Q2 Market Commentary

The stock market is off to its strongest first half start in over 20 years with the S&P 500 up 16.07% as of July 9th, 2021.  The economy is also seeing improvements largely driven by a combination of improved vaccination statistics, economic reopening and two stimulus packages worth $2.8 trillion.

So far, our year of the recovery thesis described in our Q1 outlook is coming to fruition and we do not see it drastically changing.  But rather than check-in on our previous outlook, our focus is now on the following narratives:

  1. Stimulus, Act II
  2. Inflation
  3. An Update on Biden Tax Proposals

Stimulus, Act II:

After months of negotiations across the halls of congress, an agreement—albeit tentative—is in place for a $1.2 trillion Bipartisan Infrastructure Framework. Details below:

Data as of July 13th, 2021

The emphasis on getting it done now is due to an amalgam of factors, namely: historically low interest rates allowing manageable debt-servicing costs, infrastructure-related scares (See: Texas’s ongoing power grid troubles, historical drought in the Southwest United States, New York City’s energy conservation request, and the Colonial Pipeline hack), and a general consensus across the aisle that something must be done.  Economists with market analytics firm S&P Global assert that “infrastructure, if chosen wisely, may be a long-term solution, providing the productivity boost needed to help get the U.S. expansion back on track” adding that a well-reasoned infrastructure bill “would likely add a cumulative $1.3 – $1.8 trillion to GDP by 2027.”  Such targeted spending bolsters our country’s infrastructure while creating millions of jobs and facilitating future economic growth.  Opponents of further government spending often cite concerns over inflation as a major reason to pull back on spending. However, leadership at the Federal Reserve remains steadfast in their view that inflationary pressures are transitory in nature.

Inflation:

Whether it’s on the news, social media or if you’re in the process of building a home you are likely aware of the latest discourse around inflation.  But the difficulty with inflation is that it’s causes are tough to pinpoint.  Thinking back to the last crisis in ’08, many pundits, economists and market forecasters predicted rampant inflation in the years to come due to the stimulus response to the housing crisis.  Taking a look below we see that although we experienced a short-term spike in inflation following the ’08 crisis, inflation subsequently trended lower the following decade.

Source: JP Morgan Guide to Markets June 30th, 2021

Admittedly, the world in 2008 looked much different than 2020, with the obvious difference being COVID-19.  But taking a look at the knock-on effects of a world shut down reveals a global supply chain crisis.  Discrepancies in policy responses and vaccination rates have caused an unequal recovery, especially for smaller emerging markets where manufacturing’s off shored by global corporations.  Such disruptions cause supply-demand imbalances across a variety of goods, resulting in demand outpacing supply.  The idea that inflation is transitory stems from the perspective that as the world reopens and smaller markets catch-up to the US, this imbalance starts to resolve itself.  A good example of this phenomenon is the price of lumber, a primary input for homebuilding.  The chart below shows a significant increase followed by an equally steep decrease in costs

Figure 2: Price of Lumber; as of July 9th, 2021

(source: https://markets.businessinsider.com/commodities/lumber-price)

It’s with this backdrop in mind that Federal Reserve policy makers maintain the view that inflation is transitory, but they’re prepared to act should the data reveal cause for concern.  For now, the Fed’s signaling an interest rate hike in late 2022 or early 2023.  The likelier policy change in the months ahead is the Biden administration’s tax agenda.

An Update on Biden’s Tax Proposals:

Our primary focus across the broad-ranging tax proposals set forth by the Biden administration is on policies affecting personal income tax, pass-throughs and Estate & Gift taxes.  In May, the U.S. Treasury released a 114-page document outlining provisions for amending laws surrounding trust & estate tax.  Some of the proposals highlighted by the National Law Review include:

  • Treat death and gifts of appreciated property as realization events that require gain to be recognized as if the underlying property was sold, subject to a $1 million lifetime exclusion. Gains on gifts or bequests to charity or to a surviving spouse would be excluded from tax but the basis would carry over.
  • Treat all pass-through business income of high-income taxpayers as subject either to the 3.8% net investment income tax (“NIIT”) or the 3.8% Medicare tax under the Self-Employment Contributions Act (“SECA”).
  • Increase the long-term capital gains rate and qualified dividend income rate to 39.6% (43.4% including the net investment income tax) from 20% (23.8% including NIIT to the extent the taxpayer’s income exceeds $1 million, indexed for inflation. This proposal is proposed to be effective retroactively for gains and income recognized after April 28, 2021.

Other proposals not included in Treasury’s report but likely to change include lowering the lifetime estate tax exemption from the current $11.7M per-person to as low as $3.5M per-person, as well as increasing the top estate tax rate to 45%.  The likelihood of all, or even most, of these changes is unknown.  But it’s best to prepare for potential changes sooner rather than later to be in the best position possible to manage what lies ahead.  Consulting with your team of financial advisors, estate lawyers and CPA is paramount in the weeks and months ahead.

Conclusion:

While the economy continues to propel ahead it is important to take note of potential bumps in the road.  As COVID variants pop up across the globe vaccination efforts are imperative for a sustained global recovery.  With markets fully recovered from the pre-COVID sell-off and a critical infrastructure bill hanging in the balance, we remain constructive about the next phase of this market cycle.  Our primary focus in the near-term is ensuring our clients are well-positioned for potential changes in tax policy.

Disclaimer:

The information provided is for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Callan Capital Management’s views as of the date of distribution. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. Callan Capital Management does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. Callan Capital Management has obtained the information provided herein from various third-party sources believed to be reliable but such information is not guaranteed. Certain links provided connect to other Web Sites maintained by third parties over whom Callan Capital Management has no control. Callan Capital Management makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Callan Capital Management is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of Callan Capital Management. For detailed information about our services and fees, please read our Form ADV Part 2A, and our Form CRS which can be found at https://www.advisorinfo.sec.gov or you can call us and request a copy at (866) 912-4888

Trump v. Biden Tax Plans

The US presidential election is shaping up to be likely one of the most contentious and consequential in modern history, making its potential policy, growth and market implications top of mind. Although President Trump hasn’t released a formal plan yet, he has generally expressed his intent to preserve, and expand on, the Tax Cuts and Jobs Act (TCJA) passed in 2017. Joe Biden has put forward a few proposals to raise revenue, as well as several proposals to provide targeted tax breaks for lower- and middle-class individuals while increasing taxes on those making over $400,000 per year as well as corporations. It’s also important to keep in mind the fundamental role of Congress in passing tax legislation.  Depending on the makeup of the White House, Senate, and House of Representatives, passing tax legislation may be challenging. Below we have summarized the key points of each parties’ tax proposals.

Generally, it is not advisable to take any action now based on what might happen in the November election. However, we do know that regardless of the outcome of the elections; the winners won’t be taking office until 2021. It is prudent to have a strategy in place that you can execute if needed as the timeline will be tight, especially during a pandemic.

If Democrats take control of the White House and both chambers of Congress, year-end tax planning for high earners in 2020 will likely be all pulling forward as much income and as many deductions as possible. One of the most impactful pieces of Biden’s tax policy is the increase in taxes on capital gains for those earning over $1 million per year. If a taxpayer has income plus capital gains in a year that, when added together, exceed the $1 million mark, all capital gains above $1 million would be subject to ordinary income tax rates, as opposed to the current top capital gains rate of 20%. One way for high earners or those looking to sell highly appreciated assets to avoid those gains being taxed at the proposed new top rate of 39.6% is to sell those assets and realize gains in 2020–before the potential change in rates becomes effective.

Another major piece of Biden’s legislation would be the reduction of the estate tax limit. Clients who have estates over $5 million per person or who own hard-to-value assets, such as a private business, may wish to engage in gifting while the lifetime gifting limit is at $11.58 million per person. The IRS has already stated that it won’t ‘claw back’ previous transfers of assets if the exemption amount goes back to its pre-TCJA levels, so a client could choose to make a large gift now and lock in that higher exemption amount without triggering any transfer taxes.

Once a lower limit is in effect, clients will need to begin exploring more complex wealth transfer vehicles such as the use of Grantor Retained Annuity Trusts (GRATs), Charitable Lead Annuity Trusts (CLATs), and sales to Intentionally Defective Grantor Trusts (IDGTs).

Year-end Roth IRA conversions could also become a particularly attractive option for some high earners, as Roth conversions represent an easy way for a taxpayer to pull forward what would otherwise be future income into the current year. In this strategy, an individual would convert a portion of their traditional tax-deferred IRA into a tax-free Roth IRA and pay the taxes on the conversion in 2020. Once converted, Roth IRA distributions are tax-free while traditional IRA distributions remain taxed as ordinary income.

There are a lot of variables to consider and predictions, while helpful for planning, are only forecasts about what might be expected to happen in the future. We recommend you start planning now and wait until after the election to take action, if at all. We believe election year tax planning should be about speeding up or slowing down something you were already thinking about doing anyway. Don’t allow fear to cause you to take actions you would not have considered otherwise because even if your political calculations prove correct, that does not mean the expected tax policy will automatically follow. Anything can happen in politics. Our best advice is to start planning now but stay resilient and incorporate flexibility into your plans so they can accommodate different outcomes.

Important Disclaimer

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov. The S&P 500, or simply the S&P, is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices, and many consider it to be one of the best representations of the U.S. stock market.

PAYCHECK PROTECTION PROGRAM

The Paycheck Protection Program (“PPP”) authorizes forgivable loans to small businesses to pay their employees during the COVID-19 crisis. The following contains recommended strategies for using those funds in compliance with the rules of the program.

The Paycheck Protection Program is a loan designed to provide a direct incentive for small businesses to keep their workers on the payroll. SBA will forgive loans if certain criteria are met and the money is used for specific qualifying expenses. No collateral or personal guarantees are required. Neither the government nor lenders will charge small businesses any fees.The loan amount is based on 2.5 times your average monthly payroll up to a maximum of $10mm. Payroll includes U.S. based  W-2 employees up to $100k per employee. Sole proprietors should use 2019 Schedule C income to determine loan amount.

You can apply through any existing SBA 7(a) lender or through any federally insured depository institution, federally insured credit union, and Farm Credit System institution that is participating. You should consult with your local lender as to whether it is participating in the program. 

Once you have been approved for the funds and the distribution is made to your account, you have 8 weeks to meet the criteria for loan forgiveness under the program. If you do not meet the requirements, a portion or all of your distribution will convert into a 2 year loan at 1% interest with a 6-month deferral. 

Here are some tips to ensure compliance and maximum forgiveness with the PPP rules:

To receive loan forgiveness, you have 8 weeks starting on the day the loan is disbursed into your account to spend the funds on qualifying expenses.

At least 75% of your loan must go towards:

  • Gross pay;
  • ER paid health care;
  • ER match retirement;
  • State unemployment tax;
  • Severance pay

Up to 25% of your loan may go towards:

  • Rent
  • Business loan interest
  • Utilities

Maximize qualified expenditures during the 8-week period to meet the 75% requirement by paying wages more frequently, making retirement contributions, and early bonuses if necessary. Be sure not to exceed the 100k cap on total gross wages. If you cannot meet these expense requirements, the portion of your loan deemed not forgivable will convert into a 2 year loan at 1% with a 6 month deferment period.

It’s important to track these expenses to ensure you do qualify for maximum forgiveness on the loan. It is the borrower’s responsibility to provide proof of qualifying expenses. First, we recommend you set up a separate bank account to track what your spending for future audits to avoid claw backs and disallowed costs. A clear audit trail with separate dedicated bank account easiest way to go. Where possible, avoid commingling of funds with your existing business assets. If you have already deposited the funds into your regular business account, we recommend you move the funds you have not yet used into a separate account and create a clear audit trail of the funds you have already spent as well as the transfer into the new account. Also, be sure to write down the reasons your businesses needed the loan to support your attestation that your business was impacted by Covid-19. In the event of an audit, you will want to have clear evidence that your business was adversely affected.

There are two major reductions that can effect your loan forgiveness. Loan forgiveness will be reduced if either of the following occurs:

Employees who made less than $100,000 of compensation in 2019 have their compensation reduced by 25% or greater or the number of full-time employee equivalents is less than the same number of employees during either (you may choose the more favorable period):

     February 15, 2019 through June 30, 2019; or

     January 1, 2020 through February 29, 2020.

Treasury Department has stated that you can hire employees back by June 30, 2020 and still qualify for forgiveness.

Avoid double dipping into other programs designed to help small business. The Employee Retention Credit is not allowed if you take a Payroll Protection Program loan. In general, higher average payroll tends to favor using the PPP, while lower salaries may make using the Employee Retention Credit a better move. In either case, you cannot use both. If you have all or a portion of your PPP loan forgiven, you cannot use the deferral of payroll taxes provision. If you receive a PPP loan and use it to pay your own compensation, you likely will not qualify to receive unemployment assistance until the loan has ‘run out’.

Do not misuse PPP funds. If you realize you made an error, contact your bank to remedy the error immediately. Misuse of PPP funds is subject to criminal penalties.

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov.

Moving for Tax Breaks

In recent years, high-tax states began to suspect a tax-dodging trend as more taxpayers changed residences while still maintaining ties to their former home states. As a result, these states have been more aggressive with their residency audits. Increasingly, states are challenging former residents who attempt to change their domicile to another state.

Although the rules vary among states, generally speaking, most states define a “resident” as an individual who is in the state for other than a temporary or transitory purpose. States consider a person’s “domicile” to be the place of his or her permanent home to which he or she intends to return to whenever absent from the state for a period of time. Most claim the right to tax an individual’s income if they are believed to be a resident and domiciled in that state.

  • Location of employment
  • Location of business relationships and transactions
  • Serving on the board of directors for a business or charity
  • Residence—whether a person’s former residence was sold, rented, or retained, and whether he or she rented or purchased real property in the new state
  • The amount of time spent in the state versus amount of time spent outside the state (183-day rule)
  • Where the taxpayer is registered to vote
  • Location of the school a family’s child attends
  • Memberships in country clubs and social organizations
  • Where charges are incurred, location of bank accounts, investments, and ATM withdrawals
  • Freeway fast-lane pass charges
  • Records of airline frequent-flier miles
  • Jurisdiction issuing a driver’s license, vehicle registration, professional license, or union membership
  • Church attendance and membership
  • Location of doctors, dentists, accountants, and attorneys
  • Official mailing address and where mail is received

Each state also has specific rules that can trigger audits. Three major red flags are 1.) a significant increase in taxable income in the year of residency change; 2.) a spouse with a different state of residency; and 3.) filing a resident state return in the first year after a move and then filing a non-resident state return the next year.

Taxpayers have the burden of proving which states they spend time in during the year. If you live elsewhere but travel on a regular and frequent basis to another state, it is a good idea to maintain a diary that clearly indicates the dates you are in a specific state, accompanied by supporting records such as transportation tickets and receipts.

Just as establishing as many ties as possible to the new state can be helpful when a change of domicile is desired, it’s also helpful to try and sever ties to the old domicile. When domicile challenges arise, they almost always revolve around the old state being unwilling to give up its status as “domicile,” rather than an issue of the new state refusing to accept that status.

Unfortunately, there’s no single bright-line test that can be used to “prove” a change in domicile, because it’s based on a determination of “intent” that simply isn’t always clear. But the good news is that there is a long list of “dos” and “don’ts” that individuals can follow to help give themselves the best opportunity at proving a bona fide change that can result in lower income taxes, lower real estate taxes, enhanced creditor protection, and other valuable benefits.

Important Disclaimer

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov.