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Harvest Your Capital
Gains?
Do
The Math When Considering Paying Taxes Now
Rather Than Later
While Republicans plan no
changes in the tax on long-term gains, Democrats are anxious to
roll back the Bush tax cuts, in which case the rate would rise to
20%.
Investors
are wondering whether they should take gains before any tax rate
increases kick in. There
should be no rush to sell now, certainly not before the election
results are in. So what about next year?
If the Democrats do win, the Inauguration isn’t until
mid-January and then the Congress will need to debate the merits
and pass a bill to institute higher rates.
Historically, any time there has been a change in capital
gains rates, the date for the change has never been applied
retroactively. If
this holds true, investors will have full warning when the change
will take place. This
advance warning also helps the government raise revenues because
an impending increase in capital gains rates is usually
accompanied by an disproportionate amount of selling to “take
advantage” of the lower rate still in effect (but about to be
eliminated).
We
say “take advantage” cautiously because we are not sure
investors are serving themselves well by employing this strategy.
Certainly if it is known that you will be selling in the next few
years, the strategy can make sense. But to a long-term
holder, the benefits are less certain. It is important to
remember that individual investors’ estates are forgiven capital
gains taxes at death through a step-up in basis. If there is
to be a sale before death, investors need to consider whether a
20% tax in 2018 for example, is actually worse than a 15% tax in
2008.
What
rate of return would an investor need to make on its money to make
the client indifferent to paying the capital gains tax at the
current rates, versus the higher possible capital gains rates in
the future?
We
have included a table that shows the discount rates to apply when
making the “now-or-later” decision:
| |
5
Years |
10
Years |
15
Years |
20
Years |
20%
Federal +
7% State |
4.181% |
2.069% |
1.375% |
1.029% |
28%
Federal +
7% State |
9.731% |
4.753% |
3.144% |
2.349% |
For
example, as long as an investor earns as little as 2.069% annually
over the next 10 years, paying a 20% tax in 2018 is preferable to
paying today at the current rate.
This
article and other articles are provided for
information purposes only. They are not intended to be
an offer to engage in any securities transactions or to
provide specific financial, legal or tax advice. Articles
may have been rendered partly inaccurate by events that have
occurred since publication. Investors should consult
their advisers before acting on any topics discussed herein.
Futures are not suitable for all investors.
They involve risk, and an investor who employs them can
lose all or part of his investment.
Before
engaging in a futures transaction, investors must receive
certain regulatory disclosure materials.
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