The new tax act, also known as the Tax Cuts & Jobs Act, includes a number of important changes that will directly impact your tax liability and indirectly effect your investments. Here are three key ways your personal finances will be impacted by these changes:
(1) The amount you pay in taxes
Regarding the income tax cuts, most of us will see an income tax benefit with the best benefits realized by those in the highest income brackets (see exhibit 1). While income taxes decline for most of us, the changes in deductions/exemptions could have a big impact on your tax liability. In exchange for higher standard deductions and child tax credits, personal exemptions were either eliminated or limited under the new law. So, even though most income tax brackets were lowered, more of your income could be subject to tax due to the restriction or elimination of some important tax breaks.
If you want to do a quick estimation of how the legislation will affect you, I recommend this calculator from MarketWatch.com.
(2) The impact on your stock investments
The new tax act permanently lowers the tax rates for businesses, freeing up additional cash to be used elsewhere. Under the plan, the corporate tax rate falls to 21 percent, from the current 35 percent. Legislators of the act expect businesses to use the cash to invest in operations, including new jobs and increased employee compensation. However, publicly-traded companies can also return the extra capital to shareholders in form of dividends and stock buybacks, enhancing the value placed on the stock by investors.
Since the tax act was passed in mid-December, the stock market has continued to respond very favorably to the cuts, as shown in exhibit 2 below, with both the S&P and DJI indices up over 2%. How much this tax cut “benefit” impacts you depends on the amount of money, if any, you have invested in the equities markets (i.e., company stock, stock funds).
(3) The value of your home
The new tax act reduces the tax benefits of home ownership by capping the combined deduction on state and local income, sales and property taxes at $10K per year. If you live in an area that has high property tax rates (like NJ and NY), you will no longer be allowed to claim a deduction on the property taxes you pay over $10K. This could be a sizeable loss for people that have property taxes well in excess of the $10K threshold, and may have a negative impact on the resale value of those homes. This threshold will certainly be a consideration for home buyers, and will likely become a key negotiation tactic to get a lower price on homes with high property taxes. According to Moody’s Analytics and Business Insider, of the 25 counties expected to lose the biggest percentage of potential value increase as a result of the tax act, 19 are located in NJ or NY (see exhibit 3).
When you add it all up what do you get? New tax laws that are going to benefit those in highest tax brackets with significant investments in the stock market, while penalizing home owners living in areas with the highest property taxes. Another way to look at it from a financial standpoint: If you live in one of the counties listed above and don’t have children in the school system or earn sufficient income to justify owning property there, then the new tax act just gave you another good reason to downsize and/or move.