Subscribe to our email list
Follow Us On Twitter
Weekly Strategic Insight
September 29, 2017

The Tax Man Plan

Republicans hit the microphones this week to reveal their “framework” for tax reform.  The 35 page Better Way plan that originated on Paul Ryan’s desk back in June of 2016 has been watered down into the 9 page Unified Framework for Fixing Our Broken Tax Code released on Wednesday.  For those uninterested in reading the source material, here are the highlights:
Lower Rates, Fewer Brackets - Brackets fall from 7 to 3+1 (12%, 25%, 35% and ??%).  The plus one is a yet defined high income bracket meant to placate Democrats. Income levels where the brackets transition haven’t been determined.
Double Standard Deduction – This doubling takes the 0% tax bracket up to $24,000 for those married filing jointly.  Since 75% of Americans don’t itemize, this doubling should provide additional relief.  For the wealthy who itemize, it’s of no benefit.  Most likely fewer will itemize in the future, further simplifying the code.  
Increased Child Care Credit - Nice gesture, but undefined.  Currently $1,000 per child.  A new non-child dependent credit of $500 also appears for the first time.
Reduced Itemizations – For the 25% of Americans who itemize, reductions here take a toll.  Mortgage, charitable, educational, and retirement itemizations stay, while state and local tax deductions go.  Itemized deductibility will receive contentious debate, funded primarily by PACs located in Connecticut, New York, New Jersey and California.  However, often the state tax deduction gets negated by the AMT so it may be a wash.  Overall, fewer itemizations means fewer loopholes, loosely defined as deductions your neighbor qualifies for that you do not.
Repeal of Estate Tax and AMT - While the moral argument for the estate tax includes redistributing outsized family fortunes (see the Rockefeller’s), in reality, this tax generates more pain than revenue.  For 2017, only 5,460 estates paid taxes totaling $20 billion. 98% of all estates in 2017 owed no tax at all as they totaled less that the current $5.5 million taxable threshold.  Republicans argue that illiquid small businesses and farms get victimized by the tax, but, per the IRS, only 80 of the 5,400 returns filed impacted small businesses and farms.  This may be a negotiable give up for the Republicans. 
The AMT was adopted in the 1970’s to limit tax reduction strategies for the wealthy.  However, income levels were not indexed for inflation and around 5 million filers now pay the AMT.  This is just bad design and needs to go.
Big Business Tax Cut – The 35% corporate tax rate falls to 20%.  Additionally, companies can write off business investments immediately rather than over time.  Undoubtedly, adopting these provisions will support higher levels of employment, incomes and investment.
Small Business Tax Cut – Most small businesses simply pass their business income on to their owners.  This results in a 39.6% business tax rate. Under the plan this rate falls to 25%.  Clearly, this will result in entity gamesmanship as people attempt to convert compensation into distributions.  The loophole seamstress has work to do here.
Eliminate Offshore Profits Tax - The United States taxes US corporations on repatriated profits generated in other territories.  This provides incentive for large multinationals to stockpile cash overseas.  No other developed country does this and we need to eliminate it to encourage even more investment within the US.
Notable absences to the framework include cuts to capital gains taxes and removal of the Obamacare tax array.  Sad.  In essence, this bill targets corporate tax relief with simplifications elsewhere.  Luckily, this framework did harmonize the White House, Senate and House Republicans.  This should reduce party infighting and direct negotiations across the aisle where they belong.
In sum, to quote Perry Green, our resident tax savant, “I have three criteria for the perfect tax system: low rates, easy preparation, and applicable to everyone except me.  In the immortal words of Meatloaf, two outta three ain’t bad.”
Where to Invest Now
The reform provisions presented on Wednesday held little surprise.  Trump broadcast his ambitions on the campaign trail and the Ryan led Republicans published their plans over a year ago.  Nonetheless, the “odds” of passage have risen over the past month as talk became ink.  To identify the investment winners, one only needs to look at the biggest legislative beneficiaries:

Clearly, small companies benefit more from corporate tax reductions than large companies. 

When it comes to sectors:

Everyone benefits some, but financial services firms benefit most.  Note the tax rates on tech and real estate…those sectors barely pay tax at all.

Combining these two perspectives quickly reveals that the sweet spot for investors, should tax reform pass, is small cap financial stocks.  Let’s test our theory over the past month leading up to the release:

Yup.  Small cap financials win the day.  Energy had a good month off of a low bottom, but the move relates to a hurricane/North Korean-induced price recovery in oil.  Technology companies, which dominated this market all year, have now become the funding currency for the previously reviled.

Bottom Line:  The Tax Reform plan announced this week dramatically lowers corporate tax rates while simplifying and lowering tax burdens for families and individuals.  It’s not perfect, but it can pass, as the Republicans coalesce and utilize the remaining negotiating space to woo Democrats.  As analysts revise earnings estimates upwards, investment capital should migrate away from the overplayed large cap technology names to the all but forgotten small cap financials.  Add to the tax benefits the benefits of higher interest rates, and it may be time to bank the banks!

Have a great weekend!!


David S. Waddell

CEO, Chief Investment Strategist

More from W&A

2017 State of the Union

W&A State of the Union 2017
David S. Waddell:
"Choosing the Right Partner"
W&A
CORE VALUES

We care about our clients and associates as family.

We require ethics, intelligence, and competence in our associates.

We hold ourselves accountable to our recommendations by personally practicing our financial planning principles, and investing our own funds where we invest client funds.

We place equal emphasis on financial planning, investment management & communication.

We contribute our time, talent and capital to improve the quality of life in our communities.

Email Disclaimer:  This communication and its content are for informational and educational purposes only and should not be used as the basis for any investment decision. The information contained herein is based on publicly available sources believed to be reliable but not a representation, expressed or implied, as to its accuracy, completeness or correctness.This information presented is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. No information available through this communication is intended or should be construed as any advice, recommendation or endorsement from us as to any legal, tax, investment or other matters, nor shall be considered a solicitation or offer to buy or sell any security, future, option or other financial instrument or to offer or provide any investment advice or service to any person in any jurisdiction. 
Sources include the Big Charts, Wall Street Journal, CNBC, Factset, Morningstar, Marketwatch, St. Louis FED, BEA, S&P and Bloomberg. This information presented is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. No information available through this communication is intended or should be construed as any advice, recommendation or endorsement from us as to any legal, tax, investment or other matters, nor shall be considered a solicitation or offer to buy or sell any security, future, option or other financial instrument or to offer or provide any investment advice or service to any person in any jurisdiction. Nothing contained in this communication constitutes investment advice or offers any opinion with respect to the suitability of any security, and has no regard to the specific investment objectives, financial situation and particular needs of any specific recipient.
This email represents the opinion of W&A and is for informational purposes only.  It is not a recommendation nor is it intended to be construed as tax or legal advice by the recipient.  Past review of investments are no guarantee of future results.
powered by emma