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The fast-approaching November 3rd election is prompting investors to ask some key questions. The following are three common questions we have heard and our perspective in response.

1) Are equity markets higher when a specific political party is in the White House?

As both President Donald Trump and former Vice President Joe Biden tout their platforms, it is fair to wonder whether having a Republican or Democrat as President has an impact on US stock market performance. Historically, the political parties tend to advocate for differing priorities, Republicans often promoting tax cuts and Democrats often favoring domestic spending. Corporate and personal income tax rates were lowered during President Trump’s administration. The Biden plan would make clean energy investments by rolling back some corporate tax cuts. Surely such differences in approach must lead to different stock market outcomes. Or do they? The historical data reveals a mixed picture with no conclusive advantage when either party is in office.

Annualized Market Returns During Presidential Terms
S&P 500 Index1

PresidentPartyTime Period (1st full month to last full month in office)Annualized Return
Richard NixonRepublican2/1969 to 8/1974-2.9%
Gerald FordRepublican9/1974 to 1/197720.2%
Jimmy CarterDemocrat2/1977 to 1/198111.7%
Ronald ReaganRepublican2/1981 to 1/198915.8%
George H.W. BushRepublican2/1989 to 1/199313.9%
William ClintonDemocrat2/1993 to 1/200117.6%
George W. BushRepublican2/2001 to 1/2009-4.4%
Barack ObamaDemocrat2/2009 to 1/201716%
Donald TrumpRepublican2/2017 to 9/202013.4%

Taking a non-partisan approach starting in February 1969 of remaining invested in a security directly tracking the S&P 500 would have outperformed a market timing approach for those who invested only when a Democrat or Republican was President. This example is a good reminder that there are additional forces influencing equity market performance beyond Presidential politics. Global interest rates, stock market valuations, and corporate earnings all influence market performance. While politics may dominate the news, investors should not become distracted.  The most effective strategy likely remains staying invested in the market over the long term.

2) This time feels different. What should I do to protect my portfolio from the election year’s risks?

The pandemic, the recession, high unemployment, harsh political discourse, a divided nation, California wildfires, Gulf Coast hurricanes – all current events that have created an atmosphere of uncertainty unlike any other in recent memory.

However, even in this time the ability for companies to adapt and grow over the long run regardless of the political or economic climate has not changed. Historical data tells us that the S&P 500’s Presidential election year returns from 1926 to 2016 had 19 positive years and only 4 negative years.1 To draw a comparison to another dark period, there were three Presidential election years during the latter part of the Great Depression and World War II (1936, 1940 and 1944), and both 1936 and 1944 were surprisingly positive for the S&P 500. While 1940 posted a -9.8% return, this was not nearly as low as other negative years for the S&P 500 since 1926.1

Even in a troubling world, investors would be wise to remain disciplined with their investment strategy and focused on their long-term goals. The tried and true tenets of saving, investing, and rebalancing are the best remedies for the political noise.

3) What are the candidates’ plans for ordinary income and capital gains taxes? Should I do anything now?

Not surprisingly, the two candidates offer different approaches to personal income and capital gains taxes. The Tax Cuts and Jobs Act of 2017 (TCJA) was a significant revision to the tax code and was passed during the Trump administration under a Republican-controlled House and Senate. The law lowered personal income tax rates, doubled the standard deduction, capped the deduction for state and local taxes and property taxes at $10,000, eliminated some itemized deductions and increased the alternative minimum tax exemption. The tax cuts in the TCJA are set to sunset at the end of 2025 and revert back to pre-TCJA rates. If there is a second Trump term, there may be an attempt to make many of the TCJA’s features permanent.

  • Tax Rates

The Biden campaign’s tax plan touts that taxes would only increase for taxpayers with income over $400,000 per year. Their plan proposes an immediate increase in the top ordinary income tax bracket rate from 37% to the pre-TCJA rate of 39.6% and lower the income threshold where this top rate applies. Currently, the top marginal bracket applies for those whose annual income is $518,500+ filing single or $622,050+ for married filing jointly.2 It is uncertain whether Biden’s proposed $400,000 threshold applies to single or married filing jointly filers.

Capital gains tax rates have not changed during the Trump administration. A second Trump term may see an effort to lower capital gains.3

The Biden plan would tax both long-term capital gains and qualified dividends at the corresponding ordinary income tax rate if a taxpayer’s annual income exceeds $1 million. This would nearly double the capital gains tax rate from the current 20% maximum to 39.6%. The current 3.8% surtax on net investment income would still apply.2

  • Deductions

The TCJA also doubled the standard deduction and eliminated or restricted many itemized deductions resulting in fewer taxpayers itemizing their deductions.4 Capping the deduction for taxes paid to $10,000 effectively increased taxable income for some residents from higher income tax states such as California, New Jersey and New York. The TCJA also eliminated the Pease limitation which capped certain itemized deductions for taxpayers with adjusted gross incomes in 2017 over $261,500 for single and $313,800 for married filers.4

It is uncertain if further changes would be made to the itemized and the standard deduction during a second Trump term. The Biden plan would cap the value of itemized deductions at no more than 28% for high earning taxpayers in the 32%, 35%, 37% or the proposed 39.6% marginal bracket.  The cap on itemized deductions would have little to no impact on taxpayers in the marginal brackets below 32% and would not apply to those taking the standard deduction.  The Biden plan would also restore the Pease limitation on certain itemized deductions.  If implemented, both changes would increase the effective tax rate for taxpayers in the higher marginal brackets.2

  • Credits

The Biden plan includes several expanded credits targeted at lower to middle income households.2 Tax credits are dollar-for-dollar reductions of income tax. A non-refundable credit provides a refund up to the amount of taxed owed while a refundable credit provides a refund when the credit is more than the tax owed. An advanceable tax credit allows the credit to be claimed immediately versus waiting to file a tax return to receive the credit.

Personal Tax CreditCurrent LimitBiden Plan
Child Tax Credit$2,000 per child under age 17$3,600 for children under age 6, $3,000 for children older than age 6 and younger than age 17
Child and Dependent Care CreditMaximum of $3,000 for one child and $6,000 for two or more childrenRefundable credit of $8,000 for one child and $16,000 for two or more children
First-Time Homebuyer Credit5Available between April 8, 2008 until May 1, 2010. The maximum credit was capped at 10% of the home purchase price with a maximum credit of $7,500 to $8,000 for a single or married filing jointly taxpayer(s) depending on when the home was purchasedNew refundable and advanceable credit of up to $15,000
Caregiver CreditNot available currently$5,000 credit to assist individuals providing informal care to those needing long term care
  • Other Changes

Other notable changes proposed by the Biden plan include:2

  • Eliminating the qualified business income deduction for business owner taxpayers earning more than $400,000 with pass-through businesses including partnerships, LLCs, S corporations and sole proprietors and;
  • Replacing the tax deduction for contributions to IRAs, 401(k)s, 403(b)s, and other pre-tax retirement accounts with a new credit equal to a percentage of the retirement plan contribution. The change is intended to equalize the tax benefits (in dollars) of retirement plans for all taxpayers.

Possible Strategies

Strategies are available for taxpayers who believe that taxes will be higher in the future. A Roth conversion now will have you pre-pay taxes at lower rates generating tax-free growth and withdrawals in the future. If you have unrealized capital gains, you can recognize them now at lower rates. If available, investment losses can be deferred to future tax years. Typically, deductions should be pushed into future tax years if higher tax rates are anticipated.

It is not time to implement strategies because many questions must be settled before any new laws are enacted. Even if Biden were to win, his tax proposals might not be approved if Congress remains divided with a Democratic House and Republican Senate. If the Democrats were to gain control of both houses of Congress, Democratic Party members have a wide range of opinions from progressive to moderate that do not guarantee agreement on tax policy.

With so much unsettled, it would be prudent to educate yourself with the help of your B|O|S wealth management team. If warranted, we can help you create a plan for several election outcomes and you will be ready to act when there is more clarity.

Footnotes:

1 S&P data ©2019 S&P Dow Jones Indices LLC, a division of S&P Global., Dimensional Fund Advisors Elections and Markets Investor Seminar October 2020.  The time period starts with the first full month through the last full month in office.

2 https://www.kitces.com/blog/biden-tax-plan-cuts-democrat-proposal-capital-gains-396-increase-estate-exemption-retirement-credit

3 Mary Duffy & Heather Harman, Andersen Tax Press Room: Tax Release Biden Hits the Campaign Trail with Tax Policy Proposals, July 23, 2020.

4 https://www.taxpolicycenter.org/briefing-book/how-did-tcja-change-standard-deduction-and-itemized-deductions#:~:text=The%20TCJA%20eliminated%20or%20restricted,because%20of%20the%20tax%20overhaul.

5 https://www.irs.gov/newsroom/first-time-homebuyer-credit-questions-and-answers-basic-information

Filed under: Wealth Management

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