Capitol Hill and Tax Bill Update – December 2017

December 1, 2017 / Market Update

Congress is back in session. But like a toddler, their direction is unsteady, unpredictable and bares watching.

While there has been much attention given to “tax reform”, it is also important to note that on December 8, the government will run out of money unless the Senate acts to extend funding. This requires 60 Senate votes, which is far from certain.  A government shutdown would result in closure of non-essential government operations, a lay-off of some employees, and finger pointing by both parties.  It would become a big media event leading to possible short term market volatility.

The tax bill being rushed through Congress is very much a “work in progress”, so there are some unknowns. However there are many similarities between the Senate and House versions, so it is possible to get a rough idea of what may eventually emerge.  The House has already passed their version.  The bills are “only” projected to reduce taxes by $1.5 trillion over ten years so qualify for special treatment known as “reconciliation” in which the Senate only needs 51 votes to pass their bill.  (As a frame of reference, if you spent $1 million per day for 2,700 years, you would be approaching $1 trillion).  If the Senate passes a tax bill, both bills will go to a joint committee to resolve the differences, be signed by the President and would likely become effective January 1, 2018.

Calling these bills “tax reform” is a misnomer. Reform generally connotes simplification.  The House and Senate versions are relatively similar, and neither could be considered simple. And believing that everyone would see their taxes decline is overly optimistic.  Many taxpayers may wind up paying higher taxes since some of their deductions would be capped or eliminated.

Of the $1.5 trillion in tax cuts, approximately $1 trillion of those cuts would go to reducing the taxes of corporations. The details are complex and the tax rates would be significantly lowered, but as the result of other proposed changes, not all corporations would benefit equally.  Retail companies, capital intensive industries and companies with international operations would be winners.  Technology, pharmaceutical, builders, realtors and insurers would not fare as well.

The proposed changes in individual taxes are perhaps even more complex. These proposed changes would have quite different impacts on individuals, depending upon where they live and how they earn their money.  While the current tax rates would be slightly modified, other significant changes are proposed as well.  Lower tax rates are proposed for some small business owners, while the alternative minimum tax (AMT) and the estate tax would be eliminated or reduced.  Offsetting these tax reductions would be an elimination of deductions for state and local taxes, capping the mortgage deduction and a reduction in other tax benefits that homeowners have enjoyed for years.  Some homeowners would be more likely to face capital gains taxes when they sell their homes.

The net impact would likely be lower taxes for some small business owners, those who have low state and local taxes and mortgage interest expense, and those who are subject to AMT, and / or  who already use the standard deduction.  Individuals living in high tax states or have high earned W-2 income would likely be adversely affected by the tax bills.  Many of the provisions would have an adverse tax affect on homeowners and, at least on the surface, appear to be a direct attack on homeowners.  Investors would also be hurt by the elimination of the option for using specified lots for determining capital gains, reducing the flexibility when capital gains are realized on partial sales.

For many the tax bills in Congress are a two edged sword. The prospect of lower corporate taxes has helped boost stock market returns this year.  However many individuals, especially homeowners, and those living in high tax states potentially face a net tax increase from the bills.

Although it is generally believed a tax bill will pass in the near future, we do not know for certain what provisions it will contain. It does appear that the ability to take itemized deductions would be more limited and the standard deduction increased.  Given that uncertainty, if you itemize your deductions, here are a few things you might consider doing in 2017:

 

  • Pay or pre-pay State and local taxes before year-end because they may not be deductible in 2018
  • Make 2018 charitable donations in 2017 rather than waiting until 2018, since you may wind up using the standard deduction next year. You can also consider a tax-deductible donation to a Donor Advised Fund (DAF) this year actually with the money sent to the selected charities in future years.
  • If you believe that you will exceed the 10% cap on medical deductions in 2017, be sure to pay all medical bills you receive in 2017 since you may elect to use a higher standard deduction in 2018.

 

In general, homeowners and those living in high tax states should not be surprised to see their tax bill rise in future years.

While I am heartened by the apparent benefit to corporations and the stock market, I am disappointed on how these bills have been rushed through Congress with little public debate and disregard for the already troublesome deficit which will fall on future generations. As usual the bills have been influenced behind the scene by vested interests.

The next step is for the Senate to pass their bill and then reach agreement with the House on the ultimate bill. And once 2018 rolls around, we will all be faced with trying to understand the implications and complexities of “tax reform”.


About the author

John Eckel: CFP®, CFA is President of Pinnacle Investment Management Inc. of Simsbury. He has been included in BusinessWeek.com’s list of the Most Experienced Independent Financial Advisors, has been named four times to Worth Magazine’s list of Top Financial Advisors, included twice in Medical Economics list of Top Financial Advisors for Doctors and named twice in JK Lasers list of Top Professional Advisors for Baby Boomers.