Last week, Joe Biden introduced his comprehensive economic plan, including his “Buy American” plan. In response to questions regarding how to pay for the new programs, reference was made back to tax proposals previously announced earlier in his campaign. Some proposals are simply a reversal of some of the provisions enacted by the Tax Cuts and Jobs Act of 2017. Others are new and will impact both individual and corporate taxpayers.
While Biden’s proposal is centrist relative to the high-profile progressives (Senators Warren and Sanders), it will bring meaningful change to the tax code and headwinds for investors.
The tax provisions previously enacted under the Tax Cuts and Jobs Act of 2017 and relating to individual taxpayers came with an expiration date of December 31, 2025. As it relates to estate planning with the increased exemptions, many individuals are in the process of implementing trust strategies to take advantage of the increased exemptions before they return to lower levels. The timeline for completing this planning may be accelerated depending on the outcome of not only the Presidential election, but also by control of the House and Senate. Nevertheless, we believe it is a good idea to complete the execution and funding of trusts by year-end to assure that the full benefit of the increased gift and estate as well as generation skipping exemptions can be utilized.
The more significant impact of the Biden Plan are the items that are not simply a rollback of the Tax Cuts and Jobs Act of 2017 provisions, but are provisions that have not been planned for and that implement new tax rates. The bulk of these proposed changes target higher-income taxpayers.
For business owner clients, whether operated as a C Corp or Pass-Through Entity, the potential income tax changes have the potential to significantly alter income and business valuations. Business owners considering a possible sale of their business could see after-tax proceeds reduced by nearly 50% if the increased capital gains tax rate were to be implemented.
From an economic perspective, we believe Q2 is likely to be the bottom for most indicators. From here we expect significant improvement, which will be meaningful on a percentage basis, though still well below full output/employment. With the looming election there will be substantial pressure on Congress to continue providing enhanced unemployment benefits (which are set to expire July 31) and corporate support. Congress is in recess until July 20 so we expect a flurry of activity around month end.
Corporate profits have been elevated in recent years and our current expectations are that these would decline independent of the fall election. If the Biden Plan is implemented, this would put further pressure on profit margins. A recent Goldman Sachs analysis estimated the increase in corporate tax rates would reduce Earnings Per Share (EPS) for S&P companies by 12%.
As we look ahead to the fall, we envision a couple of factors that may contribute to heightened volatility. The first would be a rising probability of a Democratic Senate alongside a President Biden. Currently they need to pick up three seats to reach 50, and a Democratic Vice President would be the tie-breaking vote. This presumes the two independent Senators (Bernie Sanders, Vermont & Angus King, Maine) continue to caucus with Democrats. The second is potential policy responses from the Trump administration in an effort to shore up support through the fall, which could include particularly aggressive trade actions and rhetoric.
The chart below highlights the historical average annual return under various political regimes. It is notable that some degree of balance is a good thing and market concerns about a Democratic Congress are valid.
A Democratic sweep could be a headwind for equities, particularly in sectors expected to face increasing regulation. These could include for-profit education, for-profit prisons, defense and aerospace and energy. Conversely, Democratic control of the “power of the purse” would benefit infrastructure programs, renewable energy, and absent a “public option,” a number of healthcare companies could benefit from additional spending if we see an expansion of the Affordable Care Act.
Another area that will surely be impacted by the election is US trade policy. In recent years many CEOs and CFOs have lamented the tremendous uncertainty on this issue. Clarity around the path forward, even in the face of a more restrictive regulatory regime, should lead to an uptick in corporate investment.
Independent of the election results, we expect Congress and the Federal Reserve to be active in supporting the US economy well into 2021.
In anticipation of continued market volatility, Oxford has been evaluating all facets of our portfolios, but with a particular focus on real assets and assessing how tax rates would impact our fixed income allocations, particularly within niche segments of the municipal bond market. As always, our managers are making decisions on a company-by-company basis to assess how these changes might impact cash flows and the shifting range of outcomes from current market prices.
Engaging Your Oxford Team
In the upcoming weeks and months, we will explore strategies to consider throughout the remainder of the year to minimize the potential negative tax impact for individuals and business owners that may result if the Biden Plan were implemented. These may include considerations of strategically recognizing capital gains, exploring tax-loss harvesting opportunities to offset gains, planning considerations around adjusted gross income, the impact on deal structure for business owners considering a partial or full exit strategy as well as estate planning strategies to fully capitalize on gift and estate and generation-skipping exemptions.
There are a number of variables that must fall into place before implementation of Joe Biden’s tax policies would occur. Besides his election as President, the most important may be the control of the Senate. Regardless of the election outcomes, your Oxford team is positioned to ensure that our affluent family clients continue to develop well thought out wealth enhancement strategies and implement them timely and efficiently. Consultation with your Oxford team and an analysis of the possible impact of any tax policy, regardless of the candidate, will allow your full team of advisors to identify the optimal solutions for your family.