Analysts: Tax reform should bode well for consumers, businesses

Lower overall taxes for many U.S. consumers and business owners is believed to be a positive for the continued economic growth in 2018, according to Stuart Freeman, co-head of global equity strategy for Wells Fargo Investment Institute.

Freeman and his colleagues held a webcast for investors on Jan. 10 to discuss the new tax law and potential impact. Freeman said the investment firm has raised its GDP projections for 2018 to 2.9% from 2.3% prior to the passage of the tax reform bill. He said earnings among U.S. companies should increase 10% this year. He said mid-cap companies should see a 5.5% uptick in revenue growth with earnings increasing roughly 11% over last year.

The small-cap sector is expected to see earnings rise as much as 36% this year. Freeman said domestic companies should see better margins now that taxes will be lower, and for that reason the firm is a minimum of equal weight in all the equity. He said small caps were recently upgraded to equal weight from underperform.

Freeman said consumer discretionary stocks should benefit as much as any sector because consumers will have more money to spend. For this reason, the firm is more bullish on the consumer discretionary sector. He said consumer staples have less room for growth, but they should have some tax relief given they pay high rates on average.

He also said the financial sector should benefit from lower tax rates and increased lending opportunities as businesses and consumers may be more inclined to borrow. Wells Fargo is also bullish on the industrial segment citing the 28% tax rate being dropped to 21% as a nice benefit that should help bottom lines.

Freeman expects the technology sector will benefit the most from repatriation of funds as part of the new tax bill. He also said investors are expected to benefit from increased share buybacks from companies looking to put the added cash flow to good uses.

The downside of the new tax law could be increased inflation if spending rises quickly. Brian Rehling, co-head of fixed income strategy at Wells Fargo, doesn’t expect sustained inflation but there could be a spike or two forcing the Fed to act more quickly with rate increases.

He said Wells Fargo anticipates two rate hikes in 2018, but that is subject to change if the economy heats up too quickly. He said there really aren’t many changes to the bond markets from the new tax law. He said equities hold more growth potential, even with market highs in many stocks.

INDIVIDUAL IMPACT
The new tax law will have an impact on the majority of U.S. households, especially those with children. Kris Gretzschel, the manager of the income tax team at Wells Fargo Advisors, said there were a number of changes impacting families from higher standard deductions to 529 plans now having a provision for K-12 education.

She said the 529 plan that is a saving fund to pay for college expenses was tweaked to all tax-free withdrawals up to $10,000 per year for tuition at elementary or secondary schools. There is no provision for homeschooling. She also said 529 plans are  now eligible to roll into ABLE accounts for disabled children. For instance, if a family has a 529 plan for a future college expense but the child becomes disabled, the funds could transfer tax-free into the ABLE account and that doesn’t impact any government benefits.

Gretzschel said many of the deductions and exemptions for individuals had a Cinderella clause and they will expire in 2025. She said because the standard deduction has been doubled, many households will no longer have enough expenses to itemize. That would mean they would not be able to claim any charitable contributions for deduction.

She said deductions of interest expense is also impacted. While the goal was to simplify the deduction table, Gretzschel said the new law is anything but simple. She said the easiest way to determine if interest is deductible is to determine how the funds are used. Funds used to purchase or improve or buy a home are still deductible. If home equity is used to purchase a boat, that interest is no longer deductible.

She said mortgages originated after Dec. 15, 2017, will have a $750,000 price cap for interest deductibility. For instance, with a $1 million home purchase, only the interest on $750,000 is deductible, the other $250,000 is excluded. Mortgages in play prior to Dec. 15 are grandfathered under the old law.

The allowable exemptions for estate planning have also been drastically increased under the new law. Dan Prebish, director of life event services at Wells Fargo Advisors, said couples who completed estate tax plans prior to 2013 should review their plan with tax professionals to ensure they have the maximum assets that can pass through to heirs without taxation.

Prebish said the estate tax also has the eight-year Cinderella clause, so before changes are made to a family’s estate plan, long-term implications need to be evaluated with tax professionals. Gretzschel said there will be notices from the IRS over the next several months explaining their interpretation of the new law and that is subject to change.