After the failure to repeal Obamacare, President Donald Trump is now focusing on another campaign promise — tax reform. Last week, he proposed the biggest U.S. tax overhaul in three decades that would make America more competitive.
The plan calls for lowering corporate income tax rates, reducing the number of income tax brackets from seven to three, cutting taxes for small businesses and doubling the size of Americans' standard deductions in a bid to bolster take-home pay for the middle class.
Trump’s Tax Blueprint in Detail
The proposal lowers the corporate tax rate from 35% to 20%, below the 22.5% average of the industrialized world. It limits the maximum tax rate applied to the business income of small and family-owned businesses conducted as sole proprietorships, partnerships and S corporations to
25%, down from 39.6% (read: Bet on These ETFs on New Hopes for Tax Reform).
For individuals, Trump’s plan would shrink the current income tax brackets from seven to three: 12%, 25% and 35%. While the top income tax rate for individuals will be cut from 39.6%, the bottom tax rate on low-earning Americans will rise from 10%. The framework also offers tax relief to middle-class families by doubling the standard deduction to $12,000 for single filers and $24,000 for married couple filing jointly.
Additionally, the Trump administration proposed a shift from the current 35% worldwide tax system to a territorial system, allowing companies to send their offshore profits back to the United States without incurring extra taxes.
Other details of the proposed plan include substantially higher child tax credit, the repeal of the alternative minimum tax, the retention of charitable giving and mortgage interest deductions and the scrapping of most itemized deductions including the state and local tax deduction. It would also eliminate estate tax – known colloquially as the "death tax."
Though the massive tax cuts will create an economic surge boosting job growth in manufacturing and other sectors, it could add trillions of dollars to the country’s deficit. The Committee for a Responsible Federal Budget policy group estimated that the plan contains about $5.8 trillion of total tax cuts over a decade and would have a net cost of $2.2 trillion through 2027.
The tax reform is the most prestigious legislative move for Republicans to enter into 2018 midterm elections. However, it is facing a difficult fight in the Congress, with Trump’s own party divided and Democrats hostile (read: 5 ETFs to Buy if Trump Tax Reform is Enacted by Year End).
The legislative move has led to the return of Trump trade and investors are cashing in on the opportunity with ETFs that are deemed to gain most on tax reforms. Below, we have highlighted some of these funds.
iShares Russell 2000 Growth ETF (IWO - Free Report)
Small companies pay huge taxes in America and a tax cut could be a big boon to these companies. While there are several options in this space that would gain from the proposal, IWO seems to be the most exciting choice as it offers exposure to companies whose earnings are expected to grow at an above-average rate relative to the market. It charges 0.24% in expense ratio and has $8.5 billion in AUM. The fund has a Zacks ETF Rank #2 (Buy) with a High risk outlook (read: Three Reasons to Bet on Small Cap ETFs Now).
Vanguard Consumer Discretionary ETF (VCR - Free Report)
The consumer discretionary sector will benefit the most from a reflation rally, as tax reforms will help businesses and consumers, boosting discretionary spending. VCR is by far the most popular and low cost choice in this space with AUM of about $2.2 billion and expense ratio of 0.10%. The fund has a Zacks ETF Rank #2 with a Medium risk outlook (read: 4 ETFs to Profit from Sector Rotation).
Technology Select Sector SPDR Fund (XLK - Free Report)
The tech titans hoard huge cash overseas and are poised to benefit the most from Trump's proposed tax reform policy. In fact, the top five U.S. hoarders are Apple (AAPL - Free Report) , Microsoft (MSFT - Free Report) , Alphabet (GOOGL - Free Report) , Cisco (CSCO - Free Report) and Oracle (ORCL - Free Report) that hold 88% of their money overseas, according to Moody’s. XLK is the best way to tap as these giants account for nearly 36% in the portfolio. It is the most popular tech ETF with AUM of more than $17.7 billion and charges 14 bps in annual fees. The product has a Zacks ETF Rank #2 with a Medium risk outlook (read: 5 Sector ETFs for Revenue Growth Play).
SPDR S&P Bank ETF (KBE - Free Report)
Since banks have higher tax rates, reduced corporate rates would lead to higher profits. In addition, the repatriation of hundreds of billions of dollars in cash could find a home in banks. Tax reform may also cause a rise in interest rates that would expand net margins and bolster banks’ profits. Given the tailwinds, the ultra-popular bank ETF, which offers equal weight exposure, could be a big winner. It has amassed $3.6 billion in its asset base and charges 35 bps in annual fees. The ETF has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.
PowerShares Buyback Achievers Portfolio (PKW - Free Report)
Trump’s tax reform is expected to benefit buyback ETFs. This is because lower corporate taxes would boost companies’ profitability and drive shareholders’ wealth. PKW tracks the NASDAQ US Buyback Achievers Index, which comprises companies that have repurchased 5% or more of their common stock in the trailing 12 months. PKW is one of the popular funds in the niche space, managing an asset base of more than $1.3 billion and charging a higher annual fee of 63 bps (read: Are Buyback ETFs in Trouble?).
iShares Core Dividend Growth ETF (DGRO - Free Report)
Tax savings will likely result in fatter and faster dividend hikes, thereby raising the appeal for dividend products. In particular, dividend growth ETFs like DGRO will benefit the most from the enactment of the tax reform. The fund provides exposure to companies having a history of consistently growing dividends. It has accumulated $2.1 billion in its asset base and charges 8 bps in fees per year. The product has a Zacks ETF Rank #3 with a Medium risk outlook (read: Best ETF Strategies for a Hawkish Fed).
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