A Word on the New Tax Cuts & Jobs Act

The Tax Cuts and Jobs Act overhauls America’s tax code to deliver what appears to be historic tax relief.  We will stress that it is a really good bill for U.S. companies that do most of their business in the U.S. These companies generally have high tax brackets, such as retailers and banks. It clearly benefits value stocks over growth stocks as the lower tax rates help dividend oriented companies free up earnings that can be used to distribute to stock holders. Below please see a summary of the bill:

  • Corporate Rate: The final package lowers the corporate rate to 21% effective January 1, 2018, down from 35%.
  • Individual Rates: The final package retains the seven individual rate brackets, but it changes the rates and attachment points. The top rate will be reduced from 39.6% to 37%. These changes would sunset after 2025.
  • Significantly increases the Standard Deduction from $6,500 and $13,000 under previous law to $12,000 and $24,000 for individuals and married couples, respectively.
  • Expands the Child Tax Credit from $1,000 to $2,000.
  • Preserves the Child and Dependent Care Tax Credit.
  • Preserves the Adoption Tax Credit.
  • Expands the Medical Expense Deduction for 2017 and 2018 for medical expenses exceeding 7.5% of adjusted gross income, and rising to 10% beginning in 2019.
  • Maintains the Earned Income Tax Credit for low-income Americans.
  • Estate Tax. The final bill doubles the estate tax exemption from the $5 million base set in 2011, to a new $11.2 million for individuals and $22.4 million for married couples. This will essentially make estate tax a non-issue for nearly every American Family. (Estate tax is estimated to only be paid by the richest 0.1% of American Families with the new tax plan)
  • Like-Kind Exchanges. The final bill preserves the like-kind exchange benefit for real property.
  • Individual Mandate. The final bill effectively repeals the Affordable Care Act’s (ACA) individual mandate by reducing the tax to zero.
  • Repatriation Rate. The final bill includes slightly higher deemed repatriation rates at 15.5% for cash assets and 8% on illiquid assets.
  • Banks clear beneficiaries as they see far more dessert than vegetables in final package. As expected, banks fared well in the final tax package. Banks should benefit from top-line growth if the package spurs economic activity, bottom-line growth as banks are generally full taxpayers, and possibly even a steepening yield curve as the package’s inflationary impact materializes. Furthermore, the final bill dropped the controversial FIFO proposal, repealed the corporate alternative minimum tax, and avoided the big bank tax conversation altogether.

The Mortgage Industry made the best of a bad hand. On balance, the final tax bill negatively impacts higher-end housing markets, but the mortgage industry softened the blow by securing a handful of victories in the eleventh hour.

We briefly discuss these issues below:

  • Mortgage Interest Deduction: The final package maintains the mortgage interest deduction (MID) for existing mortgages, but limits the deduction to $750k of acquisition debt on mortgages originated after December 15, 2017. The $750k threshold splits the difference between the House and Senate plans. Debt on both first and second mortgages under the $750k threshold will be deductible, but the legislation suspends the deductibility of home equity lines of credit (HELOC). The MID treatment under current law, including the $1M threshold, would return in 2026 under the conference agreement. Zillow estimates that 44% of U.S. homes are worth enough to take advantage of the mortgage interest deduction under current law, but that figure will drop to 14% under the conference committee compromise.
  • The bill allows up to $10,000 in state and local tax (SALT) deductions, which is slightly broader than original proposals focused exclusively on property tax. This will really hurt high value homeowners in high state income state taxes like California. Notably, the decimation of the SALT deduction, coupled with the doubled standard deduction, will inherently reduce the tax benefit of homeownership.
  • Capital Gains Exclusion. In one of the clearest victories for the mortgage industry, the final package maintains the existing structure of the capital gains exclusion stemming from the sale of a home. Specifically, under previous law homeowners were allowed to exclude up to $250,000 from the sale of a home for individual filers and $500,000 for married couples filing jointly if they have lived in the home for two of the last five years. Previous House and Senate proposals would have materially altered this provision, which could have negatively impacted already constrained supply in certain markets, but the industry was able to secure an eleventh-hour victory by maintaining this law.