Rosica noted that Obama mentioned tax reform in his acceptance speech on Tuesday night as one of the items that he needs to get done (see Obama Wins Re-election, Pledging to Reform Tax Code). “There are certainly indications that there will be something coming and changing, so we need to build some plans to take into account, if we hear something before the end of the year, what course of action we would take,” he said. “And if we don’t, then based on what we’re feeling and seeing at that point in time, whether we should pull the trigger on some of these items based on what happens in 2013 or not.”
For example, with long-term capital gains currently taxed at a 15 percent rate today and rising to 20 percent in January, plus a 3.8 percent Medicare tax, the taxes could go up nearly 24 percent. “If we knew that was certain to be the tax for all of 2013 and beyond, then that might drive someone who was otherwise going to sell their position in a stock to trigger that this year,” said Rosica. “There is a breakeven point for doing that. If you were to sell it today, recognize the gain, and perhaps purchase that same stock and then hold it, there is a point for that breakeven versus just holding onto that stock and subjecting the entire gain to 23.8 percent down the road. Those are not two-year or three-year breakevens. They’re more like five years on those kinds of things. And the question is: who is really comfortable with what the taxes are going to be five years out? They could be something completely different, so are you willing to pay the toll and pay the tax today for something that has a five-plus-year breakeven or do you want to just let it ride and then pay the taxes once you eventually sell that position or not? It requires some analysis in those situations to really be postured so that you can pull the trigger on the one that makes the most sense.”
Rosica believes that while the information on future tax rates is not yet available, the framework is available to come up with those scenarios and then be ready to make a decision. “At some point, when it’s December 31, it’s time to make the decision, right? You have to go one way or the other on this,” he said. “And if there’s no more clarity than we have today, then you probably don’t do some of those things, but if there is, then you may.”
Rosica advises clients not to wait until the end of the year. “If you wait until we get clarity, it could be the last week in December before we get some, and you then have to figure out what strategies you should implement based on that,” he said. “I think it’s going to be too late to get anything done. Line up some strategies based on understanding what your situation is, and the types of income you have, such as what is and is not subject to the Medicare tax, because we have that kicking in January 1. Despite what happens with other tax rates, that doesn’t seem like something that’s necessarily going to change based on the administration that’s in office now. It’s a change that would require some significant negotiation. So understand the types of income that you have, whether it’s wage income, self-employed income, interest or dividends, and what’s going to be subject to which tax. How much is that going to cost, and how can you plan around some of those items based on what your situation is? Just prepare yourself now to understand what actions you might take. Be ready to execute any of those strategies so if we get any more clarity, you will know which way to go, and if we don’t, you’ll know what to do in that situation as well.”
