Tax return season is quickly approaching. Personally, I’m grateful I will not be filing tax returns for any major financial institutions, as the abundant regulations imposed on many of them further complicate the tax calculation. The centerpiece of President Trump’s tax reform bill, signed into law at the end of 2017, is the slashing of the corporate tax rate from 35% to 21%, as you can see in this week’s chart. It sounds like all the corporate CFOs should raise champagne glasses. But is the rate cut the complete picture?
I recently came across some of the finer details which could have a meaningful impact to financial institutions. For instance, just like banks, insurance companies’ capital could be affected by the combination of the lower corporate tax rate and the updated loss carrying provision. Risk-based capital (RBC) ratios may consequently be adjusted. Several provisions related to deferred acquisition costs and tax reserve aim to limit the flexibility of tax deferring. It seems that lawmakers hope financial institutions would generate more tax from higher current profit to subsidize the tax reform.
Switching to the investment side, the repeal of the corporate alternative minimum tax will further life insurance companies’ ability to enjoy the tax benefits from municipal bonds similar to property & casualty carriers, who have been major investors in the municipal bond market. On the other hand, investors will demand better yields from municipal bonds due to the thinner tax benefit (21% versus 35%) to achieve investment goals. Don’t forget that the highest personal income tax rate is 37%. This creates an interesting disparity of municipal bond tax value between corporations and high-income individuals and will tune the municipal bond market.Key Takeaway
Cutting the corporate tax rate from 35% to 21% will boost the profitability of many financial institutions. However, in the near term, the life industry might experience lower RBC ratios and even higher tax payments. Municipal bonds could become more or less attractive depending on the valuation and their purposes. The timing of the enactment makes it difficult for companies to react optimally. The full effect will take years to present. For me, I will judge the tax reform by watching my paychecks.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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