The world of politics and political maneuvering never ceases to amaze us. When most considered the Build Back Better Act and its potential tax increases as being left behind – here comes its sequel. Spoiler alert: a quick summary on the good news is that most of the proposed tax increases are not in this bill. The bad news – it doesn't mean they are gone, it just means that they aren't in this particular bill.
Has it passed? What are the odds of more changes?
First, the deal isn't done yet. This new bill, the Inflation Reduction Act of 2022, has been approved by the Senate and now moves to the House for a vote. While there is always a possibility of additional changes occurring, the probability of that is pretty low. There appears to be strong alignment on the Democratic side of the aisle to take this bill across the finish line, which means the House vote later this week will most likely be uneventful and procedural.
What's included in the Inflation Reduction Act (as of now)
Without getting into the nitty-gritty details unrelated to taxes, investors should be aware of three key tax increases/tax law changes investors should be aware of. One that got significant press at first is now of no consequence to most investors, one is of some consequence, and one is of more consequence.
The one that is no longer of consequence is the proposed changes to the "carried interest loophole." This change lived for less than two weeks in the new bill before it was scuttled in negotiations and dropped from the bill altogether.
Instead, a 1% excise tax on stock buybacks has been added to the bill. This one is of some consequence as it impacts some investors. Simply put, a 1% tax rate on stock buybacks reduces the benefits investors receive from the buybacks. It also could be a disincentive for companies to do buybacks. On the other hand, companies may divert this type of shareholder payout activity to increased dividend payments. (Both buybacks and dividends are ways that corporations distribute excess income back to shareholders). The impact of this one may take some to study and analyze.
The change of more consequence but still not a direct tax on investors is a Minimum Tax on the profits of many large and/or multinational companies. The new tax is a minimum 15% tax rate on companies with at least $1 billion in income. Taxes on corporations largely get passed through. Some of that "tax expense" pass-through could come in the form of reduced earnings. This could have some impact on investors. Share prices are largely dictated by the earnings and earnings growth of companies, so this new tax could have an as-yet not fully known impact on the stock prices of the specific companies impacted. More details will surface over time.
Is what's not in the deal now gone?
This is the question many are asking, primarily because investors want to breathe a sigh of relief. The thing is, just like the trend of vintage fashion, that which is old can become new again. Just because the proposed tax increases over the last couple of years didn't make it into this latest iteration of the budget reconciliation bill doesn't mean that they are gone for good. Many of the recently proposed tax increases still have supporters in office. As we have previously written, nothing is for sure when it comes to political outcomes.
How to prepare for the potential of future tax increases
As previously written, when faced with tax-rate uncertainty, tax planning matters even more. Always be prepared. That's probably the best policy when it comes to investing and taxes.
Next, embrace tax management in taxable portfolios. By having an investment process that focuses on minimizing taxable distributions, you can help your clients limit the things that trigger tax payments. This also helps in control those negative tax surprises that occur when investors don't always embrace tax management.
Lastly, tell your clients what you're doing to improve their after-tax outcomes. In our recently released Value of an Advisor Study, helping clients reduce the impact of taxes is one of the greatest value-adds advisors can bring to the client relationship. Anytime taxes are in the news, it makes clients and prospects much more receptive to the value you offer on these topics.
We can't control which taxes and which tax increases might occur in the future. Advisors can manage how investments might be impacted by them. By minimizing tax drag on things that generate sizable tax bills, you can help your investors keep more of their money today, and likely for many years to come.
© Russell Investments
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