“Don’t tax you, don’t tax me, tax that man behind the tree.”
—Louisiana Senator Russell Long; former chair of the Senate Finance Committee (1966 to 1981)
The House Ways and Means Committee released H. R. 1, The Tax Cuts and Jobs Act, on Thursday, November 2. The House Republican bill provided some clarity in terms of specific breakpoints for tax rates, and details on which deductions would be eliminated or reduced. While this sheds some light on the direction tax reform is heading, the end result is still unclear. It’s not a law yet, it’s merely a bill that must matriculate a grueling journey through both chambers of Congress before landing on the President’s desk for his signature. At this stage, we can see the key items the bill contains.
However, anticipating and positioning for tax reforms is very difficult, given the uncertainty surrounding the bill. There are three proposed changes that most affect the individual income tax return. If they survive the legislative process, the rules could have a massive impact on the individual tax return and may actually result in some tax simplification.
If tax brackets change to a four-bracket system, it may become more important to manage income and deductions with the goal of staying within a certain bracket—because there will be a large price for tumbling into the next bracket. If and when the bill becomes law, there may still be some planning opportunities to lower taxes this year, if time allows.
For example: If your itemized deduction under the new plan would be less than the proposed standard deduction of $24,000 (married, filing jointly), you might accelerate your 2018 deductions (such as charitable donations) into 2017, thus getting a deduction for an amount that otherwise would have been lost to next year’s higher standard deduction. But if it looks like you would consistently fall under the $24,000 amount, you might “bunch deductions” every other year, making charitable donations only in alternating years so as to exceed the standard deduction. However, both the deduction for medical expenses and state and local income taxes (TN sales tax deduction) are going away. So, this may be a difficult strategy going forward.
With respect to the corporate tax return, a 20% top corporate rate has been proposed, down from 35%. It’s roughly in-line with most developed nations, and is expected to be supportive of stocks. But it’s early in the game and any discussion of the final points is pure speculation.
New highs and the fundamentals
There is no question about it—those who have invested in a well-diversified equity portfolio this year have been handsomely rewarded. Of course, we rarely recommend diving into a portfolio that’s 100% invested in stocks, unless you are young and your tolerance for risk is high.
The tailwinds that have driven stocks over the last year—and for that matter, over recent years—remain in place. Economic growth in the U.S. has been quite resilient, even in the face of devastating hurricanes. The U.S. Bureau of Economic Analysis reported at the end of October that Gross Domestic Product (GDP) expanded at an annual pace of 3% in the third quarter. It’s the second-consecutive quarter of GDP growth that has met or exceeded 3%. The economy hasn’t experienced that since 2014.
This expansion is not just what’s happening at home; we’re also witnessing an acceleration in economic activity around the world. The byproduct for investors is solid corporate profit growth. It’s a key factor in the stock market equation. Throw low inflation and low interest rates into the mix and the S&P 500 Index set 11 new all-time closing highs in the month of October.
We have never favored market timing as a strategy. It’s not realistic for investors to think they can sidestep the inevitable declines and then get back into stocks just as the inevitable upswing begins. It’s simply not possible to accurately and consistently predict the future. That might seem obvious, but we have to say it anyway.
Our approach has always been a time-tested strategy that is based on the historical data that takes the bumps in the road into account. We won’t venture a guess as to how markets may perform next year or through the remainder of the decade, but we’ll participate in the upside and use various evidenced-based strategies that will mitigate, though not eliminate, the downside. History tells us this has been the best path to wealth accumulation and reaching financial goals.
As always, we are honored and humbled that you have given us the opportunity to serve as your financial confidant and advisor. Nonetheless, please reach out to us if you have any questions or if you would like to discuss any other matters, we would be happy to talk with you.