More On Tax Planningfrom The Advisor's Professional Library
- Annuities: Variable Annuities Annuities are hot. The tax rules vary with the circumstances. Advisors must be aware of these intricacies when discussing annuities with clients.
- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
As 2012 comes to a close, and the Mayan calendar crowd snuggles deep into their shelters, the issue of the fiscal cliff hits us squarely in the face. To sell or not to sell? That is the question. Unfortunately, I don't think there's a real definitive answer to this.
In mid-1993, President Clinton raised taxes, to the chagrin of many, and to make matters worse, made the tax hikes retroactive to the first of the year. I remember being up in arms about this most egregious act. I even believed that his decision might be overturned, though I'm not sure by whom. Today, we have a little over two weeks before the Bush tax cuts expire. Along with this comes an increase in the capital gains rate, the expiration of the payroll tax cut and a brand new 3.8% Obamacare tax. Ouch!
If Congress doesn't act quickly, taxes will rise, the budget axe will fall, and every taxpaying American will have to ante up as they will be required to pay more. I said every "taxpaying" American because clearly there are many who do not pay income taxes. So do we sell and capture capital gains at the 2012 rate or risk a higher rate beginning in 2013? Hmmm.
At this point, I am leaning toward selling this year—especially for holdings with a substantial unrealized gains. However, there are a few additional issues to consider on behalf of my clients, including projecting the tax bracket for the client in the next few years and the level of risk that the individual investment carries.
Issue #1: Projected Tax Bracket
If the client’s projected bracket is expected to decline, for example if they are retiring, you may want to wait. Obviously, there are numerous factors to consider here.
Issue #2: The Risk Versus the Expected Tax
How much risk does the investment have? Let's assume you have a $50,000 holding with a $10,000 unrealized LT capital gain. The expected federal CG tax if sold in 2012 would be $1,500 ($10,000 x 15%). $1,500 is about 3.0% of $50,000. Therefore, if the investment's standard deviation indicates that a 3.0% loss (or greater) is easily within range, then selling may make sense. This is because a loss of 3.0% would equal the tax paid if sold in 2012. Since realizing capital gains for 2012 means that you keep 85% of the gross sale (commissions and other fees not withstanding), wouldn't you rather have 85% of a higher number? Then you can reinvest and start over.
Issue #3: Macro Considerations
If we do go over the fiscal cliff, and a recession ensues, stocks will not react favorably. Hence, selling some positions now may be prudent.
Issue #4: Winners, Losers and the Wash Sale Rule
To lessen the blow, consider selling some losers to help offset the gains you plan to realize this year. Of course, you'll want to watch out for the wash sale rule if you plan to claim a capital loss.
Whatever your decision, make sure you document your actions. It's always good to have a paper trail to substantiate why you did what you did. Compliance will appreciate it. Finally, if you're an RIA, put on your compliance hat, sit back and have a cold one to celebrate another year of independence! There's nothing like it!