ETFs to Bet on the Final Tax Bill: What Hot, What's Not

After negotiating on two versions of the bill already passed by the House and Senate, Republicans unveiled their final tax bill - which would reshape the tax code in three decades, making America more competitive. The Congress will vote on the legislation on Tuesday and sent it to President Donald Trump for his signature by the end of the year (read: Senate Passes Tax Bill: 5 ETFs to Buy Now ).

The combined plan will likely ease the burden of businesses instead of the middle class and calls for lowering corporate income tax rates, repeal of the corporate alternative minimum tax, double the standard deduction for individuals, and restructuring of the way pass-through businesses are taxed.

The tax reform represents the first major legislative achievement for Trump after nearly a year of his control on the Congress and the White House. It is also the most prestigious move for Republicans ahead of the 2018 midterm elections.

Inside The Final Bill

The new proposal lowers the corporate tax rate from 35% to 21%, starting next year and 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 20%, which is lower than 23% called for in the Senate-passed bill (read: 4 Sector ETFs & Stocks Set to Explode Higher on Tax Cuts ).

For individuals, the final version keeps the seven tax bracket intact but lowers the rates for most brackets. The new tax rates are 10%, 12%, 22%, 24%, 32%, 35% and 37% compared with the current structure of 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. The framework offers tax relief to middle-class families by doubling the standard deduction to $12,000 for single filers and $24,000 for a married couple filing jointly.

Additionally, the final bill allows companies to send their offshore profits back to the United States without incurring extra taxes. It sets a one-time tax for companies to repatriate more than $2.6 trillion held overseas, at rates of 15.5% for cash and cash-equivalents and 8% for illiquid assets. The final version also eliminates corporate alternative minimum tax and scrap Obamacare's provision that requires most Americans to buy health insurance or pay a penalty, beginning in 2019. Plus, it does not call for a repeal of the estate tax but nearly doubles the real estate exemption to above $11.2 million from $5.6 million.

Other key takeaways of the bill include a child tax credit of $2,000 with $1,400 of that refundable, reduction of cap on mortgage interest deduction to $750,000 from $1 million, and medical expense deduction with a floor of 7.5% instead of 10%, among others.

Though the massive tax cuts will create an economic surge boosting job growth and earnings of the corporates, it could add trillions of dollars to the country's deficit. Per the "very preliminary" analysis by the congressional scorekeeper Joint Committee on Taxation, the final bill would expand budget deficits by more than $1.4 trillion over a decade. Meanwhile, according to FactSet data, analysts are projecting double-digit earnings growth for each quarter of 2018 and solid revenue growth for U.S. corporations.

What Hot, What's Not?

While the tax reform would lead to broad-based market rally, small caps will likely be the winner making top-ranked ETFs exciting picks. Vanguard Small-Cap Growth ETF VBK , Vanguard S&P Small-Cap 600 Growth ETF (VIOG) and iShares S&P Small-Cap 600 Growth ETF IJT have a Zacks ETF Rank #1 (Strong Buy) and has gained nearly 4% each over the past one month (read: 3 Small-Cap Growth ETFs Surging to #1 Rank on Holiday Fervor ).

Among the S&P 500 sectors, financials, in particular banks will be the biggest beneficiaries of reduced tax rates and a shift to the territorial system. The tax reform may also cause a rise in interest rates that would expand net margins and bolster banks' profits. That said, SPDR S&P Regional Banking ETF KRE and SPDR S&P Bank ETF KBE look compelling at present. Both funds have a Zacks ETF Rank #3 (Hold) and have gained more than 6% over the past one month.

As lower corporate taxes would boost companies' profitability leading to increased buybacks and fatty dividends, ETFs that focus on these activities will gain. Some of the solid picks in this area include iShares U.S. Dividend and Buyback ETF DIVB , PowerShares Buyback Achievers Portfolio PKW and iShares Core Dividend Growth ETF DGRO . These funds are up 5%, 6.8%, and 5.1%, respectively, in the same time frame.

Apart from these, the newly launched EventShares U.S. Tax Reform ETF TAXR and Republican Policies Fund GOP will see a huge upside potential from the tax overhaul. This is because TAXR seeks to provide exposure to investments that are impacted by the reform of the U.S. Tax Code system while GOP offers exposure to investments that are impacted by the Republican Party's political agenda (read: 8 ETF Picks for December ).

Though most of the corners will enjoy a huge rally, these are some losers. The homebuilders are expected to lose as the new bill lowers the value of the mortgage interest deduction to $750,000 from $1 million, thereby limiting the purchase of luxury homes. This in turn would impact the profitability of the homebuilders leading to a decline in the stocks and ETFs. As a result, the highflying iShares U.S. Home Construction ETF ITB and SPDR S&P Homebuilders ETF XHB could see rough trading next year. These ETFs are up 5.5% in the past one month and have a Zacks ETF Rank #2 (Buy).

With the repeal of ObamaCare individual insurance mandate in the final bill, iShares U.S. Healthcare Providers ETF IHF , which offers exposure to companies that provide health insurance, diagnostics and specialized treatment, would be hurt. The Congressional Budget Office (CBO) has estimated that repealing the mandate would result in 13 million lesser people being covered by health insurance. IHF is up 7.5% over the past one month and has a Zacks ETF Rank #3.

Further, the tax cut has dampened the appeal for muni bonds, which are known for their tax shelter, especially those within a high tax bracket. As such, the ultra-popular iShares National Muni Bond ETF MUB will likely be in trouble if the proposed tax bill finally becomes law. It has added 0.1% over the past one month and has a Zacks ETF Rank #4 (Sell) (read: Muni ETFs: Value Trap or Value Play in 2018? ).

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SPDR-SP HOMEBLD (XHB): ETF Research Reports

ISHARS-US HO CO (ITB): ETF Research Reports

SPDR-KBW BANK (KBE): ETF Research Reports

ISHARS-US H C P (IHF): ETF Research Reports

ISHARS-SP SC GR (IJT): ETF Research Reports

ISHRS-CORE DG (DGRO): ETF Research Reports

SPDR-KBW REG BK (KRE): ETF Research Reports

VIPERS-SC GRWTH (VBK): ETF Research Reports

PWRSH-BYBK ACHV (PKW): ETF Research Reports

ISHARS-NAMTF (MUB): ETF Research Reports

US-TAX REFORM (TAXR): ETF Research Reports

REP-POLICIES (GOP): ETF Research Reports

ISHR-US DIV BB (DIVB): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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