Year-End Shifts in Portfolios Not Always Worth It
With two weeks left in the year, many investors are scrambling to figure out their tax liability for 1993 and whether they can lower it by making last-minute portfolio shifts.
The problem, say tax experts, is that there is more than the usual amount of confusion about the best moves to make. And for many people, the best move may be no move at all. Here are answers to some of the most common year-end tax questions.
* Should you take capital gains now? Recent heavy selling in formerly high-flying smaller stocks suggests that some investors are scrambling to lock in capital gains. But if they’re doing so because they assume tax rates are going up next year, they’re misinformed: Tax rates have already gone up for regular income, and they aren’t going up at all for long-term capital gains.
The tax hikes in President Clinton’s budget-deficit-reduction plan, passed by Congress in August, are retroactive to Jan. 1 of this year. There are two new tax brackets of 36% and 39.6% on wages of higher-income earners (see chart). They’ll stay the same in ’94.
And here’s what investors forget: The top tax rate on long-term capital gains--that is, on assets owned more than a year--remains 28%, for 1993 and for ’94.
That means there’s no tax-related reason to take long-term gains willy-nilly this year, unless you simply believe an investment’s potential has peaked. Remember too that because capital gains are taxed much lower than ordinary income, there is an inherent advantage to staying in investments likely to generate gains in the long run (like stocks) rather than shifting to interest-paying investments (like money funds).
Another misconception: Investors may know that the new tax law allows them to stretch payment of their retroactive tax increase for 1993 over the next three years. But Bob Willens, tax expert at Lehman Bros. in New York, notes that only the increase in your 1993 tax (if you’re in the new higher brackets) can be stretched out, not your entire tax. And you can’t stretch out any of the tax you owe on long-term capital gains realized this year.
* Should you take losses now? Because this has been a good year overall for stock and bond investors, many have already realized capital gains. It may make sense to sell losing investments to offset those gains.
You can use losses to offset gains dollar for dollar. But if your net capital losses exceed your net capital gains, remember that only a puny $3,000 of excess losses can be deducted from ordinary income in any one year. The rest must be carried forward into the next tax year.
Again, experts say your decision to take a loss should be based first on the investment’s merits (or lack thereof), not tax considerations. Also remember that if you’re planning to sell a security to record a loss for 1993, but you like the investment’s long-term prospects and therefore plan to buy it back in 1994, you must wait at least 30 days. Otherwise, the IRS disallows the loss for tax purposes.
That 30-day wait could hurt you if you sell this late in the year, particularly in the case of depressed smaller stocks. The deeper they slide in December, the greater the chance they’ll rebound sharply in January, when tax-related selling ends. If you must wait until late January to buy something back, you may pay a much higher price.
A related, if reverse, issue: If you’re tempted to buy a stock mutual fund between now and year-end, don’t. Most funds are preparing to make their annual capital gains payments to shareholders. If you buy now, you may incur an instant tax liability. Better to wait until Jan. 1 to buy.
* Should you accelerate onetime stock awards and other 1994 bonuses into 1993? Some firms give employees the option of taking year-end bonuses in either year. For high-income earners (more than $250,000 a year), it may make sense to take a bonus now. Reason: You’ll avoid the 1.45% Medicare payroll tax, which doesn’t apply to wages above $135,000 this year but will starting next year, says Gregg Ritchie, a personal financial planning expert with KPMG Peat Marwick in Woodland Hills.
But if your earnings are in the vicinity of $135,000, Ritchie says, the Medicare tax savings you might realize from accelerating a bonus could be offset if the bonus pushes you into a higher tax bracket. Thus, he says, he’s working with such clients to do the math and determine whether only part of a bonus should be accelerated.
If all of this makes it sound as if you should consult an expert before you make any serious year-end financial moves, you’re getting the point. Tax planning and investment planning go hand in hand, and they both should be done taking a long-term view. By necessity, “I have gotten away from doing just one-year tax projections for clients,” says Jeff Saccacio, director of personal financial services in California for the accounting firm Coopers & Lybrand in Los Angeles.
Likewise, remember that this year in particular, doing nothing--especially for long-term investors happy with their portfolios--may be the best advice of all.
The Tax Hike Is Now
The increase in federal income tax rates last summer was retroactive to Jan. 1, 1993--meaning your year-end financial maneuvers shouldn’t be based on expectations of higher taxes in 1994. They’re already here. 1993 FEDERAL TAX RATES
Marginal tax rate: 15% Taxable income levels: Married/Joint: $0-36,900
Single: $0-22,100
Marginal tax rate: 28% Taxable income levels: Married/Joint: 36,901-89,150
Single: 22,101-53,500
Marginal tax rate: 31% Taxable income levels: Married/Joint: 89,151-140,000
Single: 53,501-115,000
Marginal tax rate: 36% Taxable income levels: Married/Joint: 140,001-250,000
Single: 115,001-250,000
Marginal tax rate: 39.6% Taxable income levels: Married/Joint: over 250,000
Single: over 250,000
Source: Deloitte & Touche
