Tax Reform thoughts on capital gains & qualified dividends

It's good to be back among the normal folks now that tax day has passed.  This is our first email message since the end of tax season so I hope you had a good end to your April.

 

The budget battles have begun in Washington and there is a lot of talk about a fairer, flatter tax system.  While tax overhaul may not be imminent, we will pay close attention to the debate and prepare a series of email messages discussing the possible changes.

 

Our expectation is that tax reform will produce lower rates, coupled with a broader tax base (meaning fewer deductions and credits) similar to the tax revisions passed in 1986.  However, passage isn’t likely until 2013 or later, since neither party has a specific plan yet.  Tax overhaul is only in the discussion stages now but we should begin planning & preparing for what’s to come because many investment decisions will be affected.

Let's start with capital gains and qualified dividends. Reform probably ends their special low tax rates.  Congress did that in 1986, taxing all capital gains and dividends as ordinary income, subject to the taxpayer's marginal tax rate.  Similar tax treatment is likely in a future overhaul and the 15% maximum rate on long-term gains and dividends provides a tempting target for the political class.

 

After the 1986 law, the maximum rate on gains was 33%.  Thus, selling appreciated assets prior to reform will be a huge tax saver. 

 

There is a double-edged sword to this approach, as history reminds us.  The 1986 changes sparked a HUGE wave of selling before they took effect (along with depressed asset valuations and the S&L crisis -- basic law of supply & demand stuff here folks).  So keep in mind that tax consequences aren’t the only factor to take into account when deciding to sell an asset.

 

If you’re thinking of doing an installment sale with payouts spread over several years, don't count on Congress grandfathering the 15% top rate on your gains.  Lawmakers didn’t do that in 1986...the profit portion of installments received after 1986 was taxed as ordinary income.

 

The next round of reform may repeat the sell-off scenario (but hopefully not another financial crisis).

 

More to follow...enjoy your week.