Monday, October 22, 2012

More on Year End Tax Planning

Photo courtesy of Ron Buist (
The next couple of months promise to be very interesting ones in the market.

The election outcome is of course very much in doubt at this writing.  Meanwhile, there are growing fears among corporate America that Congress will not act with sufficient resolve and alacrity to deal with the impending "fiscal cliff". Investors are left struggling how to best manage their accounts in light of the uncertain tax environment in 2013.

Although advisers typically tell clients not to make investment decisions based on taxes, this year might be different.

With capital gains rates at historic lows, and facing a pretty good likelihood that rates will move higher next year, many firms are advising clients to take capital gains this year, especially if they anticipate needing funds in the next year or so.

Bloomberg carried a good article this morning discussing different approaches being advocated by some large banks and brokerage firms. Here's an excerpt:


That’s the message from some financial advisers, who are telling wealthy clients that the remainder of 2012 amounts to a last-chance sale on federal tax rates. Taxes are set to rise in January in the U.S., pushing the top rate on dividends to 43.4 percent from 15 percent and the top rate on capital gains to 23.8 percent from 15 percent...

An investor who sells $100 of stock with a cost basis of $20 in 2012 would see proceeds -- after capital gains taxes -- of $88, said Robert Barbetti, managing director and executive compensation specialist at J.P. Morgan Private Bank. Next year, if Congress doesn’t act, earnings from the sale would drop to $80.96 if rates rise to 23.8 percent. That means the stock price would need to rise at least 9 percent for an investor to be better off selling in 2013, said Barbetti, who is based in New York

Meanwhile, Ned Davis Research (NDR) thinks that investors should focus on those sectors that have done particularly well over the last year as ones where selling in anticipation of higher taxes makes the most sense.

In a report issued on Friday,  NDR analyst Gary Sarkissian writes that investors should consider swaps from the best returning sectors into lagging groups in anticipation of potential tax-related year-end selling pressure.

NDR figures investors might be tempted to take profits in sectors like media, banks and health care stocks.  At the same time, automobile and semiconductor stocks may be interesting buy candidates, based solely on their year-to-date underperformance.

I'm not sure I totally buy into the idea that you should sell your winners and buy the laggards based on upcoming changes in tax policy.  However, NDR cites some pretty good historic evidence that this strategy has played out well in the past when tax rates were set to rise, so perhaps it is worth considering.

The Bloomberg article, by the way, pointed out that the last time there was a significant change in tax policy (1986), "positive realizations spiked 91 percent to $328 billion from $172 billion a year earlier, according to the Tax Policy Center.  Most investors waited until December to sell, according to a 1994 report in the National Tax Journal."