By Michael Babikian
There’s no argument from either side of the political spectrum on at least one point: President Donald Trump has championed some polarizing legislation so far in his term.
But regardless of your political affiliation, as a financial professional and even an individual, you no doubt benefited from his Tax Cuts and Jobs Act, the biggest tax cut in 30 years.
Because of my background in tax law, I’ve found last year’s tax cuts and their implications for the insurance industry quite fascinating. The way I see it, there’s good as well as bad, but, more importantly for many of us in the insurance industry, an interesting paradox has developed.
Overall, the positive side of the scale is meatier. First and foremost is the impact lower taxes have on business income. The reform targeted larger, more likely C corporations, although it does also benefit small businesses – or pass-through entities – such as S corporations, limited liability corporations and partnerships.
A pass-through entity is not subject to income tax; instead, revenue is passed through and taxed as personal income. This part is staying the same; the difference under Trump’s act is that an additional deduction of up to 20 percent is allowed on that income.
The trickle-down effect of these tax cuts offers an additional boost to the industry: Consumers have a bit more breathing room in their discretionary income to reconsider their needs in general, which, I hope, includes insurance.
On a global scale, the tax reform prevents non-U.S. insurers and reinsurers from avoiding U.S. taxes, previously considered an unfair advantage. If foreign-based companies are now subject to the same tax obligations as their domestic counterparts, it becomes more of an even playing field. They could decide to limit or cease U.S. operation, which would decrease competition and, to a degree, ease the hyper-commoditization that has plagued the industry over the past few years.
The tax reform is a significant piece of a larger pro-business or pro-growth mentality, one that features deregulation. An example of the regulatory relief that could boost business is rolling back environmental protections. Whether or not you agree with the idea of curtailing the Environmental Protection Agency, the fact remains that, anytime there are fewer regulations to limit business efforts, you’re going to have a more active stock market, because investors have more confidence in businesses commercializing in a less fractioned environment.
Speaking of regulatory relief, I’d be remiss if I didn’t recognize the deregulation that happened right here in our own backyard. As I’m sure you know, the 5th Circuit Court of Appeals vacated the Department of Labor fiduciary rule on June 21. Those who work on commission – insurance agents – would have been most impacted, and many feared that commissions would disappear altogether.
But we’re not talking pure greed here. What rule supporters didn’t value is that the additional regulatory burden could have had an unforeseen negative impact on individuals with less money to invest. That’s because it simply wouldn’t have been financially viable to work with lower-net-worth clients given all of the additional hours the rule would require agents to spend just on paperwork to clear compliance hurdles.
What I’ll say is this: There’s no question the objective of the rule was sound. Of course the client’s best interest is of the utmost importance – it’s why you do what you do to begin with. But ultimately, we can’t depend on regulation to act as an intermediary between agents and their clients. Putting more layers between them is the opposite of what I believe is the best way forward for the industry, which is deepening the relationship between consumers and their advisors.
Additionally, there was a change to how life settlements are taxed. The new law makes the tax treatment of life settlements more favorable to the seller. The IRS (Revenue Ruling 2009-13) stated in 2009 that life settlements would get unfavorable tax treatment versus surrendering a policy with a gain. The new tax law basically reverses that ruling and puts a surrender and settlement on par with each other from a tax perspective.
The seller of the policy will no longer need to reduce basis in their policy by the cumulative cost of insurance charges. Accordingly, the seller is now not taxed on amounts up to basis in the policy (premiums paid minus withdrawals and dividends taken). The seller is taxed at ordinary income tax rates for any amount in excess of basis up to the amount of the cash surrender value. Finally, the seller is taxed at capital gains rates for any amounts received in excess of cash surrender value.
Negative Impact Of Tax Reform
Now, we’ll pivot to the potentially negative impact of the reform: the higher estate and gift tax exemption. Trump doubled the exemption to $11.2 million per individual and $22.4 million for married couples. Estate planning is bread and butter for many advisors, and this change greatly reduces the number of people subject to the tax.
However, all is not lost. Remember that this change expires after eight years, at which point we have no idea what will happen, so clients expecting to live past 2025 must consider that many of these changes might not be permanent. The nature of estate planning is forward-thinking, so wise individuals will still make it a priority.
Of lesser impact but still notable is the fact that this exemption doesn’t affect what is owed for state estate taxes. With these two points in mind, conversations about estate planning should and can still be had.
All told, the aggregate impact of Trump’s administration on financial professionals – specifically the Tax Cuts and Jobs Act and the death of the DOL fiduciary rule – has been positive. As I wrote earlier, I support anything that facilitates a close relationship between advisors and clients and helps advisors do their jobs – because expert advice and guidance together with innovative solutions and a customer-centric experience are the best ways to help consumers navigate and prepare for their financial futures.
Michael Babikian is CEO of LegacyShield. He may be contacted at [email protected].
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