The Impact of Potential Tax Changes
November 30, 2016 | Your Finances
With the 2016 election in the rearview mirror, speculation is rampant about the future of President-elect Trump’s tax policies. The priorities he has identified in his tax plan will shape his tax-related legislative agenda over the next four years, potentially influencing your tax and investment strategy.
Trump has pledged to simplify the tax code, reduce tax rates, eliminate loopholes and free up capital for investment and job creation. What remains to be seen are which parts of his agenda will succeed in Congress and how actual legislation will change the tax policies and laws currently on the books.
While investors cannot dictate tax policy, the economy or markets, you do have some control over how much of your investment profits you pay in taxes – regardless of the current administration. And although tax decisions should never drive your investment strategy, working with a financial professional to create a more tax-efficient investment portfolio can help minimize taxes over the long term.
Trump Tax Proposal
An overview of Trump’s proposed tax law changes posted on his campaign website includes the following objectives:
- Consolidate the current seven tax brackets into three
- Retain the maximum 20 percent tax rate for capital gains
- Cut the maximum tax rate to 33 percent
- Eliminate the 3.8 percent Affordable Care Act tax on investment income
- Lower the business tax rate to 15 percent
- Abolish the personal and business alternative minimum tax
- Allow companies to bring back billions of dollars in revenue that they have stashed overseas at low one-time tax rates
- Increase the child care credit
- Eliminate the estate tax
With Republicans in control of the presidency and Congress for at least the next two years, it is likely that at least some tax changes will be signed into law.
Potential Economic & Personal Impact
These proposals carry many potential implications, including:
- Trump’s plan to slash personal and corporate income taxes could translate into bigger budget deficits, an increase in economic growth, higher corporate profits and an increase in your disposable income.
- Any time the deficit increases, the government must issue more debt, which includes Treasury bonds, bills and notes. Traditionally, larger deficits are associated with higher inflation and higher interest rates.
- If rates rise, dividend-paying stocks could get hurt because of competition from higher bond yields. Because rates have been so low, dividend-paying stocks have done well because of the lack of interest income available in bonds. Now, rising yields may provide competition.
- A decrease in income tax rates could possibly cause municipal bond yields to be less attractive to investors due to the lower difference in yield with taxable bonds. Inflation Protected Securities may become an important diversifier to add to bond portfolios if inflation expectations continue to rise.
- After years of underperformance due to low inflation and oversupply, commodities may once again act as an important diversification tool to manage inflation risk. The picture for commodities is also brightening due to more of a balance between supply and demand.
- Corporations with money sitting in overseas bank accounts could benefit from the ability to bring those funds back into the U.S. at lower tax rates, which they may then invest for the long term in property, plants and equipment. This additional cash may also force companies to buy back shares and increase dividend payments, which can help reward investors in the shorter term.
Taxes and Your Portfolio
As I said before, taxes should never drive your investment decisions. In the long term, however, considering how to make your portfolio more tax efficient can help increase returns and lower your tax bill. That’s because the less you pay in taxes, the higher the returns on your investments. Strategies such as harvesting investment losses, contributing more to your tax-deferred retirement account and locating assets in specific types of accounts can individually or collectively lower your tax bill.
Harvesting investment losses involves selling stocks, bonds, mutual funds or exchange-traded funds that have lost value from your taxable investment portfolio. Then you can use those losses to offset gains or even your income from a job or self-employment (up to $3,000 a year). Losses can also be carried forward to future years to offset gains.
Continued and additional contributions to your tax-deferred retirement accounts can significantly reduce your tax liability. You can continue to make those contributions up until April 15 of the next calendar year and apply them to the previous year’s tax return.
Asset location strategies involve placing specific types of securities in specific types of accounts to minimize taxes. For example, because the interest from high-yield bonds is taxed as ordinary income, it can make sense to place any high-yield bonds or bond funds in a tax-deferred account, such as a retirement plan.
Using these strategies can help increase the tax efficiency of your portfolio. But remember, your overall objectives are much more significant than this year’s tax bill. Your risk tolerance, family situation, financial goals and time horizon should be your top considerations to build a sustainable investment portfolio that is positioned to meet your goals.
The Trump administration is likely to bring at least some changes to tax policy, some of which will impact your investments. Stay in touch with your tax advisor and your financial professional to see how these changes might impact you and what actions you might want to take to respond in a way that makes sense for you.
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