Clowns to the left of me,
Jokers to the right, here I am,
Stuck in the middle with you,
Yes I'm stuck in the middle with you,
Stuck in the middle with you.
-Stealers Wheel
With only a short time to go until the US potentially goes over the proverbial "fiscal cliff", our elected representatives appear to be no closer to a solution than during the debt ceiling debate last summer. If a solution is not reached, we do know that federal income taxes will rise across the income spectrum along with capital gain rates for most filers. I'd like to focus on the importance of understanding the impact of rising capital gains rates and why investors should review their portfolio prior to year-end.
Tax rates on long-term capital gains will rise from 15% to 20% assuming the Bush tax cuts expire on 12/31/12 or in a potential compromise to avert the fiscal cliff. For individuals with an adjusted gross income (AGI) of $200,000+ or couples filing jointly with an AGI $250,000+ an additional 3.8% surtax on long-term capital gains will be added to help fund Obamacare. Why is this important?
Let’s assume that long-term capital gain rates rise to 20% in 2013 and an investor chooses to realize long-term capital gains during 2013. Their investment would have to appreciate approximately 6.25% just to break even with realizing the long-term capital gain prior to year-end at the current 15% level.
For investors that will be subject to the 3.8% surtax and we assume that long-term capital gain rates are 20% in 2013, their total long-term capital gain rate will be 23.8%. If this assumption holds true and an investor chooses to realize long-term capital gains during 2013, their investment would have to appreciate approximately 11.5% to break even with realizing the long-term capital gain during 2012. To put that in perspective, the S&P 500 index has averaged approximately 9.25% per year over the past 25 calendar years through 2011.
No one can accurately predict the future direction of taxes. That being said, I firmly believe that it is best to be proactive, consider all of your options and have a thoughtful plan in place. But, until our elected representatives in Washington DC are able to provide some real guidance, I am stuck in the middle with you.
