Tax Reform Impact – Capital Gains and Investment Income

Recently I was at Powell’s bookstore In Oregon when I came across this book which attempts to be an introduction to the complexities of taxation. I thought that this was in the spirit of what I was going to try to do as I start to review the 2017 Tax Reform act and its’ myriad impacts on the economy and individual incentives.

As an individual investor, I started with looking at capital gains and investment income. Some thoughts:

1. The same general split applies; long term gains are taxed at favorable (lower) rates, and short term gains are taxed as ordinary income. The ordinary income tax brackets are always higher than the capital gains brackets

2. The tax rates for capital gains are 0, 15% and 20%. These are the same as under the previous tax laws.
Here is a brief article from the Motley Fool

3. The rates on ordinary income have gone down a bit, so the average person would pay less on gains, all else being equal (but this gets into your state and the standard deduction, a different topic). Thus there is no significant impact on investments here, it should be slightly favorable

4. Although there was talk of changing the way stock sales are accounted for to limit “tax loss harvesting”, these changes did not occur. I believe that you can still deduct up to $3000 in losses against ordinary income, but I haven’t been able to find that yet to confirm either

5. The 3.8% surtax on gains if your income is above $250,000 remains the same; this does not seem to be impacted by the law

6. While there were changes throughout the code that impacted REITS (real estate limited trusts) and MLP’s (Master Limited Partnerships), these changes didn’t fundamentally impact their value to classes of high income investors (they still have favorable tax characteristics)

7. There was some discussion of eliminating the Federal tax free nature of municipal bonds, but that deduction remained intact

8. There also was some discussion of changing the 401(k) deductions; this too, remained intact

Thus for investors, the basics of investing for individual investors (not the super wealthy) and the impact of taxation did not see significant changes under the new tax law. The types of tactics you would use under the prior tax law mostly moved into the new environment intact.

Cross Posted at LITGM

10 thoughts on “Tax Reform Impact – Capital Gains and Investment Income”

  1. I really wish they had extended the dividend paid deduction to all corporations, not just quasi pass-throughs like REITs and RICs. It would have encouraged regular corporations to pay dividends to their shareholders. That would eliminate double taxation, remove the incentive to hoard cash at the corporate level, and get cash into circulation. Oh well.

  2. They’re not going to hoard cash. With the lower corporate tax rate and pass through deduction, companies now have a strong incentive to circulate their cash on purchases of capital assets that will increase sales. That will then increase individual employment, which will increase personal income. That income will then be spent and invested in people’s communities. That will then increase fulfillment in individuals’ lives as they interact and build better lives and better communities.

    The dividend cash that many investors were receiving for sitting on their corporate shares will be replaced by income from their investments in small businesses that employ Americans. So Carl, log off Motley Fool and sharpen your pencil because you need to move your money where the real growth is going to be, which is producing real, tangible goods and services that are going to improve everyone’s lives.

  3. The new rules for deduction on pass-through entities are pretty complex in terms of which kinds of business are eligible and which are now. Lots of opportunities for CPAs and tax lawyers.

    Based on my understanding so far, REITs have become a more desirable investment (from a tax standpoint) in that some components of their distributions which were previously taxed at ordinary income rates will now be at qualified dividend rates.

  4. To segway a bit, one major disappointment in the new tax bill is a lack of change to US extraterritoriality for earned income.

    I’m an ex-pat professional working in the Middle East and I have to compete against Brits, Swedes, Canadians, Indians, Romanians, South Africans, etc etc. They ALL are exempt from home country earned income taxation.

    While I get the first roughly $100k excluded, Americans still needed to be cashed-up to offer competitive salaries. That, of course, makes us more expensive and ergo, less likely to be hired, given comparable skill levels.

    While it doesn’t affect me too much, as I give 40% off the top to my ex-wife and 20% to my college-student child, somebody fix this, please!

  5. “To segway a bit”
    Such an awesome typo.

    I find the Dem hysterics regarding the tax cut to be hilarious. But does anyone have a link to a somewhat sane explanation of this concept that is now being pushed in CA & NY to boost payroll taxes in response? As far as I can tell it’s utterly insane and would be incredibly destructive, especially to small business and the bottom half of income earners, i.e., it’s a perfectly normal modern blue policy. But is there anything out there where an advocate tries to describe its benefits and why they don’t think it would have massive damaging effects?

  6. I think what he is sencing is that if the tax cut will help the middle and lower income earners, directly or indirectly, some states (blue and purple) will hike state taxes to reduce the paycheck bottom line so their wish that the promised benefits of the tax bill will largely fail to happen (while they reduce their deficits with increased tax revenue).

    Win-Win- but only in the short run. Businesses and employees can hardly miss this death defying shell game and the migration will continue if not accelerate. More importantly the differential growth rates among the states will be markedly amplified. The Laffer curve will become more real to them every day. This might be a case of geopolitically self-inflicted Armageddon.

    Some of them such as Nancy, Moonbeam, Cuomo, Sanders, Warren and Schumer are just too dense to get it and they and others of their persuasion are so ideologically and power driven that it might not make any difference to them if they do or did understand the practical effects. After all we are due for another crisis not to be wasted on growing statist power. Even if the pie is getting smaller, getting a bigger piece can still work in the near term. Can’t they still trust the Feds to redistribute from the Flyoverlandia to the bankrupt Wastelandia parts?

    Howdy! Welcome ya’ll! Leave your progressive expectations of entitlement and social justice at the state line. Bring your A game and seize the opportunity. If not, this might be a rude awakening for Ya’ll.


  7. “Businesses and employees can hardly miss this death defying shell game and the migration will continue if not accelerate.”
    Yeah, as far as I can tell, the genius payroll tax plan is that since (allegedly) so many blue staters are going to pay more in taxes because of the SALT limitation, the state will jack up payroll taxes, which will (of course) mean employees will get paid less, but they’ll still come out ahead because they will also pay less in taxes, so that they won’t be hurt by the new SALT limitation, and states will still get the same amount of money, just via a different channel. But I can’t be sure because I’ve never seen an advocate actually try to honestly argue for it.
    But even trying to give it a fair hearing, I see a whole bunch of problems:
    1. The overwhelming majority of people aren’t even subject to the SALT limitations, so it’s a solution in search of a problem.
    2. The people who are subject to both the SALT limitations AND the newly raised standard deduction are very well off, and so many/most of them don’t get their income primarily through payroll anyway.
    3. People won’t accept a pay cut. They will tell their employers to shove it, and will leave.
    4. So, in order to cater to a small number of very wealthy people, you increase the cost to a business of every worker, AND you cut the pay of every worker (or maybe not “every” since I’ve never seen an actual plan, but if it’s not imposed generally then you have the problem of greatly increased red tape, etc.)
    Again, I’d like to hear the plan fleshed out honestly by an advocate, but as far as I can tell it’s complete lunacy. So of course the silver spooned dynasty boys in charge of CA and NY love it…

  8. Brian, remember that despite the “fighting for the little guy” rhetoric, no politician can afford to piss off wealthy donors. So now that the Trump administration is sticking it to the BLUE 1%, the Democrats are screaming. It’s brilliant on Trump’s part, except the Democrats have such contempt for their base’s intelligence that they are willing to risk looking stupid to people they assume are too stupid to notice. Cynical? No, just experienced.

  9. Yeah, I can see the cynical/political reasons–you don’t want the proles to benefit from the GOP tax cut, so you tell them they’re going to suffer, then you impose your own “fix” that makes them suffer, so they blame the GOP for it. It’s quite genius.
    But I think there must be economists who actually believe it will work, similarly to how there were economists who actually believed Obamacare would work. I understand those arguments, even as I knew they would never actually work because they had no connection to reality. But I don’t understand the rationale for the payroll tax hike plan.

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