Personal Finance

Tax Cuts and Jobs Act (TCJA) Investment Implications

The Tax Cuts and Jobs Act (TCJA) has been passed by Congress and should be signed into law soon by President Trump. The primary focus of the TCJA is the structural changes to the business side of the tax code. We remain encouraged by many of the law’s provisions that would positively impact economic growth and stock values.

Impact on 2018 Outlook: The Joint Committee on Taxation estimates show that the tax cuts would total around $181 billion or 0.9% of GDP in calendar year 2018, with a major portion of this in corporate tax cuts. This should translate to a positive benefit on economic growth in 2018. However, the impact on S&P 500 corporate earnings are more substantial with the impact of tax reform adding about $10 to earnings per share in 2018 or about 7%.

Important Corporate Provisions

Corporate Tax Rate: The law sets the statutory corporate tax rate at 21% – down from 35%, which today is the highest in the industrialized world. The 21% rate is effective in 2018.

This provision should ultimately make the U.S. much more competitive for attracting global investment and keeping existing investment – it would take away the incentive for moving corporate headquarters and research facilities to lower tax countries. While the U.S. economy is the biggest beneficiary, other beneficiaries include small cap stocks and corporations with the majority of their earnings in the U.S. – namely Consumer Discretionary, Consumer Staples, Industrials, and Telecoms (see table below).

Expensing: The law allows full expensing of equipment for the next five years. Business investment is the major driver of productivity and this would help economic growth potential and ultimately worker wage gains. There has already been an impressive acceleration in corporate capital expenditures and this provision should add fuel to that acceleration. Industrials, Technology and Financials are major beneficiaries of this provision.

Territoriality: The law shifts the U.S. to a territorial system, where US companies will not pay taxes on their future overseas profits.

Deemed Repatriation: The law has a one-time mandatory tax on accumulated foreign profits of 15.5% on cash or liquid earnings and 8% on non-cash or illiquid assets (factories and equipment). This is a much lower rate than they could previously get. This one-time tax is meant to serve as a transition from the old “world-wide” system to a new “territorial” one in which foreign profits will generally not be taxed at all, with exceptions intended to discourage abuse of foreign tax havens.

There is an estimated $2.5 trillion in earnings held overseas with $920 billion held in cash. S&P 500 Technology companies hold $633 billion in untaxed overseas cash while Health Care firms hold $151 billion. These companies should benefit from bringing money back to the U.S. for share buybacks, dividend increases, and further investment.

Interest Deductibility: The law caps corporate interest expense at 30% earnings before interest, taxes, depreciation and amortization (EBITDA) in 2018 through 2021and then caps it at 30% of earnings before interest and taxes (EBIT) after 2021.

Taxation of Pass-throughs: The law lowers the tax rate on pass-through businesses, with a 20% deduction on pass-through income (sunsets after 2025). Taxpayers with incomes over a threshold of $315,000 face additional restrictions. Qualified REIT dividends and publicly traded partnership income are eligible for the 20% deduction.

Sector and Industry Implications:
Domestically-oriented Sectors with High Effective Tax Rates are Major Beneficiaries.

Source: Janney ISG, Bloomberg

We Remain Positive on the Economy and Stocks:

We think tax reform will be very beneficial to corporate America and the U.S. economy. We remain overweight stocks relative to bonds and cash. We also remain overweight Financials, Industrials, Health Care, and Energy and are favorably neutral on Technology. Many companies within these sectors should benefit from tax reform. We are also favorable on small-cap stocks.

Disclaimer: Past performance is no guarantee of future performance and future returns are not guaranteed. There are risks associated with investing in stocks such as a loss of original capital or a decrease in the value of your investment. This report is provided for informational purposes only and shall in no event be construed as an offer to sell or a solicitation of an offer to buy any securities. The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The opinions expressed herein may be given only such weight as opinions warrant. This Firm, its officers, directors, employees, or members of their families may have positions in the securities mentioned and may make purchases or sales of such securities from time to time in the open market or otherwise and may sell to or buy from customers such securities on a principal basis.

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