Towards the end of the year, we do a final review our clients’ taxable accounts for year-to-date capital gains as well as unrealized gains or losses. Typically, we are looking for opportunities where it might make sense to offset some of the realized gains with some of the unrealized losses, if we can do so without compromising the integrity of the portfolio. This is a difficult exercise in normal times, because each client’s situation is unique. For example, does the client already have a significant capital loss carry forward? Is the client retired and in a relatively low tax bracket where realized large gains would subsequently push up their Medicare premiums?
This is an odd year for tax planning. Currently, if the Bush tax cuts expire on 12/31, the rate on long-term capital gains would increase from 15% to 20%. If you have unrealized gains this year and no loss carryforward, it may make sense to accelerate some gains in order to pay tax at the current 15% rate.
If you already have a loss carryforward, these losses would be more valuable next year when capital gains tax rates are higher. Therefore, you would want to hold off on taking additional gains.
If you are subject to alternative minimum tax (AMT), this further complicates the analysis. We currently do not know what the AMT exemptions are for the current year or for 2013. If Congress does not pass a one-year “patch” as they have done in the past, then a significant number of households (possibly 20-20 million additional) will be paying AMT for 2012.
Although taxes are a factor in the investment decision-making process, we never want to make an investment decision solely for tax reasons. We also want to look at the client’s overall asset allocation, portfolio diversification, and financial goals. If you have questions or thoughts about your specific situation, please contact your Parsec advisor. Keep in mind that the more information we have about your individual situation such a marginal tax rate and the amount of any capital loss carryforward, the better we can advise you. Also, we are not accountants and are not licensed to give tax advice, so you should check with your CPA before making any major tax-related decisions.
According to Barron’s, the potential tax shock portion of Fiscal Cliff is about $506 billion. Contrary to popular belief, many of the components would raise taxes on the middle class in addition to the wealthy. For example, of the rollback of the Bush taxes cuts on income would increase taxes about $38 billion by restoring the 36% and 39.6% brackets on income and an additional $22 billion if dividends were taxed at ordinary income rates, for a total increase of $60 billion. The impact on all other income brackets would be about $95 billion, since there are a lot more taxpayers affected.
Failure to patch the AMT by indexing the exemption amount for inflation would cause taxes to increase by about $114 billion. This would hit middle and upper-middle class income families hard, particularly those living in areas with high state income tax rates.
By contrast, the amount of taxes hikes due to “Obamacare” is projected at $23 billion, which is much smaller than the major components above despite all the media attention.
Since the Fiscal Cliff would hit all taxpayers hard, not just the “rich”, I am optimistic that a compromise will be reached, particularly with regard to tax rates for the middle class and the AMT patch. This would lessen the impact of the tax portion of the Fiscal cliff by 40-50%. In the meantime, we can expect continued media focus and possibly an increase in short-term market volatility until there is clarity on these important issues.
Bill Hansen, CFA
December 3, 2012