As the mud-slinging continues in the U.S. presidential campaign amongst the two candidates, Donald Trump and Hillary Clinton, taxes are one of the issues where the candidates differ. Trump, as the Republican candidate, of course favors tax cuts. Clinton, as the Democratic candidate, favors targeted tax increases aimed at the more wealthy people in the country as the issue of the widening wealth gap between the rich and the poor becomes more pronounced. Recently, we read an interesting article in an issue of Barron's comparing the presidential candidates on a series of issues. (Subscription required to view linked article.) (Note: Most people will know that Rupert Murdoch, owner of multiple conservative media outlets, owns Barron's, which leans Conservative, especially in its opinion pieces.) One such issue discussed was taxes as they relate to stock investments and the estate tax. We thought it would be interesting to discuss the potential Clinton tax increases indicated in the Barron's article, since Clinton is leading in the polls. Therefore, set forth below are potential Clinton tax increases relating to stocks/estates, and our comments.
1 - Taxing Capital Gains at Ordinary Tax Rates
In 2013, the U.S. government enacted tax law revisions that changed some tax rates for long-term capital gains and made some tax rates for long-term capital gains permanent. (Long-term capital gains rates apply to stock held for at least 366 days, more than one year.) In 2013, the U.S. government increased the highest tax rate on long-term capital gains and certain dividend payments to 20 percent for high income earners, a 5 percent increase from previous rates. Tax rates for those who make less than the amount deemed a "high income earner" (with respect their filing status - single, married, etc.) had their maximum capital gains and dividends tax rates remain at 15 percent. Taxpayers in the two lowest tax brackets can have a zero percent tax rate on any capital gains.
A lower long-term capital gain tax rate is appealing to investors, given that such rate is appreciably lower than the tax rate paid for regular income. (In 2016, the top marginal income tax rate of 39.6 percent is for taxpayers with taxable income of $415,050 and higher for single filers, and $466,950 and higher for married filers.) Therefore, a lower long-term capital gains tax rate for such high income tax filers would save such filers a substantial amount of money. For example, for each $1.00 of long-term capital gains, under the top marginal tax rate a taxpayer would pay $.396 in tax for such dollar made. Under the long-term capital gains rate, such taxpayer would pay $.20 in tax for each such dollar made, almost 50 percent savings. With many in American society commenting about the increasing wealth gap in the country, such advantageous tax rates for the high income earners are coming under attack.
As noted above, commentators in Barron's and elsewhere believe a President Clinton administration would push for higher long-term capital tax rates. In particular, there are people who believe a President Clinton administration will seek to tax long-term capital gains at ordinary income rates. We believe, however, that taxing long-term capital gains at ordinary income rates will not happen anytime soon given the likely continued control of the U.S. House of Representatives by the Republicans. We do believe there are other ways that a President Clinton administration can alter long-term capital gains taxation, such as: 1) extending the period to hold stock to qualify for the long-term capital gains rate to 5 years; 2) increasing the top tax rate for long-term capital gains for high income earners to 25 percent; and 3) lowering the amount of income that qualifies a tax payer as a "high income earner." We believe it would be difficult for a Clinton administration to enact any changes to long-term capital gains tax rates given Republican opposition in Congress. We also believe that even if a President Clinton administration could change some long-term capital gains tax rates, most investors' investing strategy would not change.
2 - Taxing Dividends at Ordinary Tax Rates
Perhaps the most devastating change that could occur to investors is a change by a President Clinton administration to tax rates applied to qualified dividends. (Qualified dividends, as defined by the United States Internal Revenue Code, are ordinary dividends that meet specific criteria to be taxed at the lower long-term capital gains tax rate rather than at higher tax rate for an individual's ordinary income.) Tax rates on dividends, a significant source of income for many retirees, are critical to the well being of such retirees, and therefore, are a "hot-button issue" that U.S. legislators must be careful with. In 2013, in the same laws relating to long-term capital gains tax treatment noted above, qualified dividends for individuals in the 25 percent, 28 percent, 33 percent and 35 percent income tax brackets remained at the 15 percent tax rate. Individuals in the "higher income" tax bracket noted above had their qualified dividend tax rate increase to 20 percent. Taxpayers in the 10 percent and 15 percent tax brackets saw their tax rate on qualified dividends remain at zero percent.)
As noted above, commentators in Barron's and elsewhere believe a President Clinton administration would push for a higher qualified dividend tax rate. In particular, there are people who believe a President Clinton administration will seek to tax qualified dividends at ordinary income rates. We believe, however, that taxing qualified dividends at ordinary income rates for most taxpayers in lower tax brackets will be a "third-rail issue" given that such taxpayers are struggling for returns on their assets, the importance of qualified dividends for retirees, stagnating earned income wages for jobs and dwindling pension options (and other retiree streams of income). We also believe the likely continued control of the U.S. House of Representatives by the Republicans would prevent significant changes to taxation of qualified dividends. We do believe there are other ways a President Clinton administration could alter qualified dividends taxation, such as: 1) increasing the top tax rate for qualified dividends for high income earners to 25 percent; and 2) lowering the amount of income that qualifies a tax payer as a "high income earner." We believe it would be difficult for a Clinton administration to enact any changes to qualified dividend tax rates given the damage such changes could do to the Democratic Party's standing with voters and given Republican opposition in Congress. We also believe that even if a President Clinton administration could alter some qualified dividend tax rates, most investors' investing strategy would not change. (We do believe, however, that the price-to-earnings ratios for many dividend-paying stocks could compress given the lowered value of the dividend payouts for such stocks.)
3 - Eliminate Stepped-Up Basis for Inherited Stock
As noted above, commentators in Barron's believe a President Clinton administration would also eliminate the step-up in basis, which would dramatically affect taxation on inherited assets. Under current estate tax laws, the cost basis on inherited assets (such as a stock) increases, or is stepped up, to the stock price at the time of death of the shareholder. Such stepped-up tax basis significantly decreases the capital gains liability of the inheriting person(s) on older assets acquired at much lower prices by the deceased shareholder. For example, shares purchased at $1 by the now deceased shareholder that were priced at $10 on the date the shareholder died would have a tax basis of $10 for the inheriting shareholder(s). Under a potential tax change by a President Clinton administration, the inheriting shareholder would have to pay tax on the difference between the $1 purchase price of the inherited shares and the $10 price on the date of inheritance. Note also, under such a new tax scheme, an inheriting shareholder may be hit with double taxation under potentially lowered estate tax thresholds as noted below.
We believe, however, that eliminating the "stepped-up tax basis" tax law for most taxpayers in lower tax brackets would be another "third-rail issue" given that most tax payers in such tax brackets own far less stock than tax payers in higher tax brackets. In addition, eliminating a stepped-up tax basis for inherited shares with significant unrealized capital gains would force inheriting shareholders to sell some shares of the inherited stock to pay their tax bills. Forcing some inheriting shareholders to sell stock that may have been in families for many decades would not only be financially damaging, but also psychologically damaging by forcing inheriting shareholders to part with shares in companies that may have been in the family for generations. Further, if an inheriting if new tax laws force inheriting shareholders to sell shares of dividend growth companies, such inheriting shareholders would also be losing dividend payouts in shares of stock they do not want to sell but for the eliminated stepped-up tax basis law.
We believe the likely continued control of the U.S. House of Representatives by the Republicans would prevent significant changes to stepped-up tax basis law for inheriting shareholders. As with the potential tax law changes noted above, we do believe there are other ways that a President Clinton administration could alter the stepped-up tax basis law, such as: 1) eliminate the stepped-up basis provision for high income earners; and 2) limit the stepped-up tax basis benefits for a high income earner. We believe it would be difficult for a Clinton administration to enact any changes to the stepped-up tax basis laws given the damage such changes could do to the Democratic Party's standing with voters and given Republican opposition in Congress. We also believe that even if a President Clinton administration could alter some stepped-up tax basis laws, most investors' investing strategy would not change.
4 - Lower Exemption Level for Estate Taxes
Another potential change by a Clinton administration highlighted by commentators on Barron's could be a potential cut to the Federal exemption level for estate taxes. In particular, commentators believe a President Clinton administration would propose cutting the estate tax exemption to $3.5 million from the current $5.45 million, and replace the 40 percent tax rate on estates above the $3.5 million level with a 50 percent rate, a 55 percent rate for estates over $10 million, a 55 percent rate for estates over $50 million, and a 65 percent rate for estates more than $500 million. Most Americans will never be affected by such estate tax rate changes if a Clinton administration would ever be able to implement them, as such Americans do not have estates anywhere even close to even the lowest level amount. Of course, a President Trump administration believes an estate tax is a "death tax" and that such tax should be eliminated altogether.
The likelihood that a President Clinton estate tax plan would be passed into law is extremely low given that Republicans control the House of Representatives in Congress. A Trump administration eliminating the estate tax altogether has essentially no chance of getting passed either, given the balance of Democrats and Republicans in the U.S. Senate. We believe little will change with regard to the estate tax unless Democrats take control of the Presidency, U.S. Senate and House of Representatives at the same time and that is not likely to happen in the near term. Long term, however, something needs to happen in the U.S. given its ballooning budget deficit and the widening wealth gap between the richest and poorest in the country. When and what will happen to narrow the gulf between the rich and poor in the U.S., we do not know. What we do know is that the U.S. is a consumer-led economy that needs more of its consumers to be financially sound for the overall economy to function properly. As for most stock investors, we do not believe they will change their strategies near term given potential changes to the estate tax rates. Higher income earners will likely employ tax lawyers and estate planners to lower their tax bill if any changes to estate tax rates are made.
We reiterate that this article is not about politics, but rather, a discussion of potential changes to tax laws that may affect investors. With that said, we ask commentators on this article to refrain from making specific comments on the presidential candidates. Rather, we ask commentators to state how any potential changes in tax laws would affect their investing strategies. In addition, we ask commentators to comment on what changes they believe would be fair to investors and what changes would not. For the record, a change in qualified dividend tax rates from the current 15 percent (which applies to us) to an ordinary tax rate would cost us almost $6,000 in additional taxes in 2017 and would rise to about $6,500 in 2019. Ouch!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.