What Do Potential Tax Changes Mean for Your Investments?
To get an idea of where our tax rates could be going (and the opportunities that could be coming), compare and contrast the tax proposals floated by President Trump and the House GOP.
Whether it’s tax cuts or a fundamental rewrite of the tax code, the tax system is incredibly complex, and changes to it can dramatically impact investments. Even though President Trump and the House GOP recently announced tax proposals, investors still don’t have a clear picture of how any proposal would affect their cash flow and investment strategy — because negotiations have yet to begin.
What investors can do to prepare for tax reform is to compare the House GOP tax plan to President Trump’s plan, and look at where the plans align or diverge. While any tax proposal carries far-reaching implications, and additional intricacies beyond the headline issues, I’ve taken a look at what some elements of the plans could mean for investors. We’ve identified two specific areas of an individual’s investment future that will likely be affected by any change to the tax code.
Investing in Large-Cap Businesses
One of the bigger differences in the tax proposal out of the House is the tax rate investors would pay on capital gains and dividends. It’s lower than both the current rate, and the rate in President Trump’s proposal — both of which feature a 20% maximum capital gains and qualified dividend tax rate. In the House plan, the tax rate is equal to half the ordinary income tax rate. For the top bracket, that would be 16.5%.
As a result, the House plan shapes up to be a stimulus-oriented tax cut that would spur more investment in stocks, bonds and other alternatives. If that comes to pass, investor appetite may shift toward assets that pay consistent dividends that have lower chances of being reduced, such as large-cap stocks. Investors may also see an additional benefit from a lower capital gains tax rate if they’ve been reluctant to sell assets at the current capital gains tax rate. Under the House proposal, the capital gains rate is much more favorable.
Investing in Your Business
Entrepreneurship has declined since the financial crisis of 2007-2008. The most recent U.S. Census data shows that new business creation has hit 40-year lows. People aren’t investing in themselves to start and run businesses. In the current environment, some large corporations are taxed at a lower rate than pass-through entities, more commonly referred to as small-business owners, but that could change.
The House plan calls for a 20% corporate tax and a top rate of 25% that would apply to pass-through entities (essentially, small businesses) such as sole proprietorships, partnerships and S corporations. The Trump tax plan calls for a reduction in corporate tax rates beyond even what the House has proposed. Regardless of business structure, each corporate entity would be taxed at 15%. That’s a major cut for C corporations — currently taxed at 35% — and pass-through entities — taxed at the owner’s individual tax rate, as high as 39.6%.
Both the plans seem to be intended to create a more pro-business, particularly pro-small business, environment. They figure to encourage more people to focus on their professional lives and start or continue to run, and invest in, their own businesses. Beyond that, they would also level the playing field between large corporations and small businesses.
Tax Changes and the Stock Market
The merits of each of these potential plans — or a combination of the two — will be heavily debated in the coming months, but chances are high that some changes are on the way. The tax plans of both the House and President Trump impact investors in different ways, and it’s important to understand those differences.
It’s also important to understand that nothing happens in a vacuum. The stock markets tend to be anticipatory and to price in any policy changes in advance of them actually happening. That throws a monkey wrench into investing for those trying to find the right opportunities today or develop a strategy for the future.
Capitalizing on areas where tax reforms may benefit investors shouldn’t be attempted without the help of a professional who understands how to navigate this landscape. So, while elected officials work to rewrite tax rules, the best thing investors can do is examine what’s currently out there, speak to their financial adviser and develop a plan of attack in the event that these changes come to fruition. That’s the path toward a pleasant investment outlook.
About the Author
Phil Simonides, CFP®
Senior Vice President, McAdam Financial