The essence of investment management is decision-making amidst uncertainty. Those times when the perception of certainty is highest are often followed by outcomes that confound our expectations. Speaking of confounded expectations, let’s examine how the recent election affects our investment decisions, with a focus on tax optimization strategies.
One month ago, the strong consensus was that Hillary Clinton would win the presidency, and speculation focused on the question of whether the Democrats might also take the Senate and even the House of Representatives. We now know that Donald Trump surprised most observers by winning the presidency, finding a narrow path to a clear victory in the Electoral College, despite losing the popular vote by more than two million ballots.
Clinton promised big tax increases on the wealthy. Thus planning for a Clinton Presidency included the possibility of realizing more taxable income in 2016 and deferring tax-deductible expenses to 2017. (Whether she would have been able to enact those higher taxes, and whether she really meant what she said, are now moot points.)
President-elect Trump campaigned on the promise of tax cuts for all. Analysis of his plan suggested significant potential benefits for higher-income earners and the investor class. Anticipating lower taxes under a Trump administration would suggest deferring income into 2017 and accelerating expenses into 2016.
On November 30, Treasury Secretary-designate Steven Mnuchin stated that there will be “no absolute tax cuts” for the wealthy. As is usual with new presidents, especially when the party controlling the White House changes, campaign promises have to be reconciled with political and fiscal realities. We won’t know the final form of Trump’s tax program until next year.
The most likely tax changes appear to be a decrease in corporate tax rates, perhaps combined with some sort of tax holiday for companies that repatriate profits squirreled away overseas. At present, there is no clarity about lower tax rates on dividends, long-term capital gains, or ordinary income. Given Mnuchin’s comments, whether individual tax brackets change, and how, remains substantially unclear.
Lower taxes on companies boost effective earnings, which has been a powerful driver of the Trump rally in U. S. equities. Companies with the highest effective tax rates have also been the biggest movers since the election.
With the clock quickly running out on 2016, we need to make decisions based on the best information we possess. U.S. stock prices are near all-time highs, with valuations at levels only seen previously in 1998 and 1999. Risks are high and potential opportunities low, and we will act to manage and reduce these risks.
We will continue to move toward more tax-efficient investments in taxable accounts for clients who are higher-bracket taxpayers. For older clients, we may retain highly-appreciated stock positions in hope of taking future advantage of a stepped-up cost basis. For younger clients, for whom any likely step-up in basis is decades away, we lean toward realizing gains on appreciated positions if we can transition to more tax-efficient investments with better risk/reward characteristics. In other words, pay some immediate tax now in order to reduce taxes in the future.
Where we have authorization to do so, we’ve begun informing our clients’ tax preparers about realized and unrealized gains. We’re also examining the intersection of portfolios with tax returns to look for opportunities to create long-term tax advantages.
If you haven’t already authorized us to communicate with your tax preparer and you’d like to, or if you’d like to discuss the possibilities for improving your tax position, please call or email us at any time. We’d love to hear from you.
By James S. Hemphill, CFP®, CIMA®, CPWA®/ Managing Director & Chief Investment Strategist
Jim has been a CERTIFIED FINANCIAL PLANNER™ professional since 1982. Jim specializes in complex wealth transfer and retirement transition strategies and coordinates TGS Financial’s investment research initiatives.
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