Implications Of The Tax Cuts And Jobs Act For Munis

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives

The 2017 Tax Cuts and Jobs Act will impact advisors and muni bond investors. Here’s what they should expect moving forward in 2018.


Check out our H2 hedge fund letters here.

WerbeFabrik / Pixabay

The Act’s most obvious change is a reduction in the highest marginal Federal tax rate from 39.6% to 37% for married filers earning more than $600,000, beginning this year. However, the Affordable Care Act’s 3.8% surtax on annual investment income over $200,000 remains as does the ACA’s 0.9% increase in Medicare taxes.

For those investors living in relatively high-income, property, and sales-tax states, limitations on the deduction of state and local taxes (SALT) will boost their adjusted gross income. This could cause an increase in federal taxes, all other things being equal. Along with the reduction of SALT, the standard deduction has been raised by nearly 90% to $24,000 for married couples, up from $12,700 in 2017.

In addition, the bill has particular significance for wealthy investors who will own homes with high leverage. They can expect their mortgage interest deductions to be limited on new loans of $750,000 or less, and only on a primary residence. This will hold true until at least 2026, when this and several other provisions in the new tax law are set to expire.

And wealthy investors will want to keep an eye on the expiration of the inheritance-tax exclusions. The new act ratchets up the 2011 Obama-era $5 million indexed individual exclusion to $11.2 million, with a sunset in 2026. Married couples can double the exclusion to $22.4 million. As more wealth passes to subsequent generations, we can expect more new municipal bond buyers.

Corporate tax rate cuts could reduce the value of buying tax-exempt municipals by large corporations and insurance companies. It is not clear yet how a possible reduction in demand from such investors might play out in 2018 or if corporate owners of municipals are going to be sellers. All other things being equal, we should see a reduction in demand, but given the race to issue new and refunded bonds in November and December, it may well be that supply falls as least as quickly as demand. It is also worth considering that corporate portfolio managers may be slow to move because of the uncertain future of the 2017 Tax Act’s sustainability, given the very political nature of its adoption.

For issuers, the year-end rush to market by state and local governments was motivated at least in part by the Tax Act’s elimination of tax-exempt advance refundings. Cost-saving refinancings have driven new issue volume for more than 30 years. In fact, before the 1986 Act was adopted, there were only minor limitations on the number of cost-saving advance refundings a state or local government might structure. Deliberations during the drafting of the 1986 Act concluded that the cost-saving proliferation of tax-exempt refundings was cannibalizing the taxable Treasury market’s demand, and therefore needed to be curbed. Consequently the 1986 Act limited advance refundings to a single cost-saving advance refunding during the life of the underlying project financed by tax-exempt bonds.

Read the full article here by Tom Lockard, Advisor Perspectives