In Archived

Across the country and certainly in Washington D.C., there is all too much discussion about the year-end “fiscal cliff”.  This commonplace headline refers to the possibility of inaction by Congress that would ultimately lead to significant automatic tax increases and deep cuts in federal spending.  In theory, these two activities should have a positive effect on reducing the U.S. deficit considerably.  But, it is widely feared that such drastic increase in taxes and reduction in spending would lead to slower GDP growth and potentially place the U.S. back into a recession.
As investors, what should we be considering as we look towards the year end though the debate continues in Washington?

Long Term Capital Gains

In cases where there is an overweight holding of legacy stock or other appreciated investments which our research suggests should be pared back, we are working with clients to trim gains prior to year-end.  This is not a one size fits all approach and we do not think that a strategy to sell investments simply to “reset the basis” is sensible.  It is important to consider current valuation and growth potential of investments with low cost basis and, as is usually the case, there’s no need to force through a sale of a worthwhile investment simply to incur the lower tax.  However, if it makes sense to trim or sell investments, especially those held over one year, this year is likely more tax advantageous than next year given that capital gains rates are likely to increase from the historically low rate of 15% to over 20%.

Capital Losses

Under the assumption that capital gains taxes are headed higher, it may make sense to consider delaying the realization of significant capital losses until next year. These losses are likely to have a greater impact next year when they are used to offset what may be higher capital gains liabilities.


The biggest potential mover in the tax structure could be the treatment of dividend income as the reversion to being subject to ordinary income tax rates could potentially triple the current 15% rate for high income earners.  Though this is a significant change, we continue to believe that dividends will remain a sound component to investors’ total return in the coming years.  Healthy and growing dividends are generally a result of a financially strong company doing wise things with excess free cash flow for the benefit of us as shareholders.  Especially as we remain in a yield-starved environment, avoiding dividends due to tax treatment is, in our view, not a strategy worth exploring.

Income Tax & Medicare Surtax

Given the likely rise in income tax and the application of a 3.8% Medicare surtax for high earners (over $250,000 per couple and over $200,000 per individual) as a result of last year’s Affordable Care Act, it may make sense for these households to accelerate income (bonus, stock options, etc.) where possible in 2012 rather than taking it in 2013.  This may save significant dollars next year if rates rise as anticipated.  Additionally, the Medicare surtax of 3.8% will apply to the lesser of either one’s modified adjusted gross income (MAGI) or his or her net investment income.

Roth IRA Conversions

The biggest driver for those considering conversion of traditional retirement assets into a Roth IRA is a long compounding period followed by tax-free distributions in retirement.  While “conversion” allows the current retirement account to become tax-free rather than tax-deferred, it also means that the balance of the transfer is taxable as income in the year this conversion occurs.  For those considering conversion in the near term, it may therefore be beneficial to complete it in 2012 rather than waiting until next year.   Finally, this is the only planning strategy that can be reversed.  If tax rates stay the same or your income goes down in 2013 you have until October 15, 2013 to undo your 2012 Roth conversion and any taxes paid.

Family Gifts

For those who have large estates and have been considering gifting a large amount, 2012 represents a unique opportunity.  The lifetime gift tax exemption has been raised from $1 million to $5.120 million per person.  That means that a couple can give away $10.240 million free of estate and gift taxes in 2012.  Unless otherwise changed, the exemption is schedule to drop back to $1 million per person in January 2013.

The annual gift exclusion amount remains at $13,000 a year per person and will increase to $14,000 in 2013.  This annual gift exclusion resets each year (inflation adjusted) which allows you to gift again after the new calendar year.

Charitable Gifting

Maximizing gifts to charities is a greater unknown given ongoing debate.  In 2012, taxpayers are assured of the full market value of the stock as a deduction.  Charitable deductions could be more powerful next year if income tax rates rise, but there remains debate in Washington over whether certain itemized deductions may be phased out (including charitable deductions). Because of this, it makes sense to follow through on philanthropic goals this year (and be assured of the full deduction) and reassess how they relate to individual taxes once there is more certainty for 2013 and beyond.

In making significant gifts, it is always more beneficial to gift appreciated securities to qualified 501c3 organizations whenever possible.  Givers receive the benefit of the deduction, as well as tax avoidance on the capital gains imbedded in the security that was gifted.

In conclusion, there are several tax saving strategies that can be implemented prior to year-end.  In some cases waiting to take action in 2013 could end up costing you real money.  Remember that the political impact of orchestrating tax law changes can be unpredictable and, while difficult to know where tax rates will be long into the future, it certainly seems that taxes for many will be going higher.  We remain alert to opportunities to make prudent portfolio adjustments in the midst of much uncertainty.  We advise speaking with tax and estate planning professionals for guidance specific to your circumstances and would be eager to be a part of that dialogue for clients.

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