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New Tax Rules Affect Parents

The Tax Cuts and Jobs Act of 2017 went into effect on January 1, 2018 and started the year off with a bang.  Most notably, the tax reform act imposed a new cap on state and local tax deductions at $10,000 for married filing jointly couples and $5,000 for single filers.  In other words, if you’re single and the sum of your property, state and local taxes exceeded $5,000 during the year (which is easily achievable in California due to high property values), too bad – you don’t get to deduct all the expenses you paid!  Corporations received a huge tax break due to the lowering of the top tax bracket from 35% down to 21%, mostly on the backs of the Middle Class.  The threshold for itemizing taxes went up, and many expenses that qualified for a tax deduction in prior years were eliminated or phased-out, making taxes “simpler” but also resulting in a larger expense, for many. 

 

529 Flexibility

However, one positive outcome of the Tax Cuts and Jobs Act (TCJA) is new flexibility created around 529 College Savings Plans.  A 529 plan is an education savings vehicle that functions much like a Roth IRA.  You put after-tax money into the account, and the growth on the investment is tax-free if the money is utilized for qualified education expenses.  Qualified expenses include tuition, room and board, books and supplies, to name a few. 

 

Previously, the earmarked 529 savings was meant for higher education costs such as university or trade school expenses.  Under the new law, you can now draw annually up to $10,000 per child, tax-free, to pay kindergarten through 12th grade tuition at a public, private or religious school[i].  Given the new benefit, many parents and grandparents are interested in starting the tax-free savings plans as soon as a child is born rather than waiting until traditional college planning has begun.

 

The Tax Cuts and Jobs Act is a federal law, but not all states and educational institutions sponsoring 529s have been able to adopt the new flexibility standards allowing distributions for K-12 education.  In California, legislative change is still pending, therefore, it is important to check with your CPA and 529 sponsor prior to making any withdrawals, so as not to trigger a 10% early withdrawal penalty unexpectedly. 

 

Like many other tax benefits that disappeared, the TCJA rules eliminated tax deductions for interest paid on home equity loans or home equity lines of credit.  For those in a pinch to put their kids through college, the equity loans were an appealing option because the interest paid was tax deductible.  With the removal of any benefits to carry equity loans, many parents are turning towards saving early to stretch hard-earned dollars.

 

Student Loan Interest Deduction Saved

The new law leaves the student loan interest deduction unchanged at $2,500.  However, as mentioned, the threshold to qualify for itemization is higher.  Also, when student loans are cancelled due to death or disability, they are now tax-exempt[ii]

 

Alimony Taxation Changes

New divorcees (divorced post-2018) are also affected significantly under the new TCJA rules.  Under the new laws, alimony is no longer considered taxable income to the recipient[iii], essentially lowering their taxable income and possibly making it easier for the family to qualify for needs-based financial aid.

 

While the new tax laws were supposed to make taxes simpler, change always seems complicated.  The finance industry is scrambling to learn and be complaint with the new rules before the 2018 tax filing season rolls around.  There is still time to initiate planning this year that could reap tax benefits or avoid tax pitfalls.  Consult your CPA or Certified Financial Planner™ before the year is over to make sure you’re on track and taking advantage of available options. 

 This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.


[i] https://www.irs.gov/newsroom/529-plans-questions-and-answers

[ii] https://www.studentdebtrelief.us/news/discharging-student-loans-no-longer-taxable-income/

[iii] https://www.marketwatch.com/story/new-tax-law-eliminates-alimony-deductions-but-not-for-everybody-2018-01-23

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What to do in this record bull market

This week capped the longest bull market in the history of the Standard and Poors 500 Index. Technically, a bull market is the period that starts at the bottom of the previous bear market (a drop of at least 20%) and continues moving up without a new bear market drop of 20%. In the current case, the bull market has gone for 3,453 days.¹

In that span of time, the S&P 500, not counting dividends, grew by an impressive 321%. It's not the strongest rally in history (from October 1990 through March 2000 the market gained 417%), but it's still very respectable.²

The lowest previous point in the market was March 9, 2009, the end of the Great Recession, so-called because it was the worst recession since the Great Depression. It may seem distant now, but at the time, the future of the U.S. economic system was in doubt. Two of the major brokerage houses, Bear Stearns and Lehman Brothers, went under. Merrill Lynch was forced into a sale. Hundreds of thousands of Americans lost their homes and savings.

In the depths of the recession, no one would have guessed that this tragedy would be followed by a buoyant period in which U.S. stocks would quadruple in value. Tech companies, like Apple, Amazon, and Google parent Alphabet, have led the charge, becoming dominant business powerhouses. One of the current largest players in technology, Facebook, didn't even enter the market until 2012.³

On the other hand, the news on the political front is not very comforting. Trump's former campaign manager, Paul Manafort, was convicted by a jury on eight charges. His personal attorney, Michael Cohen, pled guilty on eight criminal charges, including campaign finance violations. Allen Pecker, publisher of the National Enquirer, under protection of immunity, corroborated that Trump knew about the hush-money payments. Finally, the Trump Organization's financial gatekeeper, Allen Weisselberg, has also been granted immunity in testimony before a federal grand jury. By all accounts, Weisselberg "knows where all the bodies are buried."⁴ All this is happening just a few months before the midterm elections. Midterms often upset the balance of power in government and damage a sitting President. This election could be monumental, and could cause additional volatility in the stock market.

If you're an investor, it would be natural to feel some unease sitting at the top of the market. Does this mean it's going to be all downhill from here? Is it time to get out of the market? In reality, the length of a market upturn is not a good indicator for a market downturn. Better warning signs are declining corporate profits and revenue, high inflation, and a struggling economy. None of this is occurring right now, and few economists expect a recession soon.

Nevertheless, if you're a cautious investor, you might be feeling that you want to hedge your bets. If you are, it's generally better to make small, gradual and reversible steps in your investment strategy rather than large, dramatic ones that you might regret later.

For example, if you're approaching retirement, you might want to increase the proportion of fixed income (bonds) in your asset allocation. This tends to create more stability in your investment, and enhance downside protection.

If you have some extra cash that you're hesitating to put into the market, but you have a remaining mortgage balance, you might want to utilize the cash to pay down your mortgage. You'll save on mortgage interest at zero risk.

You might use Dollar Cost Averaging, an investing strategy that is very effective when the market is volatile. Instead of investing a large, lump sum all at once, break it up into smaller pieces and invest it in equal amounts gradually: monthly, quarterly or semi-annually. If the market is down, your money will buy more shares. If the market is up, you will be buying fewer shares. Statistically, this will give you a better rate of return.

Whatever you decide to do, it's wise to get professional advice. Talk to your estate planning attorney, CPA, or Certified Financial Planner™ for a second opinion on whether your strategy is appropriate for your circumstances and goals.

¹ Business Insider 8/2018

² Bloomberg.com 8/23/2018

³ Wall Street Journal 8/22/2018

⁴ Chicago Tribune 8/22/2018

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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Capital Gain Tax Change Looms

Earlier this month, President Trump announced that he and US Treasurer, Steven Mnuchin, were determining if they had authority to unilaterally pass a massive and permanent new tax cut related to capital gains.  While the 2017 Tax Reform Act was spun as a “tax cut for the middle class,” this new proposed tax cut clearly benefits the wealthiest in America.  In fact, according to the Wharton School of Business, over 63%[i] of the new proposed tax cut would benefit just one tenth of one percent of the richest families in America.   

Under current law, when you buy a stock or mutual fund, the price you pay today is marked as your cost basis or taxable basis.  The price you sell that holding for in the future is the market value.  The difference between the market value (what you sold the investment for) and the cost basis (what you bought the investment at) is the capital gain, subject to taxation at both the Federal and State levels.  President Trump’s new capital gains tax proposal would increase the base purchase price (basis) every year by an inflation factor.  This would inherently decrease the gain, and related capital gains tax.  

As an example, say you purchase a stock for $10,000 in 1990.  It’s grown in value and if you sold it in the market today, you would receive $25,000 for that same stock, resulting in a gain of $15,000.  Under the current tax laws, a California resident might be subject to a tax expense of $3,750 (Federal capital gains tax rate of 15% + estimated CA tax rate of 10%).  However, under the new proposed tax law, the basis of $10,000 would get marked up every year since the time of purchase for inflation.  If we used the CPI index as the inflation factor[ii], the adjusted basis would be closer to $20,000.  The resulting gain after inflation would be reduced to $5,000 instead of the original $15,000 gain and the tax might be closer to $1,300; a tax savings of $2,450 or a 65%.  According to the Wharton Budget Model, if the capital gains tax change is pushed through, the tax reform would cost the US more than $100 billion in tax revenue over the next 10 years and the top 1% of US earners would take 86% of the benefit[iii].

Democrats are already pledging to fight the measure due to the bias of the capital gains tax bill to benefit the wealthy and the consequential strain on the national budget.  Normally changes to the tax code go through Congress, but President Trump knows his tax cut proposal would die there.  As such, he and Treasurer Mnuchin are investigating whether the office of the Treasurer has the authority to make this tax change unilaterally.  The last time changes to the capital gains taxes were considered was under President George H. W. Bush in 1992[iv].  However, at that time, it was determined that the US Treasury office did NOT have the authority to make changes on its own.  Therefore, if President Trump proceeds to circumvent congress and push his tax cut through, his bill will definitely face legal challenges. 

Noise regarding the capital gains tax-cut has quieted for now.  However, if the tax cut is pushed through, even for a short window of time, the change will unleash a wave of volatility in the stock market.  People who have long held stock positions fraught with unrealized gain may sell large stakes of ownership to take advantage of what is sure to be a limited tax-savings opportunity. 

Unfortunately, the Tax Reform Act of 2017 and the newly proposed capital gains tax cut benefit the ultra-wealthy at the detriment of valuable government programs like Medicare, Medicaid and Social Security.  The gap between the rich and the poor is widening and the middle class is shrinking.  The President’s divisive behavior continues to pit people against each other rather than bring them together.  Only time will tell where this newest idea settles. 

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

 


[i] https://www.usatoday.com/story/opinion/2018/08/08/trump-capital-gains-tax-plan-helps-rich-hurts-america-column/916377002/

[ii] https://www.usinflationcalculator.com/inflation/consumer-price-index-and-annual-percent-changes-from-1913-to-2008/

[iii] https://www.usatoday.com/story/opinion/2018/08/08/trump-capital-gains-tax-plan-helps-rich-hurts-america-column/916377002/

[iv] https://www.nytimes.com/2018/07/30/us/politics/trump-tax-cuts-rich.html

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Growth for Whom?

This week, President Trump was forced to back off on his aggressive trade war, defend himself against recorded audio discussing a payoff to a Playboy model, and fret over the Trump Organization financial chief, Allen Weisselberg, testifying before a federal grand jury. Understandably, Trump has seized on relatively good news that U.S. economic growth hit 4.1% in the second quarter of 2018. Nevertheless, 40 million Americans live in poverty, and remain without healthcare coverage¹. It begs the question, "Who is the growth benefiting?"

The apparently good numbers come in the wake of a massive tax cut from 35% down to 21% that Trump gave corporations at the beginning of the year. Although previous administrations have used economic stimulus in order to avoid recessions, Trump's gift came at a bullish period of economic expansion, falling unemployment and rising home values. Maya MacGuineas, president of the nonpartisan Committee for a Responsible Federal Budget, calls it a "temporary sugar-high" that has long-term negative consequences because it pushes the federal deficit to over $1 trillion.² 

The biggest beneficiaries of this largesse have been corporate executives. Corporate profits after taxes are at the highest level ever seen in this country.² Earlier this year, the United Nations Human Rights Council reported that the top 1% of the U.S. population owns 38.6% of the total wealth in the country, and that "the U.S. already leads the developed world in income and wealth inequality." ³

Only a trickle has gone towards employee raises or bonuses. $800 billion is going towards stock buybacks to boost share prices and dividends. Stock shareholders have benefited, but 84% of all stocks are owned by the wealthiest 10% of households. 40% of Americans (125 million people) have hardly any investments at all.⁴

Trump’s trade war has also created an artificial spike in growth. In anticipation of U.S. tariffs and retaliatory tariffs being implemented, foreign companies have been stockpiling goods and raw materials in order to buy before prices jump. This has temporarily boosted U.S. exports.

A 10% tariff on $400 billion of imports is $40 billion that goes into the U.S. Treasury, a welcome pay increase for the government. But who pays for the trade tariffs? For American consumers, the trade war is a new financial hit, because it raises prices. The import tax on automobiles would raise the cost of a Toyota Corolla, Honda CRV or Ford F150 by about $1,000 due to the tariffs on car parts manufactured outside the U.S. It would add about $5,000 to the cost of imported cars.⁵

In addition, General Motors estimates that because of the proposed tariffs, they would have to eliminate 195,000 jobs over the next three years. With retaliatory tariffs, these job losses could increase to 624,000.⁶

It appears that “growth” means even more wealth to a small number of already-wealthy Americans. For the vast majority of the population, it means paying more for food, housing, clothing and healthcare, including the possibility of losing their jobs.

Although Trump characterizes the quarterly number as “an economic turnaround of HISTORIC proportions,” it is actually more modest and fleeting. During the Obama administration, the economy exceeded 4.1% four times.⁷ And because of the unusual confluence of events that created last quarter’s surge, it’s likely the economy will soon return to the average 2 to 2.5% rate that we’ve experienced since 2009.

 

¹ Bloomberg 4/3/2018

² New York Times 7/25/2018

³ Los Angeles Times 6/6/2018

⁴ CNN Money, 2/16/2018

⁵ CBS News 7/2/2018

⁶ CNBC 7/3/2018

⁷ New York Times 7/27/2018

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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U.S. Stock Market Improves in Second Quarter

The first half of this year was shaky, and made some people wonder if the positive, bull market was coming to an end. Thankfully, the market stabilized in the second quarter, and made back much of the losses. The U.S. equity markets are back on the positive side.

The broadest measure of the U.S. market is the Wilshire 5000 Total Market index. For this last quarter, it finished up 3.83%. For the first half of the year, it was up 3.04%.¹

There are two closely-followed indices for the U.S. large company market: the Wilshire U.S. Large Cap index, and the Standard and Poors 500 index of large company stocks. The Wilshire index was up 3.41% in the last quarter, and up 2.62 from the beginning of the year.¹ The S&P 500 index was up 2.93% in the last quarter, and up 1.67% for the year.² The generous tax cut that Trump gave these companies, from 35% all the way down to 21%, took awhile to kick in, which is one reason why the second quarter performance was better than the first. 

Over a longer period of time, small companies tend to grow faster than large companies. This makes sense, because it's easier to double in size if you're a small company, compared to doubling in size as a mega-company. Small U.S. companies are starting to have their day in the sun. The Wilshire U.S. Small Cap index rose 7.87% in the last three months, and is up 7.08% for the year. ¹ A comparable index is the Russell 2000 Small Cap index. It is up 7.66% since the beginning of the year.³

International stocks have been hit badly by the Trump trade tariffs. Because the U.S. economy is the strongest in the world, it's like the 800-pound gorilla. Trump is likely betting that in an all-out trade war, weaker global economies will feel the pain more than the U.S., and so far this is happening. The EAFE (Europe, Australasia and Far East) index, which represents companies in developed foreign markets, lost 2.34% in the last quarter. The performance for the year is even worse, down 4.49%. Europe by itself has a loss of 2.74% over the last three months, and an overall loss of 5.23% for the year.

Emerging markets indices represent small, less-developed but quickly-growing economies, like China, India, Brazil and Russia. These suffered most of all from the trade war in the last quarter. The Shanghai Composite is already in a bear market, down more than 20% from its 52-week high. MSCI's EM index is down 8.66% for the quarter, with a loss of 7.68% for the year.⁴

Trade tariffs act like an extra tax on the people. When the U.S. slaps tariffs on goods coming into the U.S., it doesn't go into our pockets -- it goes into the U.S. Treasury as extra revenue. Because domestic producers are not forced to reduce their prices from increased competition, U.S. consumers are left paying higher prices as a result. In a round-about way, the tariffs are helping the government pay for the tax cut to corporations, and Americans are paying the price at the cash register.

Jerome Powell, the chairman of the Federal Reserve Bank, has raised interest rates a couple of times already this year. He also announced possible further interest rate increases for September, December, next March, and next June. This has a direct impact on the bond market. Typically, when interest rates go up, bond values go down, with long-term bonds affected the most. When bond values go down, the coupon rate (which is relative to the lower value) goes up. Consequently, the coupon rate on 10-year Treasury bonds has risen to 2.86%, and for 30-year Treasuries, 2.99%.⁵

You'll notice that the coupon rate between 10-year and 30-year Treasuries is not that different. This is called a "flattening yield curve," and is a concern to economists because it's an indication that the current bull market, which started in March of 2009, is running out of steam.

The stimulus given to corporations in the recent Tax Law gave an artificial boost of adrenalin to the U.S. market and economy. The benefits could be short-lived, but the long-term impact of the additional $1 trillion deficit can have dire consequences, especially if the Trump administration attempts to take it out of Medicare, Social Security and other programs that benefit everyone.

¹ www.wilshire.com/indexes/calculator

² www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf-p-us-1

³ www.ftse.com/products/indices/russell-us

⁴ www.msci.com/end-of-day-data-search

⁵ www.bloomberg.com/markets/rates-bonds/government-bonds/us

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

 

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EDUCATIONAL WORKSHOPS


 

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