What Does Tax Reform Mean For Investors?

If you’re like us, visions of sugarplums aren’t the only things dancing through your head this time of year. Major changes in tax policy — the biggest reform in three decades — have given both investors and firms like Silversage Advisors a lot to consider in their financial planning as 2018 comes to a close.

Overall, the tax reform this year provided several ways for investors to reduce their tax bill or increase their refund. The change with the most direct impact has been the decline in tax rates for most income brackets…but there were a number of less-publicized changes as well.

Here’s a brief overview of the most significant tax reform changes:

Higher Standard Deductions

One of the major benefits for many individual taxpayers is the higher standard deduction, which is now $12,000 for individuals — up from $6,350 last year. For married couples filing jointly, that deduction is now $24,000, up from $12,700 in 2017.

With nearly double the standard deduction, taxpayers who typically itemize should revisit whether that strategy is still in their best interest. Of course, if deductions such as charitable donations, interest on student loans, etc. exceed the higher standard deduction, it still pays to itemize.

Limited Mortgage Deductions

Now, homeowners can only deduct interest on mortgages of up to $750,000, down from $1 million allowed by the previous tax policy. This also applies to home equity loans if they are used to purchase a second property. And interest paid on home equity lines of credit is no longer tax deductible.

Business Income Deductions

Tax reform has also brought major changes for the way business income is taxed. For C corporations (where business income is taxed separately from an owners’ income), the tax rate was cut to 21% from 35%.

Other “pass-through” entities — sole proprietorships, LLCs, partnerships and S corps (which have fewer than 100 shareholders and are typically taxed as a partnership) — have also been affected. Many of these business owners will see a new deduction of 20% for qualified “pass-through” business income, a popular form of business income that is not taxed at the corporate level.

For many business owners, the revised deduction will reduce their income and provide the kind of tax savings found in a lower tax bracket. Those in a high tax bracket with a 37% rate could possibly bump down to a tax bracket with the lower rate of 29.6%. This deduction is reduced if the owner’s income is more than $157,500 if filing individually, or $315,000 if married filing jointly.

Limited SALT Deductions

High-income earners in high-tax states like California and New York will likely pay more in federal taxes as a result of the SALT (State And Local Tax) deductions now being limited to $10,000.

For perspective, 33.86% of California returns filed in 2014 included a deduction for state and local taxes according to IRS data. The average California SALT deduction was $17,148.35.

Expanded 529 Education Plans

Traditionally, 529 savings accounts were adopted to help families save for a college education. They allow funds to grow tax-free until withdrawn for qualified education expenses such as tuition, supplies, computers, etc. But for federal tax purposes, the new changes have expanded the use for these plans to include attendance costs for private or religious elementary and secondary school tuition. In many (but not all) states, these new uses have been approved for state tax benefits as well.

For primary education (K-12) expenses, funds in a 529 account can be used to pay for up to $10,000 each year per student (there’s no limit for qualified college expenses). Contribution limits are unchanged at $15,000 per year for individuals and $30,000 for joint filers.

Unchanged Policies

Although tax policy has incurred considerable changes, some policies many thought would be included in the overhaul have remained intact. For example, taxes on capital gains and dividends still start at 15% for taxpayers in the lower brackets and up to 23.8% for those in the highest. And retirement accounts like 401(k)s and IRAs continue to provide the same tax breaks.

For traditional IRAs and employer-offered 401(k) plans, taxpayers can deduct any contributions made to these accounts from their income tax, and delay paying a tax until they withdraw the money in retirement years. For Roth accounts, investors who deposited funds over the years can continue to rely on that money not being taxed when they withdraw it.

It’s always wise to consult your tax adviser and/or CPA when considering year-end tax strategies. We wish you a prosperous new year and are happy to discuss any questions you have regarding the impact this year’s tax reform may have on your wealth planning strategies.

Fall Portfolio Pruning

Seasonal weakness in September/October doesn’t always happen, but we’re experiencing it now. Consider the following analogy: Normal and necessary to maintain a healthy yard. Think of it in three phases:

  1. Trimming a few branches here and there, pinching dead flowers, no big deal, right? That’s akin to stocks pulling back by around 5%.
  2. The newly trimmed hedge, now 6 inches shorter, is bare on top, and will need a few weeks to grow back leaves at the top to make it look nice again. That’s more like a 10-15% correction. Doesn’t look good at first, and needs some time to grow back.
  3. And then there are the roses. Ugly stumps by end of November…only to re-bloom by February (gotta love Southern California!). Or the large trees that need annual branch trimming. Like a bear market, down 20% or more, and will certainly need more time, maybe several months to recover. Each with varying degrees of yard care, all normal and prudent.

Same with your portfolios and the markets.  How low will this correction go? Dunno. At their recent lows, the major indices were 11–15% below their fall peaks. Definitely worse than weekly yard maintenance, yet clearly in correction levels (-10% in most indices). We are still not anticipating a bear market, or winter rose bush pruning, if you will, in the S&P 500 or Nasdaq indexes, and are monitoring carefully.

Dancing Through The Volatility

Previously, we blogged about possible seasonal weakness heading into September/October. The possible came to pass, with the stock market trading in an unsettled fashion. Volatility has been high as investors weigh the effects of rising interest rates, tariffs and potentially slowing global growth against the backdrop of corporate earnings season. Investors don’t like uncertainty, and the increased number of factors that could cause trouble has not gone over well on Wall Street.

The good news? The underlying economy remains strong. Wage growth is solid, though the pace of increase could be a concern (inflationary), which we’re watching. Corporate profits had a very good 3Q, with 80% of the publicly traded companies exceeding Q3 estimates.

The markets are trying to digest rising interest rates, and so far it’s been orderly—but we expect volatility to remain high over the next 18 months as interest rates normalize back to historical levels. Current fear gauges are also starting to show excessive levels—which is a contrarian good thing for the markets. So, fundamentally, these elements should help stocks in the coming months.

Finally, a word on politics.  As you know we typically stay away from political discussions, wading in if/when it relates directly to the markets and your accounts. Clients are asking us about the impact, if any, from the Supreme Court process, upcoming midterm elections and/or the White House. So far, little if any impact.

We use the following analogy: The markets are like a well-conditioned dancer who depends on strong legs (corporate profits) and a stable dance surface (the economy).  While the musical tune from one administration to another may change, merely affecting the dancer’s style, the markets should remain spry and upright as long as the economy and profits are stable and growing.

No matter your dance tune preference, we value your business, friendship and any questions and comments you have.

Contact us with any questions at 1-888-969-7500, info@silversageadvisors.com or via this form