Warning Emptor: This article is not about the fairness of our tax system. This is a simple analysis of the tax plans available to businesses in Washington at the time of this article. Draw your own conclusions about the fairness of the tax system and who should pay what.
Tax increases are in the works for 2021. President Biden announced ahead of the election and subsequently said he wanted the corporate tax rate to rise to 28%. Corporate taxation has several elements, all of which have the potential to influence stocks, their value and the markets.
Increase the maximum corporate rate: This is the cornerstone of the proposed tax increases. This is an increase from the current 21% to 28%. It is estimated that this will raise $ 1.3 trillion in additional tax revenue. It eliminates about half of the tax cuts instituted by the Tax Cuts and Jobs Acts (TCJA). Corporate taxes are an expense for a corporation and reduce the amount of net profit. According to Strategas, a change in corporate tax and a change in global low-tax intangible asset (GILTI) income rates would cause S&P 500 earnings to decline by about $ 11.82 in 2022. Stocks tend to migrate based on their values based on their Price Earning (PE) ratio. , and if profits (“E”) decrease, prices go down.
According to Tax foundation, the increase in the corporate rate will have a negative effect on GDP. Their model indicates that increasing the corporate rate to 28% could have an effect of -0.8% on GDP and reduce the number of jobs by 159,000. The same model shows that the corporate rate would be spread over all income brackets, from the lowest 20% obtaining a long-term decrease in after-tax income of around -1.5% to the top 1% of income receiving an after-tax reduction of around -3.2% . Raising the corporate rate changes corporate income and the range and therefore spills over to all segments of the economy.
GILTI or not-GILTI? Another component of the proposed tax increase is to increase the global low intangible income minimum tax, or GILTI. This would increase the taxes of these companies by about $ 309 billion. The tax will be imposed on high-income businesses in low-tax places (such as Ireland at 12.5%). GILTI was imposed in the TCJA to remedy the “offshoring” of profits. However, subsequent regulation by the Treasury and important lobbying changed the effectiveness of GILTI. The change would raise taxes on businesses using a foreign affiliate in low-tax locations to reduce taxes. This tax was partly based on Apple has profits of $ 74 billion from 2009 to 2012 in global sales and paying virtually no tax. The change in GILTI seems likely and will negatively affect some companies with foreign affiliates in low tax locations.
Specific industries: Potential tax changes in the president’s original proposal also called for changes to depreciation for real estate, especially multi-family and commercial buildings. These industries would have increased taxable income. In particular, this could change the valuation of certain real estate investment trusts (REITs).
Minimum tax on accounting income. It’s a fairly new and interesting idea. For almost as long as we have had accounting, we have had differences between tax income and “accounting” income. Accounting income is the income reported by a business in its financial statements. Some examples among these, cash versus accrual accounting; cash accounting recognizes income and expenses when cash is received and / or paid; and income and expense recognized on an accrual basis when earned or recognized. Another good example is depreciation, a business can use a conservative depreciation schedule for accounting income (increasing income) and using accelerated depreciation for tax purposes (which reduces taxable income). One major difference is the use of inventory valuation. Companies with a large inventory can use last in, first out (LIFO) for tax purposes and first in, first out (FIFO) for accounting purposes. If a business has a lot of inventory of increasing value (due to price increases), LIFO reduces taxes by reducing taxable income and FIFO increases income.
A minimum tax on accounting income would require companies to pay a significant amount of tax based on what they report to their shareholders, compared to what they report to the government. The proposed tax is a 15% tax on businesses with net income greater than $ 100 million. At least one commentator estimates that the tax on accounting income would increase the tax burden on new investments by 8.75%.
Conclusion: taxes reduce profits. It seems very likely that some or all of the tax provisions mentioned above will end up in the next major legislation. Some provisions are potentially popular, such as the taxation of foreign affiliate income at low tax rates. However, since the 2017 Tax Cuts and Jobs Act increased corporate profits, potential tax increases will reduce corporate profits. Falling corporate profits translate into lower valuation of stocks. It is wise to examine your portfolio and consider the potential effects on your investments, as well as your overall plan. As always, I will try to answer questions. My email is [email protected] For a copy of our free IRA book, click here.