How Are High Net Worth Investors Reacting to the Proposed Tax Reforms?

July 19, 2017 · Written By Ronald Yost

With the tax reform proposed by President Donald Trump still far from becoming final, investors can’t help but wonder how stock prices will respond in the months ahead. Considering the many details still lacking, it’s difficult to determine the impact new legislation will have on consumer and investor confidence—which will greatly affect economic and market behavior.

Still, there does seem to be a certain trajectory to the tax changes, and high net worth investors are expected to take some action in anticipation of certain outcomes.  Trump’s proposed tax reforms are neither clearly outlined nor confirmed, but it seems safe to assume that the administration’s priorities are lower taxes for some individuals and, particularly, corporations, which does provide some impetus for strategizing.

The Markets Over Time

President Trump is calling for a reduction in the corporate tax rate to 15 percent, lowering the highest income tax rate to 35 percent, and doing away with the alternative minimum tax. Lower tax rates can stimulate consumer spending, and companies with greater profits from a lower tax rate will often invest in human resources, research and development (R&D), and plants and equipment. But, depending on other economic variables, this resource reciprocity is by no means certain.

Although extra income from lower taxes gives individuals and corporations more cash to spend, if there is little confidence in the economy, that cash could remain in long-term savings or stashed under the floor boards for a rainy day.

Consumer Confidence

What happens if the cash freed up from lower taxes doesn’t go back into the economy by way of spending or investing in stocks?  Is there any correlation between tax rates and the stock market? For history buffs, Ben Carlson of Bloomberg attempts to find a pattern with a historical analysis of taxes and stock market movements since the mid-1920s. However, World War II and other economic blips, such as the tech bubble and the double recession of the 2000s, muddy the waters and prevent the drawing of predictable theories.

Perhaps the best trend to watch out for is investor and consumer confidence, which are dependable precursors to an invigorated stock market.  Despite these economic vagaries, high net worth investors will be considering some action while waiting for the reforms to shake out.

1. Estate Planning

President Trump has proposed repealing the estate tax but, again, with few details.  The estate tax is a federal 40 percent tax levied on estates exceeding $5.49 million for individuals and approximately $11 million for married couples. Estates receive a step-up in tax basis at death, which softens the blow of capital-gains tax on inherited assets.  Some experts, however, suggest that whatever the outcome for estate tax, it will likely be reinstated in 10 years because the Republicans would need Democrats to support tax legislation to achieve a supermajority and avoid a filibuster.

Estate tax repeal, if it happens, could take many forms. In the past, Trump has proposed eliminating the estate tax and replacing it with a capital gains tax at death, like the system in Canada. Thus, without a clear path for this tax, estate planning is likely to be characterized by careful selection of tax-efficient investments and assets placed in charitable trusts.

2. Incorporation

President Trump’s agenda is likely to provide significant benefits to corporations. Corporations have a current top tax rate of 39.6 percent, but this rate is expected to plummet if the proposal takes effect. Under the new proposals, partnerships, corporations, and limited liability companies, or “pass-through” entities, would see their tax rate drop to 15 percent.

By setting up an LLC, wealthy people could use pass-throughs to avoid personal liability. For example, a consultant making $250,000 after expenses would pay approximately $62,000 in taxes with a 25 percent tax bracket. By incorporating and assuming a 15 percent tax rate, that consultant would pay about $25,000 less in income tax.

3. Philanthropy

President Trump’s proposal leaves the charitable deduction intact. Experts cited in the Wall Street Journal suggest that high net worth investors should consider increasing their charitable contributions and deductions. Taxpayers in top brackets who expect their rates to drop in the coming tax year may want to make donations in 2017 because the charitable deduction is more valuable against the current higher rates.

4. Deferred Income

Similarly, high-income investors who might see their tax rates fall could benefit from deferring income to 2018. Under President Trump’s proposal, the 3.8 percent surtax on net investment income on sales of stocks, funds, and other investments could be eliminated.  Deferring a stock sale until that regulation sets in could have investors realize around 16 percent in tax savings.

Whatever the outcome of the proposed tax reform, an independent fiduciary advisor can recommend the tax strategies most appropriate for your current situation, and help you maximize opportunities ahead.

Updated Reading Related to this Post:

Tax Reform 2018: The Impact on Itemized Deductions for Individuals

Tax Reform 2018: New Depreciation and Expensing Rules for Businesses

As a Senior Lead Advisor for JFS Wealth Advisors, Ron Yost has over 20 years of experience in helping individuals and families plan for wealth accumulation and preservation.  Questions about tax planning for your personal or business needs?  Contact Ron at ryost@jfswa.com.