Summary
Impact on Economy – Short-term improvement in GDP, long-term impact unclear
Impact on Corporations – Highest tax payers experience greatest benefit, highly leveraged businesses may suffer
Impact on Individuals – It depends on specific circumstances
History and Background:
The Republican-led Congress passed, and the President has now signed into law, the most sweeping tax reform legislation since 1986. Formally known as the Tax Cuts and Jobs Act, the legislation affects both individual and corporate tax rates.
Individual tax rates change minimally, with slightly lower rates for five of the seven tax brackets. Key changes include 1) elimination of the Obamacare individual mandate; 2) increase of Alternative Minimum Tax (AMT) exemption for individuals to $500,000 for a single taxpayer and $1 million for couples; 3) increase in estate tax exemptions to $11 million per person; and 4) limitation of state, local and property tax deductions (SALT) to $10,000. Of note, there were no changes made to the treatment of capital gains, or the 3.8% Medicare surtax on net investment income.
Corporate tax rates are cut more dramatically from 35% to 21%. Net interest expense is limited to 30% of EBITDA through 2021 and 30% of EBIT thereafter. The Act provides a deduction equal to 20% of business income for eligible pass-through entities. For overseas profits, there is a one-time repatriation tax of 15.5%, allowing previously untaxed foreign earnings to be brought back to the US. In addition, going forward, only the US profits of a corporation would be taxed in the US.
Direct implications of Corporate Tax Changes
Lowering the corporate tax rate is generally positive and will have the greatest impact on sectors that typically pay higher effective taxes. Retail, Financials and Telecom are seen as potential winners. However, numerous factors affect performance.
Tax Reform – Impact on Economic Growth
Estimates of the impact on GDP due to the lower tax rates and repatriation language range from 0.2% to 0.8% in 2018. The sustainability of this growth is more dependent on labor force and productivity, which are not directly affected by this legislation.
Impact on Major Asset Classes
In the bond market, provisions in the bill will likely have mixed impact. Municipal bonds may be hurt by decreased demand from insurance companies, banks, and other taxable corporations where the decline in effective tax rates reduces the attractiveness of tax-exempt income from municipal bonds. Home-state municipals may be more attractive since the deductibility of state tax required on out-of-state municipal income will be limited. Overall, municipals should remain attractive for individual taxpayers. The cap on interest deductibility may affect bonds issued by highly levered corporations. Equity market impact is likely to be generally positive, especially in the short-term. Benefits will tend to be greatest for companies with lower debt levels and small cap stocks.
Our Position
Coming on the heels of an eight-year bull market, there is only so much that can be expected from this change in fiscal policy. We have been talking about tax reform for most of the year, and many sectors seem to have already priced in the news. On a positive note, there is little here to shake up the steady global growth experienced this year. Continue to look for active managers who show skill in sector rotation as well as those who specialize in late-cycle conditions. Furthermore, we recommend consulting your income and estate tax advisor for further guidance specific to your individualized circumstances.
Disclaimers: The data contained in this report is provided from Asset Consulting Group (ACG). This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. Gryphon Financial Partners shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This was created for informational purposes only. Gryphon Financial Partners, LLC is a Registered Investment Adviser.