We hope this finds you healthy and well wherever you are. It’s hard to believe we are already in the middle of October. Before we jump into some thoughts on the September markets and tax law changes, we wanted to provide a few reminders as we approach year end.
- Required Minimum Distributions – For those of you who are required to take RMD’s. Please know that we will reviewing this for you, and if you still have a lingering RMD requirements we will be getting in touch. Please don’t hesitate to reach out if you have any questions. As a reminder if you do have charitable intentions, you can always take a portion of your RMD as a qualified charitable distribution, and we can take care of sending this distribution directly to your charity of choice. Click here to read more about qualified charitable distributions.
- Tax Review – With the tax filing recently behind us, we wanted to send a friendly reminder to send us your tax returns for review. Tax strategy has become more important than ever and we want to make sure we are helping you with your tax strategy planning.
- Year End Planning – Our newsletter next month with focus on year end planning in more detail, but please don’t hesitate to schedule a year end meeting with us here.
Tax Law Changes Increase Your Taxes?
Will you be paying more in taxes next year? This has become a more frequent question from you, and you are wondering how this will affect you. We shared some initial thoughts and suggestions in our letter last month, but we thought it might be helpful to highlight some of the major provisions as they stand now.
If proposed changes in the tax code that passed a House committee are enacted into law, there could be some significant changes to be aware of.
The major provisions include:
- Raising the top federal tax rate from 37% to 39.6%,
- Levying a 3% surtax on income higher than $5 million for single and joint filers,
- Raising the tax on dividends and the long-term capital gains tax rate for assets held over one year to 25% (up from 20%) for individuals earning more than $400,000 and for couples that earn over $450,000,
- Placing new limits on those who have large retirement account balances, and
- Putting new limits on QBI deduction for pass-through firms.
These proposals are a long way from becoming law but are winding their way through Congress. The Senate may have its own set of proposals, which would require both legislative bodies to forge a compromise before a tax bill lands on the President’s desk.
Moreover, a sharply divided Senate seems likely to pare $3.5 trillion in proposed spending, assuming legislators in the House compromise on new outlays. If new spending is reduced, smaller tax hikes could follow.
While we don’t know exactly what will happen, we do want to be aware of the potential changes so that we can act quickly if necessary.
The proposed increase in the top tax rate and the surcharge on income over $5 million. A couple filing jointly that has $600,000 of taxable will see their top rate rise from 35% to 39.6% next year, if proposed changes are enacted (4.6 percentage points, or a $6,900 increase in taxes on $150,000 of income).
However, there are ways to minimize the tax sting next year.
Consider shifting 2022 income into tax year 2021, which would be subject to today’s lower rate. And look for ways to defer expenses and deductions that you might normally incur in 2021 and push them into 2022.
Maximize contributions to tax-deferred savings and retirement accounts. If you itemize deductions, charitable contributions will reduce your taxable income.
In addition, municipal bonds, which are exempt from federal income tax, will become more attractive if a higher marginal tax rate is enacted.
The proposed 3% surtax on individuals earning over $5 million would effectively raise the top tax rate to 42.6%. This would hit very few taxpayers—but be aware that the sale of a business or large asset could push you above the threshold.
Please note that the surcharge is separate from today’s 3.8% tax on net investment income.
A higher rate on dividends and long-term capital gains tax rate is being considered. As proposed, if a capital gain is realized on or after September 14, 2021, individuals earning more than $400,000 and couples earning over $450,000 will pay a top rate of 25%. The same would hold true with dividends.
With very narrow exceptions, it would be too late to incur a long-term capital gain at 2021’s lower rate.
You may consider deferring gains, as an unrealized capital gain would not be subject to taxes. Or, rates may decline again in the future. As we commented up top, much depends on your individual circumstances.
There will be new RMD requirements for individuals who have high income and large retirement accounts, regardless of age. If you exceed $400,000 and $450,000 in income for single and joint filers, respectively, AND retirement accounts total over $10 million, you will be subject to RMDs beginning in 2022. You will also be prohibited from making IRA contributions.
However, the restriction on contributions does not apply to employer-sponsored plans such as 401ks, SEP IRAs, or SIMPLE IRAs.
If your income is above the $400,000 and $450,000 limits and retirement accounts exceed $20 million (including a Roth IRA), you would be required to distribute funds from your Roth IRA.
New limits on QBI deduction. If you are self-employed, the House proposal limits the deduction to $500,000 for joint returns and $400,000 for individual returns. Once you have exceeded the cap, additional amounts will be disregarded.
Left on the cutting room floor
Lawmakers in the House have not proposed taxing unrealized capital gains at death, as had initially been proposed by the President. Also, the step-up in basis for inherited assets is NOT in the current House proposal.
But one proposal being floated is to reduce the estate and gift tax exemption to $5 million. Tax reform in 2017 raised the limit to $11.7 million of individuals and $23.4 million for couples.
These are some of the major provisions. They may or may not be enacted into law.
We understand that taxes play a role in overall returns, but so do many variables. While we believe taxes should not drive your financial plan, we do believe it’s important to be aware of.
Sources and further reading
[[https://www.wsj.com/articles/capital-gains-and-capital-pains-in-the-house-tax-proposal-11633080602 Capital Gains and Capital Pains in the House Tax Proposal]]
[[https://www.schwab.com/resource-center/insights/content/will-taxes-rise-wealthy-what-you-should-know Will Taxes Rise for the Wealthy?]]
[[https://www.wsj.com/articles/democrats-want-to-raise-taxes-heres-your-to-do-list-11631871008 Democrats Want to Raise Taxes. Here’s Your To-Do List]]
[[https://www.cnbc.com/2021/09/13/house-democrats-plan-drops-repeal-of-a-tax-provision-for-inheritances.html House Democrats’ Plan Drops Repeal of a Tax Provision for Inheritances]]
What is it about September?
September has historically been the worst month for stocks, according to St. Louis Federal Reserve data measuring monthly S&P 500 performance over the last 50 years. If you are wondering whether the trend has abated in recent years, the answer is no, it hasn’t. Over the last 10 years, September performance has been substandard.
While analysts have offered various explanations, no one has pinpointed the reason we sometimes see seasonal weakness as summer concludes.
Look no further than the table of Key Index Returns. The S&P 500 Index fell 4.8% in September. It was the first monthly decline since January and the worst decline since March 2020 when the lockdowns began.
Key Index Returns
|Dow Jones Industrial Average||-4.3||10.6|
|S&P 500 Index||-4.8||14.7|
|Russell 2000 Index||-3.1||11.6|
|MSCI World ex-USA*||-3.2||7.1|
|MSCI Emerging Markets*||-4.3||-3.0|
|Bloomberg Barclays US Aggregate Bond Total Return||-0.9||-1.6|
Source: MSCI.com, Bloomberg, MarketWatch
MTD: returns: August 31, 2021—September 30, 2021
YTD returns: December 31, 2020—September 30, 2021
*in US dollars
Peaking at a new record on September 2, the broad-based S&P 500 Index began a pullback that can be tied to a number of factors.
Before we continue, a 4.8% drop is modest by market standards. In fact, we’ve yet to shed 10% since the bull market began in late March 2020, which would be considered a “correction” by analysts.
So, what’s behind the sell-off last month?
The economy is not contracting, and a moderation was expected after Q2’s 6.7% annualized growth rate (U.S. BEA), but the slowdown has been more pronounced than expected.
The Atlanta Fed’s GDPNow model, which incorporates economic data that impacts GDP, suggests that Q3 growth is tracking at just 2.3%. This would include Q3 data released through October 1. That means all of July, most of August and none of October’s data have been inputted into the model.
While profit growth has soared coming out of the lockdowns, per Refinitiv, a more pronounced moderation in profit growth may be on tap.
Next question, why is Q3 disappointing on the economic front? Well, the spike in Covid cases is causing some hesitation in industries that are dependent on face-to-face transactions. But there is good news on this front. The CDC says cases have slowed recently. We’ll see how this continues to play out later in the fall. While bank deposit data from the St. Louis Federal Reserve suggest consumers have plenty of spendable cash in reserve, the influx of new stimulus money has dwindled, and spending has slowed. We’re also seeing stubbornly high inflation in some industries, as supply chain bottlenecks aren’t fixing themselves.
Consider the title of this [[https://www.wsj.com/articles/why-is-the-supply-chain-still-so-snarled-we-explain-with-a-hot-tub-11629987531 Wall Street Journal story]] from late August:
Why Is the Supply Chain Still So Snarled?
We Explain, With a Hot Tub.
Utah manufacturer Bullfrog Spas depends on a complicated network to bring materials from across continents and oceans. The pandemic put it out of whack.
That sums up the problem for many manufacturers.
As Fed Chief Jerome Powell noted at the end of September, bottlenecks and shortages of key raw materials are “not getting better—in fact at the margins (they are) apparently getting a little bit worse.”
Like severe labor shortages, supply chain problems are crimping profitability, limiting sales, raising prices and hampering economic growth. Investors are taking note.
An uptick in bond yields near the end of the month also dampened sentiment. While yields remain quite low, they ticked higher after the Federal Reserve took on a slightly more hawkish tone at the September 22 meeting.
These are probably the biggest reasons for the pullback last month.
Here are a few other considerations.
The debate over the debt ceiling is taking shape. The U.S. Treasury has said it will run up against the current debt ceiling on October 18. That means it can no longer borrow to fund operations, and the U.S. would default on its debt unless Congress extends the ceiling.
As Moody’s Analytics recently noted, “The debt ceiling will be raised. Not doing so would be catastrophic for the economy, so this is an extremely low probability event.”
We’ve seen this drama play out before, and lawmakers avoided sailing into uncharted waters. Still, it’s causing some headline anxiety.
China’s largest and most indebted property developer is on the brink of bankruptcy. While Western financial exposure is likely limited, a disorderly default could create big problems for the world’s second-largest economy.
Finally, an energy crisis is brewing in Europe, while natural gas prices hit new highs in Asia. They are running about six times what we see at home (Reuters).
The U.S. isn’t directly affected, but these are costs that may get added to manufactured goods or could restrict output, adding to supply chain woes.
There are a lot of moving pieces right now that can affect your financial world. Please know that we are here, and happy to help in any way we can. As a reminder you can always schedule a virtual meeting with us here.
We wish you a wonderful October and Happy Halloween!
Kerry Meath-Sinkin, Partner & Wealth Advisor
Robert Meath, Founder & Wealth Advisor
The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ.
The NASDAQ Composite Index includes all domestic and international based common type stocks listed on The NASDAQ Stock Market. The NASDAQ Composite Index is a broad based index.
The S&P 500 is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe and is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.
The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI World Index represents 23 developed market countries.
The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. It is a float-adjusted market capitalization index.
The Bloomberg Barclays US Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in for measuring the performance of the US bond market.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
Copyright © 2021 by Horsesmouth, LLC. All rights reserved. IMPORTANT NOTICE: This reprint is provided exclusively for use by the licensee, including for client education, and is subject to applicable copyright laws. Unauthorized use, reproduction, or distribution of this material is a violation of federal law and punishable by civil and criminal penalty. This material is furnished “as is” without warranty of any kind. Its accuracy and completeness is not guaranteed and all warranties expressed or implied are hereby excluded.
This piece is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult a tax or legal advisor.