,

Deductibility of business expenses paid for with PPP funds

Congress created the Paycheck Protection Program (PPP), to provide liquidity to small businesses dealing with the effects of the economic shutdown.  It was clear from the language in the CARES Act that loans used for covered expenses would not be included in a business’ gross income. However, the Bill was silent on the deductibility of these covered expenses. The IRS recently released guidance taking the position that allowing businesses to deduct expenses paid with tax exempt income (the PPP loan) would provide a “double tax benefit.” Now, after many small businesses have taken loan money in order to continue paying their employees, make rent, or cover utility costs, they face the possibility that they will not be able to deduct these expenses if their PPP loan is ultimately forgiven.

Lawmakers from both sides of the aisle are critical of this position and are proposing legislation that would override the IRS on this issue. Senators John Cornyn, R-Texas, Charles Grassley, R-Iowa, Ron Wyden, D-Ore., Marco Rubio, R-Fla., and Tom Carper, D-Del. proposed the Small Business Expense Protection Act, an amendment to the CARES Act which would allow covered expenses to be deductible.

A separate piece of legislation enacted by The House of Representatives, called the Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act, also addresses the deductibility issue. In addition to correcting the deductibility issue, the HEROES Act would allow employers receiving loan forgiveness under the PPP to take advantage of the CARES Act’s payroll tax deferral provisions, which was prohibited in the CARES Act.

So where does this leave small business owners who are wondering how to account for these PPP financed expenses? Unless Congress passes or negotiates a fix, they will have to assume that they will not get both loan forgiveness and the ability to deduct the expenses paid for with loan proceeds. This could ultimately mean companies may need to make larger than anticipated estimated tax payments by July 15th. Hopefully Congress will act swiftly to settle this issue so that business owners can turn their attention to safely reopening as soon as they get the green light to do so.

In order to provide the best advice to our clients, we pay close attention to updates and guidance on the various CARES Act provisions, including the PPP. As soon as we know more, we will release a follow-up article with the latest information and impact to small business owners.

 

/0 Comments/by

Nine points to consider on the outlook for equities

Given the volatility in the financial markets beginning the week of February 20th, it’s helpful to
review the state of the U.S. economy entering into this stressful period, what’s happened since,
and some of the potential economic impacts. Here is my take on those topics.

 At the beginning of 2020, the U.S. economy was in very strong shape, with
unemployment falling and the labour force participation rate and wages rising.

 Compared to 2008-09, this is not a financial crisis but rather a health crisis, which
tends to be much shorter in duration (typically several months) and which should
lessen in magnitude as the Northern Hemisphere approaches spring and
summer. Banks are in the strongest capital positions ever, and strong banks with
the ability to lend are obviously important to the sustainability and health of the
economy during times of crisis. Further, the ratio of consumer debt to gross
domestic product (GDP) is about 75 percent, its lowest since 2002, down from
almost 100 percent in 2008.

 Lower interest rates will help governments, consumers and corporations
refinance debt, leading to lower debt burdens within those sectors of the
economy. However, lower interest rates, along with lower stock prices, will put
further stress on state and local pension plans, many of which are already
severely underfunded. In order to minimise risk, we have been avoiding buying
bonds from a significant number of these states. A sustained period of low rates
will also impact savers, increasing the need for other parts of the portfolio to
generate the returns needed to fund retirement and other goals. We also expect
that we will see yields on short-term fixed income, such as money market funds,
drop substantially as well, increasing the “cost” of cash.

 While bad for energy companies, their stockholders and potentially their
bondholders, collapsing energy prices are effectively a big “tax cut” for
consumers. Also, companies that are heavy energy users (e.g., airlines) will
benefit, to some degree offsetting the losses associated with lower energy prices
in other sectors of the economy.  However, there is significant risk to the high-
yield corporate bond market, as there is $85 billion of high-yield debt issued by
energy companies, and with oil prices below $40 a barrel, many of these
companies will struggle to generate profits. Much of that debt matures in the next
four years. In this type of environment, one can expect the high-yield corporate
bond market to be highly correlated with the stock market, which is one of the

reasons we generally do not recommend high-yield bonds as part of client fixed-
income portfolios. High-yield bonds do not provide effective diversification within
a portfolio that already owns stocks.

 The U.S. has the lowest percentage of trade relative to GDP, at about 12 percent
(country trade-to-GDP ratios). In comparison, most of Europe varies from around
50 percent (Germany) to the high 80s (Belgium, Netherlands). Japan is about 16
percent and the UK is about 30 percent. So, if there is a prolonged deterioration
in trade, the U.S. should be less impacted than most countries.

 If the economic disruption associated with the coronavirus worsens, governments
are likely to take action to address issues, such as coming out with loan
programs to bail out specific industries (as the government did during the 2008-
09 crisis for General Motors and the banking industry) and enact fiscal stimulus
(tax cuts or other programs to more directly help those financially impacted by
the coronavirus) [1] . Given possibilities like this, one must also keep in mind that
markets are forward-looking, recovering well before the economy does, just as
they tend to fall before the economy is materially disrupted.

 Markets generally do a good job of incorporating both good and bad news and
anticipating potential impacts on the economy. When we see markets change, it
is almost always because of new information that couldn’t have been reliably
forecast in advance. However, markets can also fall for noneconomic reasons
due to a cascade of sellers who reach their get-me-out point, have margin calls,
or are covering short put options positions that are held by sellers of volatility
insurance and sellers of structured notes (which limit downside equity risks); or
market participants who are trading with the trend. In addition, banks and
investment firms using value at risk (VaR) metrics to assess possible losses on
their books for any single day may have to sell off risks as volatility
increases. Market participants can sometimes exacerbate downward trends in
markets, but we still believe it’s best not to try to predict these occurrences but
rather to be aware they are possible. Further, if you sell, you have no way of
knowing when to get back in or when trends like the above could reverse.

 While stocks and risky fixed-income assets or pseudo fixed-income strategies,
such as dividend paying stocks, REITs (real estate investment trusts), etc., are
falling in value, safe bonds are rising in value, demonstrating their value as
dampeners of portfolio volatility, which is why we include them in portfolios.
Some “true” alternative strategies, such as marketplace lending, reinsurance and
trend-following, have held up very well and have generally generated positive
returns on a year-to-date basis.

 Finally, remember that bear markets are periods when stocks are transferred
from weak to strong hands, as does wealth when recoveries occur. We have
recovered from every past crisis, which we tend to experience with great
frequency, about every two or three years. Further, we recovered quickly in the
past from the health crises of SARS, MERS and Ebola.
Footnotes

[1] On Sunday night, March 15 th , the Federal Reserve announced that it cut the Fed funds rate to
effectively zero, a drop of a full 1 percent. In addition, it announced a massive $700 billion
bond-buying program. These actions will provide cover for other central banks to cut rates
without fear of their currencies collapsing. Congress is also working on a massive stimulus bill,
on top of the $8.3 billion approved last week by the Senate. Governments around the world are
certain to follow with packages of their own.

/0 Comments/by

Questions every investor needs to ask themselves right now

In the 1960s, sociology professor James Henslin spent time with a group of cab drivers in St. Louis to understand their gambling habits. When the drivers finished their shifts for the night they would play craps into the wee hours of
the morning, typically from 3 am to 7 am. Henslin sat in on nearly 20 of the dice games to determine how the drivers’ thoughts and actions dictated how they played.

In his paper Craps and Magic, Henslin writes about how he discovered many of the players were operating under a sense of magic over the dice:

It became evident to me that these players were convinced that they could control the dice, that is, as shown by their behavior (by their statements, gestures, and betting practices), they were not playing solely under the assumption of probability or odds, but, rather, they also moved within the framework of a system of magical beliefs.

The players would routinely throw the dice harder when they wanted a high number and throw it softer when they wanted a low number. This is also why you so often see players blow on the dice before a throw at the casino. These practices have no bearing on the outcome but they give the gamblers an illusion of control.

When stock market volatility erupts, investors are always in search of their own illusion of control. We crave predictability and control when it comes to our money but the stock market provides neither.

When stocks are rising, investing is often boring, methodical and the opposite of newsworthy. When stocks are falling, investing is often exciting fast, and scary.

 

Investors often look to find some modicum of control through the answers of gurus. We just want someone to tell us what’s going to happen next so we can either buy or sell to relieve the fear and anxiety.

In all my years of doing this, I’ve never come across a single person who has all of the answers. That person doesn’t exist.

When stocks go down in a big way I find it’s more helpful to seek out the right questions as opposed to trying to find all of the answers.

Here are some questions you can ask yourself when trying to work through how to handle stock market volatility:

 If I sell my stocks now what is the plan for getting back in?

 Has my time horizon, risk profile or circumstances meaningfully changed enough to warrant a portfolio change?

 Will my lifestyle be impacted in a meaningful way if stocks continue to fall?

 Did I build my portfolio with the understanding that stocks can and will fall on occasion?

 Have I overestimated my appetite for risk assets?

 Do I need to use the money I have invested in stocks for spending purposes in the next 3-5 years?

 Does my portfolio match my willingness, need, and ability to take risk?

 Do I fully understand the potential range of outcomes when investing in stocks?

 Is my portfolio durable and diversified enough to withstand severe dislocations in the stock market?

 Does my investment strategy fit with my personality?

 How did I react to market carnage in the past?

 How much volatility am I willing to accept in order to earn higher expected returns over time?

 What are my core investment beliefs?

 What do I own and why do I own it?

 What will cause me to buy or sell securities, funds, or asset classes in my portfolio?

There are no right or wrong answers here because it all depends on your
circumstances.

These questions work in every market environment but more so when volatility rears its ugly head because that’s when we want to take the wheel to make something happen to give us the illusion of control. Most of this stuff boils down to having a comprehensive investment plan in place to guide your actions and set realistic expectations.

But the act of creating an investment plan is the easy part. The hard part is implementing that plan during periods of heightened stress in the financial markets or your own personal life.

Even the most rock-solid of investment plans won’t give you the same illusion of control as your favorite talking head who pretends to know what’s going to happen next in the stock market.

What happens next in the market is completely out of our hands which is why the most important reason for creating an investment plan is that it forces you to focus on what you can control.

/0 Comments/by
,

IRS extends tax filing deadline to July 15

The IRS is extending the federal income tax filing deadline to July 15 as part of a growing effort to stem the financial pain from the coronavirus pandemic, Treasury Secretary Steven Mnuchin announced Friday.

The move gives Americans three months more than they normally would have to file their income tax returns for the 2019 tax year, without incurring interest or penalties.

President Donald Trump later Friday said that “hopefully” by the time the new deadline arrives “people will be getting back to their lives.”

“At @realDonaldTrump’s direction, we are moving Tax Day from April 15 to July 15,” Mnuchin wrote in a tweet about the extension.

“All taxpayers and businesses will have this additional time to file and make payments without interest or penalties,” he wrote.

Trump echoed that suggestion during a White House press conference.

Most Americans are entitled to refunds when they file their federal tax returns.

As of March 13, the Internal Revenue Service had issued 59.2 million refunds out of the 76.2 million million individual income tax returns it had received, or 77.7% of the total number of returns filed by that date.

The average refund check was $2,973, according to IRS data.

Many individual states already had extended their own tax filing deadlines to various dates to give people relief from the financial fallout of the coronavirus outbreak, which has shuttered businesses nationwide and led to large-scale layoffs.

The IRS move will increase pressure on states to align their deadlines with the new one for federal income tax returns.

New York Gov. Andrew Cuomo, asked at a press conference if state residents should pay their state income taxes by the New York deadline of April 15, said the new federal guideline should be followed.

The IRS did not immediately return a call for comment from CNBC. It is not clear if the deadline extension also will include the deadline for funding Individual Retirement Accounts for the 2019 tax year.

A proposal to extend the federal filing deadline to July was included in the Senate’s coronavirus economic stimulus bill, which was released Thursday by Majority Leader Mitch McConnell, R-Ky.

That proposed relief package calls for new federal spending that could top $1 trillion.

Earlier this week, the Treasury Department released guidance that would have pushed back only the deadline for making federal tax payments — not for filing tax returns —  to July 15.

That 90-day reprieve on payments would have applied to 2019 income taxes owed, plus first-quarter tax payments that would have been due on April 15.

Federal lawmakers and members of the tax preparation community had criticized the proposal to have different dates for filing tax returns and making payments. Mnuchin’s announcement ends that debate by having returns and payments each due by July 15.

The White House declined to comment on Mnuchin’s announcement.

/0 Comments/by

Circuit breakers and dimensional’s approach to trading

Recently, several markets, including in the US and Brazil, have hit circuit breakers, where trading is paused for a period after a specified percentage decline in the market. In all cases, trading resumed as planned. Circuit breakers can serve a useful function: they mandate a short halt during which participants can assess new information and calibrate their trading activity.

While market volatility has triggered these rarely used rules, markets have been functioning as expected, given the recent news. Both the bond and equity markets have had increased trading volumes, bid-offer spreads, and volatility. Despite this, Dimensional has continued to manage strategies efficiently and in a manner consistent with their investment guidelines.

Our investment process is designed to function robustly and account for changes in security prices, changes in available liquidity, and sharp market movements. During a trading day, it has long been part of our trading process to allow for flexibility in the timing of when to trade. For example, Dimensional may choose to pause trading around an event that could result in unusual volume or volatility, like a company earnings announcement, an index reconstitution, the release of economic data, or a development in the news.

This longstanding flexibility can be valuable when volatility is high. If needed, we can sit out the early moments after the stock markets open and overnight news is being priced in. We can also use this flexibility to plan for circuit breakers.

As we approach each trading day in each market, we consider news releases, activity in other markets, the performance of overnight stock futures, and other factors. Those evaluations may lead Dimensional to anticipate that index performance will result in a circuit breaker being triggered, which can lead to higher bid-offer spreads and other potential implicit trading costs. This information is available to portfolio managers and traders before a market opens and can be used to implement strategies as efficiently as possible. In such instances, our research1 has shown that a flexible trading approach tended to add more value when compared to an approach that requires immediacy.

Dimensional will continue to monitor markets closely. Our investment approach allows us to remain consistent in how we manage our clients’ assets through the market’s ups and downs.

FOOTNOTES

  1. 1Dave Twardowski and Ryan J. Wiley, “Global Trading Advantages of Flexible Equity Portfolios” (white paper, Dimensional Fund Advisors, 2014).

 

/by

US equity returns following past downturns

Sudden market downturns can be unsettling. Sticking with your plan helps put you in the best position to capture a recovery.

A broad market index tracking data since 1926 in the US shows that stocks have generally delivered strong returns over one-year, three-year, and five-year periods following steep declines.

Fama/French Total US Market Research Index Returns

July 1926-December 2019

Past performance is no guarantee of future results.

 

/by