Andrew Rosenberger, CFA, Senior Investment Manager
Political biases aside, one can’t deny that equity markets have received the incoming Trump administration favorably. Much of the market optimism has rightly been attributed to a reduction in corporate tax rates which will immediately serve to increase earnings upon implementation. Evercore ISI published an illuminating chart demonstrating the power of lower tax rates. Their chart below demonstrates that companies with the highest tax rates are outperforming companies with the lowest tax rates by 470bps since the election. After all, that makes complete sense given that companies who pay the most in taxes will subsequently benefit the greatest from any cut in taxes.
Yet, when we reconcile market hope versus the reality of what policy will actually be enacted, it’s easy to get lost in all the details. For that, I give tremendous credit to Barron’s which published a well-articulated overview of what to expect, at least tentatively, when it comes to tax reform. I encourage anyone with a subscription to Barron’s to immediately read their article, Advice From Wall Street’s Go-To Tax Man. However, to summarize some insightful points from the article:
- The number of federal tax brackets is expected to shrink from 7 to 3
- The top tax rate for individuals would be lowered from 39.6% to 33%
- Corporate tax rates would be lowered from 35% to either 15% or 20%
- Most forms of investment income could be treated tax favorably, including interest income which is taxed as ordinary income rates today
- Many forms of itemized tax deductions would be removed. Mortgage interest and charitable contributions would likely be spared.
- Small business owners may be taxed at a rate different from individuals. Today, small businesses income is treated the same as if it were ordinary income.
What are some of the implications of these changes?
- While there is only a week left in the year, investors should try to defer any further capital gains until next year when they are taxed at a potentially lower rate
- Earnings will go up; valuations, assuming no change in price, will look more favorable
- Municipal bonds which provide tax free income will be much less attractive on a relative basis. Also, given that municipalities use their favorable tax treatment to raise capital, this may put additional stress on spreads via funding concerns.
- Corporate spreads, on the other hand, should theoretically narrow given they get more favorable tax treatment
- Companies with deferred tax assets and individuals with loss carryforwards will see the value of those assets reduced. However, they will be valuable in the form of offsetting gains.
- Interest deductions may not be tax deductible anymore. This could lead to lower debt issuance, a smaller supply of corporate and tighter spreads.
Many of these assumptions and implications are based on a combination of Trump’s plan and the proposed House plan. While nothing is set in stone and likely won’t be for quite some time, it’s not too early to begin thinking about how these changes may impact an investor’s wealth planning and asset location strategies. Tax management will no doubt continue to play an important role in the wealth management process. But more than anything, lower tax rates will mean more flexibility for financial advisors as they determine how best to structure their client’s asset allocation to meet their long-term goals.
Brinker Capital provides several tax harvesting opportunities to help investors manage one of their largest costs. Contact Brinker Capital to learn more about how our investment solutions may provide greater tax control.
The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital does not render tax, accounting, or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. Brinker Capital, Inc., a Registered Investment Advisor.