May Market Commentary
Global stocks were dealt a setback in May. As we suggested in last month’s commentary, no progress in a trade deal with China may lead to a market selloff. Unfortunately, this occurred, with U.S. and international stocks down significantly. US bonds (Barclays U.S. Aggregate Bond Index) provided a ballast for the stock market selloff by showing a slight gain during May. Despite this short-term setback, U.S. stocks and bonds still have a significant gain for the year. Overall, returns in stocks and bonds remain quite attractive for the year.
What caused this stock market selloff? In addition to the ongoing trade dispute with China, President Trump announced he would impose a 5 percent tariff on all imported goods from Mexico beginning June 10. (An agreement recently signed with Mexico has eliminated this tariff threat.) President Trump commented this penalty would gradually increase until the flow of illegal migrants coming through Mexico is stopped. While the China trade dispute and associated tariffs should be viewed with caution, a trade dispute with Mexico could be much worse. The U.S. and Mexican economies are much more integrated since Mexico is the U.S.’s largest trading partner. While trade disputes concern us, a 5% selloff in the stock market is quite normal historically. With the Mexican tariffs indefinitely suspended in early June, stocks are beginning to recover from their May losses.
A more perplexing issue resulting from the threat of tariffs on Mexican goods is whether this is the future of our negotiations with other trading partners. This concern contributed to the selloff in global stocks late in May. While the negative sentiment with China has increased with both countries promoting their stance to their respective citizens, the U.S. and China continue to be at an impasse regarding trade negotiations. The longer this persists, the more likely a negative outcome for global economic growth increases.
The trade uncertainty is beginning to creep into U.S. economic statistics. While the U.S. economy continues to deliver solid growth, it appears as though momentum is slowing. The Federal Reserve is keeping a watchful eye on these developments and may need to begin lowering interest rates in the future to sustain solid growth in the U.S. economy. While the outcome of trade negotiations is unpredictable, we believe it is always a good time to focus on the things that ARE in your control. Keeping your focus on your long-term financial goals remains important in achieving them. If you should need any assistance in reviewing your financial objectives, please feel free to reach out to us to schedule an appointment.
Estimated Tax Payments
Are you self-employed or have significant income not covered by payroll tax withholdings? Such other income could include investment income, rental income, alimony, or business income outside of a W-2/salary. If you have such other income, you are probably accustomed to paying estimated tax payments each April, June, September and January.
Most taxpayers typically pay “safe harbor” estimated tax payments to avoid any underpayment penalties. However, safe harbor estimates may not necessarily be the most efficient cash flow technique. If you had any significant one-time gains or income items in that prior tax year, you may want to consider whether a different approach to paying your estimated tax payments makes sense.
Underpayment penalties apply if you don’t pay the lesser of 90% of current year tax (including any SE taxes) or 100% of your prior year tax liability (including any SE taxes). For those making over $150,000 a year, the 100% prior year tax liability threshold is increased to 110%.
Thus, paying 90% of current year tax may be a much better approach if you had unusually high income in the prior year or you are having an unusually low income year. Either way, wouldn’t you rather have the cash in your investment account than in the IRS’ account?
Additionally, if you make most of your other income late in the year, you could consider the “Annualized Income Installment Method” if that generates a better result than simply assuming that you earn money pro-rata throughout the year. For those that are retired, this method could also apply if you take IRA/401k distributions sporadically and perhaps later in the year for special one-time items (vacations, etc.).
This annualized method allows you to pay less estimated taxes earlier in the year, when you haven’t made as much income, and more later in the year, when most of your income is earned. Obviously, this is simply a cash flow play as every taxpayer must pay in the lesser of 90% of current year tax or 100% of prior year tax (110% for those making over $150,000) by January 15th following the tax year to avoid any underpayment penalties.
Given the low interest rates over the past number of years, the cost of underpayment penalties was really quite low. However, starting in January 2019, the IRS increased the underpayment penalty rate to 6%. Thus, it is becoming more important to appropriately pay your estimated taxes. However, with rates going up, more interest can be earned if you are able to better manage the cash flow of your estimated tax payments.
As part of our expanding tax planning services, we are happy to help you analyze the best approach to manage your cash flow while avoiding any underpayment penalties. Please contact us if you have any questions or wish to review your specific situation.