceeds limit]. 

The IRS doesn’t have good information on which to base these payments. A lot of people receiving them think it’s free money. It’s not.

When they file their taxes, the tax software will recapture any payments that were not supposed to come to them. So there’ll be a lot of surprises. It’s a big problem. 

What should financial advisors know about Biden’s Build Back Better plan regarding taxes?

This is a biggie: [Changes to] the 3.8% net investment income tax — NIIT — [on capital gains, dividends, etc.; aka the Medicare surtax].

If your income exceeds a certain threshold — it varies every year — then you have [a] 3.8% Medicare surtax.

In the 2017 Tax Cuts and Jobs Act, there were changes that basically allowed some taxpayers to avoid that.

But The Build Back Better plan changes the definition and includes income that’s derived from a trader business.

So you can’t S Corp your way out of the 3.8%. In other words, you can’t create entities and slide money through an S Corp to avoid the 3.8%. This goes into effect immediately.

What else is concerning about the Biden plan in connection with taxes?

The wash-sale rule is being expanded to apply to all assets, including cryptocurrencies. So it will start to apply to digital assets and commodities, which it did not in the past.

The wash-sale rule says that you can’t sell an asset [at a loss] and then turn around and buy it back within 30 days because then you’re simply trying to collect the tax break on the loss. 

What other tax changes are important to know about?

Bye-bye to backdoor Roth conversions. That’s a tool advisors use in marketing and to help taxpayers who otherwise are ineligible for big Roth contributions. That loophole is going to be closed.

Like many of the provisions of the Build Back Better plan, this provision, thankfully, won’t be implemented until 2031 [for pretax assets; after-tax conversions, 2021].

So if you want to get a backdoor Roth conversion in, you have a decade. After that — game over.

Please discuss what Biden’s plan says about IRA accounts that have $10 million in contributions.

If you’re a high-income taxpayer — Build Back Better says that’s income of more than $400,000 for single filers and more than $450,000 for joint filers — you’re prohibited from making contributions to IRAs of any type if they would cause the account to exceed or further exceed $10 million. 

So it effectively caps IRA values at a certain level.

The distribution would be 50% of the amount by which the value exceeded $10 million in the prior year. 

More on this topic

This law [is supposed] to go into effect in 2028. But it isn’t likely to survive. The taxpayers that it affects are some of the strongest lobbyists. The law may be enacted, but it may never go into effect.

What are your thoughts about rising inflation?

Two things: Inflation itself is one problem. The remedy for inflation is another problem.

With inflation, markets worry that [companies] [will have lower] profits because things cost more, and they have to pay more for labor. So it reduces company profits, and that reduces the company’s valuation and, therefore, its stock price.

The other element of inflation is that when it starts to rise, markets worry that the central bank has underestimated the rate of inflation. 

Once they realize that the rate is hotter than they recognized, they start raising interest rates fast to overcome it or tamp it down.

That’s invariably called a recession. It’s very, very hard on small-cap stocks. It’s not much fun for technology stocks.

What about other investments?

If you’re a big value investor — you’ve been tried-and-true to value sectors over the last 10 years though haven’t made as much money [as investing] on the growth side — your day is coming.

If inflation and interest rates rise, that will make value stocks more attractive on a relative basis. 

So everything has offsets.

When do you think interest rates will go up?

The general consensus is that inflation is high because of pandemic-related factors. I think that’s part of it, but what’s brewing under the surface that’s less easy to see and point fingers at is a labor shortage. 

Central banks have this big task ahead of them in the next six to nine months to thread the needle between watching the pandemic-related inflationary pressure abate and not allowing a labor shortage to precipitate real inflation.

Supply constraints are transitory. Labor and wages aren’t — they’re more permanent.

Please elaborate on the labor shortage.

An enormous number of baby boomers are retiring right now. The millennials and others behind them are [much smaller cohorts than the boomers]. 

They’re a different type of worker, and it’s now a completely different working environment.

So there’s a little bit of a shortage, and that means employers would have to pay more in wages.

When you start getting wage pressure, that’s when inflation is persistent and when interest rates have to adapt to make sure that inflation doesn’t run away.

How much longer do you think the supply chain disruption will go on?

We’re already seeing big cracks: A lot of the manufacturing facilities are back to full capacity. These things are going to work out. Manufacturing will catch up.

The supply chain issues will abate faster than people think. That should ameliorate a lot of the concern about inflation. 

But if they persist longer and get coupled with a labor shortage that precipitates wage [hikes], then you’ve got a problem, and you have to do something about it. Markets wouldn’t like that.

Does the financial services industry have any, shall we say, “good” problems right now?

There’s enormous pressure on advisors in their 40s because all the retirees are looking to find advisors who are going to be working throughout these [clients’] retirement. 

But the average age of an advisor is 58, and that means a whole lot of them are older than that.

All the baby boomers are looking for people my age so they can have someone they can rely on for the balance of their retirement.

They don’t want an advisor to be retiring at the same time they do.

This is a really good spot for advisors in my age category [I’m 46], because there are a lot more clients than there are advisors to serve them.

(Image: Courtesy of Jamie Cox)