Green Book Wish List

Every year around this time, the current presidential administration releases a set of tax-related proposals, essentially a wish list for tax legislation for the coming year. These so-called ‘green books’ are never passed in their entirety, but they offer a hint as to what kind of proposals will be working their way into and (possibly) through the next Congress.

The latest green book contains more than the usual number of proposed tax changes. Some of them are familiar to those who read articles in the business press. For example: raising the highest corporate tax rate to 28% (currently 21%), and creating a new highest marginal tax rate of 39.6% for individual taxpayers with income above $400,000 a year.

For those who pay a net investment income tax (joint tax filers with $250,000 or more income; single filers whose income is above $200,000) the added tax rate on capital gains, interest, dividends and rental income would go up from 3.8% to 5%. Employers would be required to withhold a 5% Medicare tax on individual wages paid in excess of $200,000 (up from the current 0.9%), and taxpayers whose net worth is above $100 million would pay a 25% minimum income tax on their total income, which would (unlike for most taxpayers) include taxing the unrealized capital gains on their investments.

The proposed corporate tax changes would also include a 4% excise tax on share repurchases by publicly-traded companies (up from 1%) and a higher corporate alternative minimum tax rate of 21%—up from 15%. And companies would be prohibited from deducting “excess” compensation for any employee earning more than $1 million a year.

Interestingly, the green book offers no proposed change to the estate tax exemption, possibly because, at the sunset at the end of next year, the generous current exemption will automatically drop to somewhere around $6-7 million. But the green book does propose to tax heirs on any gains of appreciated property that they inherit at capital gains rates. Currently, the heirs would get a step-up in basis, meaning that the capital gains obligation would go away as the tax basis resets.

It’s worth repeating that this is a legislative wish list, and not something that is currently included in a tax bill in Congress. But we can expect to see some or (possibly) all of these proposals debated in the House and Senate next year. If the past is any indication of the future, then they will be heavily modified due to lobbying efforts and other political considerations.

Profits and More Profits

It isn’t being widely reported, but aggregate U.S. corporate profits reached record levels in the 4th quarter of last year, increasing 4.1% after going up 3.4% the previous quarter. The net profit margin for companies in the Standard & Poor 500 index reached 10.7%, and the tech-heavy companies on the NASDAQ exchange reported a 23% aggregate profit over the fourth quarter.

Is this sustainable? Overall, corporate earnings rose 9% last year, which is higher than the 3.3% growth in the economy as a whole. Generally speaking, corporate revenues grow at roughly the same rate as the economy overall, so one might expect future revenues to fall back in line. But the interesting part of the picture is that companies are paying higher wages and still generating greater profits from the products and services they offer. At the same time, inflation is stuck at around 3%—which suggests that companies have the ability to raise their prices without much pushback from consumers, and are able to increase profits even as expenses go up incrementally.

This economic picture is generally bright for stock market investors, but perhaps not as bright for people who are rooting for inflation to come down.

Leftover Rollover

Suppose you’ve been contributing to a 529 college savings plan, but your son or daughter doesn’t use all the money for tuition, books etc. Do you just ask for the remainder of your money back?

Any contribution to a 529 plan is deemed to be a completed gift to the beneficiary—typically a child or grandchild of the donor. If you don’t want to incur a gift tax, then you can contribute up to $18,000 a year, but you can actually make five years of contributions at once—$90,000—if you treat the contribution as if it was spread over a five-year period. (You would do this on IRS Form 709 for all five years). If you only want to contribute, say, $50,000, then you can apply $10,000 per year. After the contribution, the money grows tax-free and can be used to pay college expenses without being taxed.

But back to the first question; you have the money in the account, but now it looks like the son or daughter isn’t going to use all of it. What do you do? You can indeed revoke the funds in the account, but that means they will be added back to your taxable estate, earnings will be taxable and the IRS will assess a 10% tax penalty.

You can roll the money from one 529 plan to another one, tax-free, so that it covers another daughter or granddaughter. That allows you to jump-start another child’s or grandchild’s college savings.

Finally, starting this year, you can transfer the stranded funds to a Roth IRA. There are restrictions. One of the most severe is that the 529 plan must have been maintained for at least 15 years, and the amount transferred must come from contributions and earnings made at least five years before the transfer. The Roth IRA must have the same beneficiary as the the 529 plan, meaning that the money can’t go back to an account held by the parents, grandparents or other children. However, the owner of a 529 plan can change the beneficiary to another individual before the transfer.

In 2024, the aggregate amount transferred from the 529 plan to a Roth IRA for any individual cannot exceed $35,000. That means the transfer might not be a good option for parents whose child suddenly decides to forego college. But for leftover funds, the money that would have gone to pay for college can be used to pay for future retirement expenses instead—and preserve its tax-free growth in the process.

Fewer Stocks, More Private Equity

It’s not generally known that the number of publicly-traded stocks has fallen substantially, from more than 8,000 in 1996 to roughly 3,700 today. Does that mean that there are fewer companies today than there were three decades ago?

Actually not. Today, a growing number of companies are staying private, often owned, in whole or in part, by private pools of investment capital known collectively as private equity (PE). By one estimate, PE funds owned approximately 26,000 companies at the end of 2022, the most recent figures available. And some of the PE firms that have been buying companies have become the largest employers in America. Carlyle, KKR Private Equity and the Blackstone Group are the third, fourth and fifth-largest employers in America, right behind Walmart and Amazon.

PE firms finance themselves by raising capital from investors, and then use the money buy out publicly-traded companies and take them private, or firms that have never gone public in the first place. The goal is to cut costs, strip out assets and then eventually sell for a profit, sometimes to another PE firm. This structure is not very different from the infamous trusts of the 1910s and 1920s, which operated outside of regulatory scrutiny similar to the way PE-owned private companies today are not regulated the way public companies are. That earlier experiment didn’t end well: there were well-publicized excesses, collapses, companies going out of business, bank runs and the Great Depression, among other things.

The PE firms are not just acquiring companies; a recent report found that three PE firms now own 11% of all the single-family homes for rent in Metro Atlanta—19,000 in all. The housing market in many American cities are adjusting to higher rents as for-profit firms buy up the available homes.

The trend has been to shift investment opportunities from what most investors are most familiar with—stocks—to blind pools managed by large firms who may not be long-term investors. Indeed the concern today is that PE firms are far more focused on maximizing short-term profits than they are at building the businesses they’ve acquired; on average, a PE firm expects to own a business for four to six years, and there have been reports that sound a lot like the corporate raider days of the 1980s, where firms were acquired, picked clean, and then abandoned into bankruptcy.

Another concern is leverage. Not all the money used to buy these firms is coming from investors; the funds have tended to borrow heavily to make their purchases, making them subject to collapse as interest rates rise and interest expenses become higher than the models predicted. Leverage can create oversized profits, but it can also come back to bite the over leveraged buyer.

What to make of all this? The first takeaway is that the stock market no longer represents the economy, and the disparity is increasing. But it’s also possible that the publicly-traded companies that most of us invest in will tend to have longer-term visions for their firms than the short-term-focused PE buyers, which means their longer-term prospects might be better. We won’t know how all this plays out for some years to come. But in the past, this same movie has not given investors—or the U.S. economy—a happy ending.

Scam Warning: Fake Schwab websites within Google searches

Search engine optimization (SEO) scams are targeting Schwab clients.

Scammers are using search engine optimization (SEO) to create fake websites that appear in search results for trusted institutions like Schwab. When clients visit these sites, they are exposed to phishing attacks aimed at stealing their information and assets.

How these scams work:

• Knowledgeable fraudsters use sophisticated techniques to create websites that appear in search engines when clients are looking for Schwab or other trusted institutions. 

• The websites are designed to look legitimate, and their position in the search results trick users into believing the top search hits are the most credible. This phishing tactic is very effective: after all, not every user will scrutinize every search result to ensure the link they're about to click is legitimate. 

• Once the client clicks on the phishing website and attempts to log in with their credentials, they receive an error message stating there's a login issue and to contact a hotline number noted in the message for further assistance. 

• When the client contacts the fraudulent number, the bad actor posing as a Schwab employee states that there's been a security breach, and someone is attempting to steal money from their account. 

• Then, the bad actor attempts to convince the client to download software to their device. 

• The overall goal is to gain access to the device and continue to facilitate additional fraud attacks, which can ultimately lead to unauthorized activity and ID theft.

The best way to avoid these types of scams is to not use Google (or other search engines) to access Schwab’s website. Save the official Schwab website as a bookmark in your browser, and use that to access the site.