How Your Taxes Might Change
We've seen a Muslim travel ban, a fired acting attorney general, a Supreme Court nominee announced, truly disturbing changes to the National Security Council, a quota system for regulations, and a promise to undo the Dodd-Frank banking regulations.
The one thing we haven't heard — a thing that is critical to the stock market rally that's driven prices to record highs — is what's happening with taxes.
Trump made strong campaign promises to cut the U.S. corporate tax rate from 35% to 15–20%. Before the election, it wasn't a particularly big deal for the stock market because most people still weren't giving Trump a chance. But when he won, stocks took off. And for a very simple reason...
Cut the corporate tax rate to 20%, and analysts say the companies of the S&P 500 will earn between $8 and $12 more in profits this year. And that would mean roughly 6–10% more in earnings than analysts were expecting before the election. So, voilà! Instant rally!
The S&P 500 now trades with a price-to-earnings (P/E) ratio of 24. No way to sugarcoat it: that's high. But if we look at the forward P/E ratio for the S&P 500, it's 17.5. Now, the forward P/E is based on analysts' estimates for earnings over the next 12 months. And here's a little secret: analysts are always wrong by about 10% when looking a year out. So 17.5 is a little high for a forward P/E. But it's not terrible...
Now, here's the thing. Analysts are saying S&P 500 earnings will rise around 24% in 2017. That's a pretty good-sized jump for earnings, and it's why there's such a big difference between the forward and trailing P/E ratios. So yeah, it's expected to be a good year for earnings. And it's actually getting off to a pretty good start. Compared to the fourth quarter of 2015, the earnings we're getting now are up about 31%.
That's good, and if earnings stay that strong, great. No problem. But when was the last time everything went as planned?
A Timely Cut
The bottom line is this: if, at a minimum, you want stocks to stay where they are, then that $8–$12 in earnings from a corporate tax cut would be nice. But if you're thinking, hey, maybe stocks can even rally a little this year, then you absolutely must have that tax cut. And as it happens, Trump's proposals for federal income tax reform might save you a good deal of money.
As it now stands, roughly 75% of Americans get taxed at the 15% rate on annual individual salaries ranging from $8,925 to $36,250, or joint earnings between $17,850 and $72,500. If you're in that 15% bracket, under Trump's plan, you'd fall in the 12% bracket. That's a 20% cut to your income taxes. But that's not all...
Trump is also proposing to boost the standard deduction from $6,350 and $12,700 for joint filers to $15,000 and $30,000 for joint filers. Of course, the standard deduction is getting such a big jump because Trump wants to do away with most itemized deductions. Yes, that means he wants to do away with dependent deductions and head-of-household deductions.
So if you're married and have fewer than three kids, you will likely pay less in taxes. But if you're a single parent, there's a 50/50 chance you will actually pay more in taxes.
Currently, if you make between $37,951 and $91,900 or $75,901 and $153,100 for joint filers, you fall in the 25% bracket. Your bracket does not change under Trump's plan. You'll still pay 25%. Whether or not your total bill is higher or lower will depend on how the dependent exemptions shake out.
Trump's plan does extend the 25% bracket to include single filers up to $112,499 and joint filers up to $224,999. Anything over that, and you go to the 33% bracket. That could actually be a little painful if you make, say, $130,000 a year. Your tax bracket would jump from 28% to 33%. That's especially painful when you see that an individual making over $416k will see his or her bracket fall to 33%.
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More Money for the 75%
It seems as though Trump's tax plans will put more money into the pockets of middle class families. That is without a doubt a good thing. This is the demographic that drives the U.S. economy. And when you consider that the average of wage of this group has basically not changed in 10 years, well, it's even better news.
But my biggest question is: what's taking so long?
It's all about the economy. And if you want to keep the momentum going in both the economy and the stock market, put some money in people's pockets. Show them they have a little extra to spend. And as an added bonus, cut that corporate tax rate so maybe people can think about getting a raise at some point this year. Our corporations can afford it — they have record amounts of cash on the books.
The Trump administration has started off with a few splashy executive orders that have been big on headlines and small on American families' bottom lines. I think it's time to reverse that. Let's get these tax cuts going and make a change that everyone can get behind.
One more thing, if I may: open a Roth IRA tax-protected retirement account. The Roth IRA is hands down the most powerful retirement savings tool there's ever been. Because when the time comes to start withdrawing the money, it's tax-free. No capital gains taxes, and no incomes taxes. That is simply massive savings. And the longer you grow your money in a Roth IRA, the bigger your savings will be.
Yes, Trump can help put some dollars in your pocket and make the future look a bit better. But you can have the biggest impact on your future by investing for it starting today.
Until next time,
An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.
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