Every president campaigns with grand sweeping promises on everything from ending wars, cracking down on gun regulations, and of course, taxes. Most Americans take these vows with a grain of salt, but President Trump’s promise of tax reform become a reality with the final version of the Tax Cuts and Jobs Act being passed by Congress on December 20, 2017. While this bill doesn’t completely deliver on his emphatic promises, it does include a number of changes to the U.S. tax code that will impact both corporations and individuals. With tax season in full swing right now, people are wondering how these changes will affect their personal situation once the bill goes into effect. Here’s what we can expect.
How Will It Affect My Personal Finances?
Although taxes are anything but simple, the nutshell explanation of the new tax bill is that it lowers tax rates for individuals and corporations, increases the child tax credit, doubles the standard deduction, and caps or eliminates several deductions.
It’s estimated that around 80% of people will see a tax cut in the first year of the legislation, and the Tax Policy Center estimates that the average person will see a tax cut of $1,610 in 2018. (1) However, the amount will vary based on income bracket. In general, the tax bill favors high-income earners, offering more tax breaks the more you earn, with fewer benefits to lower and middle class Americans. The TPC estimates that 65.8% of the total federal tax benefit will go to the top 20% of earners.
Some economists believe that the increased after-tax income could boost consumer confidence and spending, but in reality, it may not be enough to see a true economic change.
Big Businesses Will Benefit
Big businesses will significantly profit from the tax bill, namely with the federal corporate tax rate dropping from 35% to 21%. Companies will likely see a serious boost in their profits, with JPMorgan estimating that this bill could boost the earnings per share of S&P 500 companies by $10 per share in 2018. (2)
Additionally, some experts estimate that giant companies like Google will save several billion dollars in 2018 due to the new tax code. With these tax cuts, businesses could use these savings to increase wages, pay down debt, invest, or pay for capital expenditures. In fact, Apple has already pledged to bring billions of overseas dollars back to the U.S., pay taxes on it and invest it back into the economy. (3) They are planning to create 20,000 new jobs and issue stock grants of $2,500 to most of their employees, all thanks to the tax changes. (4)
Effects on Younger Savers
The act allows use of 529 saving plans for tuition at private and religious K-12 schools. Although this wouldn’t help much when used to pay for kindergarten, high school private school costs can now be offset with funds from 529 plans.
There’s another potential perk for those with an entrepreneurial spirit. For entrepreneurs and those thinking about starting a business, the act allows for a 20% Qualified Business Income deduction for certain non-service oriented business (and even service businesses if the taxpayers are under certain income brackets).
The mortgage income deduction has been reduced, slightly limiting the write off of interest on amounts over $750k (previously it was $1 million). This may not seem like a significant change but combine that with rising interest rates and the housing market may be facing a headwind. Your real estate “expert” friends most likely won’t tell you that two of the main reasons for people making money in real estate are:
- The easy access to cheap leverage (this is limited under the new Tax Act) and
- The 30+ year downtrend in interest rates, which allow for cheaper leverage and lower cap rates (which help real estate resale values)
At Accumulation Wealth Partners, we really believe in home ownerships and real estate as a core component of growing one’s wealth but also don’t think that owning a home is “The American Dream” when it comes at the expense of not prioritizing other goals in one’s financial plan. That error coupled with listening to your real estate “expert” friends that “housing never goes down” and is “always the best investment” can really derail people. We say this time and time again after the 2008 financial crisis.
The announcement of this tax bill provided a short-term boost to the economy, but the long-term market effects are yet to be seen. The Joint Committee on Taxation believes the bill will boost growth the total size of the US GDP by 0.8 percentage points over the first decade, while Goldman Sachs is estimating GDP growth will increase 0.3 percentage points above their baseline over the next two years.
Since large companies benefit from reduced taxes, their value will be pushed higher on Wall Street. The market was up in early trading after news of the bill. Many experts believe that gains are not already priced into the market and that it could continue to go up significantly through 2018.
Small and mid-cap stocks, consumer staples, telecoms, financials, and industrials pay the highest tax rate, so with the new tax cuts, values of these companies could go up in the short term. Many experts believe that stocks will rise as a result of the news, with the markets already seeing much activity. Experts at JPMorgan believe stocks could even rise 5% after the bill officially passes. (5) However, they also anticipate volatility in the new year, which we experienced in the early February correction.
Where Does This Leave You?
This tax bill is brand new, so there is still much to learn and understand before we will know how it will impact households and businesses in the near and far future. No one is sure exactly how the economy will behave in the coming months or years, but many experts expect a positive impact.
If you are one of our clients, your portfolio has been built with tax reform in mind and we are continually monitoring the markets so we can make appropriate changes if needed. If you have any questions, call or email our office.
If your friends or family are concerned with so many potential swings in the markets, now is a good time for them to review their financial plan to see how their strategies may be impacted by this tax bill and whether or not it’s appropriate to make adjustments. We’re never too busy to help someone you care about, so feel free to put them in touch with our office. Book a meeting with us today by scheduling a free 15-minute introductory phone call.
Scott Melbrod is the founder and CEO of Accumulation Wealth Partners, an independent wealth management firm in San Diego, CA. Working with a wide array of clients, from families to young Millennials just starting their careers, his mission is to provide impactful and targeted financial advice at a transparent cost to people in their accumulation phase of their lives. With more than 15 years of industry experience, he uses his knowledge to develop for his clients a structured and tailored plan designed to guide them toward financial freedom. Learn more about Scott by connecting with him on LinkedIn or emailing him at firstname.lastname@example.org.