Research

CA Answers: What Should Individual Investors Do Now That the US Tax Bill Has Passed?

Chris Houston

Answers to our clients’ questions about market action and the market environment in a few paragraphs every two weeks.

The new US tax bill creates little pressure for immediate action by individual investors, even though we expect the legislation to be quite impactful. Some investors should consider taking action before the end of 2017 if they are able, but in most cases the benefits will only be marginal, relative to total assets and income. However, as the tax bill and its ramifications become more fully analyzed and understood, investors should be ready to consider more substantial steps that could prove advisable with their investments or otherwise.

The tax bill that has now passed both the House and the Senate (with the President’s signature expected sometime between now and early January) makes major changes to the US tax system, affecting individuals, business, and tax-exempt organizations both in and outside the United States. Among other changes, the bill sharply cuts the corporate tax rate and the effective tax rate for many partnerships and other pass-through entities; newly taxes the investment income of certain endowments; and slightly reduces the ordinary income tax rates for individuals.

Individuals will see other significant changes as well. Some of these changes may reduce their taxes, like the increase in exemption from the alternative minimum tax (AMT) and the elimination of the so-called Pease limitation on itemized deductions. Other changes may increase their taxes, like new limitations on the deductibility of mortgage interest, of state and local income taxes, and of state and local property taxes, as well as the elimination of miscellaneous deductions.

Given the limited change in the top marginal tax rate for individuals (moving from 39.6% to 37%), plus the absence of changes to the 3.8% net investment income surtax and the 20% tax rate on long-term capital gains and qualified dividends, investors have less need to take immediate action before these changes become effective than they would have had if rate changes were more substantial.

Whether an investor should accelerate the realization of income, gain, or loss into 2017, versus deferring it to 2018 or beyond, will depend largely on whether the investor is subject to state or local income tax and, if so, at what rate. Investors paying state and local income tax at a higher rate (say, 7% or more) might marginally benefit from accelerating income and gain into 2017 (and deferring losses), because the higher tax rate in 2017 could be more than offset by the remaining ability to deduct state and local income taxes payable for 2017. Conversely, investors paying little or no state and local income tax might marginally benefit from deferring income and gain but accelerating losses into 2017, and where the state and local income tax is around 5% or so, it will be more of a wash.  Investors should consult with their tax advisors to examine this in light of their specific circumstances, since computations may vary depending on the specific amounts, assets, and income sources, the applicability of AMT and the Pease limitation, and other details.

In all of these cases, another factor to consider is how long the investor would otherwise defer the income or gain, because there is also economic value in postponing the payment of tax and opportunity cost in paying taxes early. Moreover, with regard to investments, the proverbial tax tail should not wag the whole dog, and there may be solid investment reasons to accelerate or defer the realization of income, gain, or loss regardless of tax consequences, all the more where the marginal tax differences will only be minor. These decisions should be assessed by investors on a case-by-case basis, in consultation with their investment and tax advisors.

As with the realization of income, gain, or loss, investors should also consider whether they would be better off accelerating or deferring charitable contributions and other expenditures that might (or might not) be deductible in 2017 versus 2018. Investors who wish to accelerate contributions while preserving the flexibility to determine the amounts, timing, and recipients of grants over a longer period might consider a donor-advised fund.

Perhaps the easiest and most straightforward step that individual investors can take before year-end is to pre-pay any state or local property taxes that have already been assessed and determined but are not otherwise fully due in 2017. This can ensure that such taxes will be deductible for federal tax purposes, and at 2017’s higher 39.6% rate to boot, producing an immediate (albeit one-time) tax benefit that may otherwise be lost. State and local treasurers are aware of this opportunity and should be able to provide specific details as to what (if any) taxes may be prepaid in 2017.

Aside from considering these immediate steps that might benefit them at the margin, investors should continue to consult with their investment, tax, and legal advisors to determine how the new tax bill will affect them more substantially over the longer term and what strategies they might take with their portfolios to reduce their taxes and increase their after-tax investment returns.

Chris Houston is the Managing Director of Tax Strategy at Cambridge Associates.

Originally published on December 21, 2017

This report is provided for informational purposes only. The information presented is not intended to be investment advice. Any references to specific investments are for illustrative purposes only. The information herein does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. This research is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. Some of the data contained herein or on which the research is based is current public information that CA considers reliable, but CA does not represent it as accurate or complete, and it should not be relied on as such. Nothing contained in this report should be construed as the provision of tax or legal advice. Past performance is not indicative of future performance. Broad-based securities indexes are unmanaged and are not subject to fees and expenses typically associated with managed accounts or investment funds. Investments cannot be made directly in an index. Any information or opinions provided in this report are as of the date of the report, and CA is under no obligation to update the information or communicate that any updates have been made. Information contained herein may have been provided by third parties, including investment firms providing information on returns and assets under management, and may not have been independently verified.