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President-elect Trump and the Republican-led Congress have said that one of their top priorities is the passage of tax reform in 2017. Although we don’t yet know the details, Trump’s campaign materials call for a top individual tax rate of 33% on ordinary income (down from close to 40%) and a top tax rate of 20% for capital gains and dividends (down from close to 24%). They would repeal the 3.8% surtax on investment income instituted under Obamacare. The effective date of tax reform is uncertain, but there is a strong likelihood that lower tax rates would apply retroactively to the beginning of 2017. Rates early next year could reflect the full rate reduction, or a reduction to somewhere between the old and new rates. Either way, investors would be well advised to plan for lower taxes next year. Investors should redouble their efforts to defer income into 2017 and accelerate deductions into 2016. For instance, investors could defer the exercise of employee stock options until January, and prepay 2017 state taxes and charitable contributions in December. Remember also that lower tax rates won’t last forever. Congressional procedural rules are likely to require that the lower rates “sunset” in ten years. Before then, a Democratic Congress – or any Congress concerned about outsized deficits in future years – could raise tax rates again. Thus, investors must plan for “tax volatility” – the concept that over time tax rates ebb and flow. Investors should maintain liquidity in both taxable and tax-deferred accounts and in taxable and tax-free investments. That way they can withdraw funds from one or the other depending on whether it makes sense to pay taxes that year (and if so whether to pay at ordinary income or capital gains rates). Preparing for tax volatility allows an investor to take advantage of tax changes, whichever way they might go. |
