Year-End Planning Tips - Post Election


With the outcome of the election now clear, many questions remain about the appropriate tax and investment strategy, for the remainder of 2012 and beyond.

Some tax, investment, and general financial “best-practice” tips to factor into your 2012 and 2013 decisions are as follows:

Tax & Estate Planning Considerations


  • Estate, GST, and Gift Exemption — The Estate, Generation-Skipping Tax (GST), & Gift Exemptions are currently set at $5,120,000; however, effective January 1, 2013 the Estate and Gift Exemption is reduced to $1,000,000, and the GST is currently estimated to be $1,400,000. Although the cuts may not be quite this dramatic, it’s likely that lower exclusion and higher transfer tax rates will come our way effective January 1, 2013.


  • “Harvesting” Capital Gains — Along with the looming threat of an increase in the long-term capital gains tax from the current 15%, investors in the higher tax brackets must plan for the 3.8 percent Medicare contribution tax on net investment income that starts in 2013. Given these factors, some investors may consider accelerating long-term gains into 2012 by selling appreciated positions before year end. Postponing capital losses into 2013 may also make sense in order to reduce investment income subject to the new Medicare tax.

  • Rethink Bond Amortization — The IRS allows taxpayers who purchase taxable bonds at a premium to amortize that premium over the life of the bond. This strategy has the effect of reducing the interest includible in income. It also requires that you reduce your basis in the bond. The net effect of this strategy is a reduction in current ordinary income offset by a future increase in capital gains, which can be an attractive tradeoff. The downside is that once taxpayers make the election to amortize, they must amortize each year unless receiving IRS approval to stop.

    While the recordkeeping involved with tracking amortization has deterred many taxpayers from making this election in the past, many investment firms now calculate bond amortization as part of their standard tax reporting package. This improved reporting combined with current high bond prices (and, therefore, increased premiums available to amortize) may make the election to amortize premiums more attractive than in the past.

  • Roth IRA Conversions — The potential for higher future tax rates may make converting a traditional IRA to a Roth IRA a tax strategy worth considering for 2012. Taxpayers converting an IRA to a Roth IRA in 2012 have until the date they file their 2012 tax returns (including extensions) to “recharacterize,” or undo, the conversion. This option to recharacterize well into the following year could provide taxpayers the ability to convert now and gain a better understanding of where tax rates will be in 2013 and beyond before deciding whether to keep the Roth conversion in effect.


  • Trust Taxation — Don’t forget that the trust and estate income tax rates are also anticipated to increase in 2013 if no compromise is reached. In addition, there will be the imposition of the additional 3.8% Medicare surtax that will be applied to certain trusts when income levels reach the highest marginal tax rate. Trusts reach the highest marginal tax bracket much quicker than individual rates! The trust tax rates generally apply to undistributed income taxed at the trust level. There’s still time to implement various planning opportunities to reduce the effect of these changes, depending upon the type of trust, the asset mix, and the balanced goals of the trust.

  • Charitable Giving — Consider how gifting to charity this year rather than next year might affect your total tax bill should rates go up. Then make an informed decision as to whether or not to contribute cash or appreciated securities in the appropriate year.

Investment Considerations


  • Slow U.S. Growth and Scheduled January Budget Cuts —The U.S. economy continues to muddle along, growing at a reported lackluster 2 percent rate in the third quarter. Without legislative action, federal spending is set to be cut effective January 1, while income and payroll taxes are scheduled to increase (the dreaded “fiscal cliff”).

    While there’s no way to accurately quantify the impact, economists have estimated that the drag on the economy in 2013 as a result of the fiscal cliff could be as high as 5 percent of GDP which, if accurate, would be enough to send the economy into recession. The good news is that policymakers on both sides of the aisle understand that risk and have the ability to take action to avoid that outcome. Policymakers are likely to strike a deal after the election to reduce the impact, but the timing and extent remains a significant question that looms large as the end of the year approaches. As we’ve seen in prior fiscal negotiations, polarization between the parties has made any “grand bargain” very difficult to achieve. The easiest near-term solution for both parties would seem to be to simply delay the implementation of spending cuts and tax hikes for some period of time. At this point, however, it’s far too soon to say what direction negotiations will take or the degree to which either party will be willing to compromise.


  • Municipal Bonds Become More Attractive — Assuming income tax rates increase, the relative tax benefit from investing in municipal bonds instead of their taxable counterparts will also increase, particularly for higher income taxpayers. A more competitive tax-adjusted yield may spark some additional appeal to yield-hungry fixed income investors.

  • Higher Taxes on Capital Gains and Dividends — Favorable capital gains tax treatment for dividends and historically low capital gains rates have been positives for stock investors in recent years. If the preferential rate for qualified dividends is not renewed, the after-tax yield for dividend-bearing stocks could be reduced. For yield-hungry investors, this would be a negative development, although it’s unclear that such a change in tax policy would have any meaningful impact on investor demand for dividend-bearing stocks in particular, or stocks in general.

Financial Best Practices


  • Think Long-term — Don’t get caught up in short-term rhetoric related to how the investment markets might perform given the election results. The election itself is only one of many factors that will impact the capital markets. There are plenty of issues to consider, but the resulting reaction by any market is difficult to predict in the short run. Stick with your long-term investment plan, and adjust only at the margins.


  • Consider Capital Gains — While paying taxes today may lower the effective rate you pay (if indeed tax rates do increase), it’s still an impairment of capital. If you otherwise wouldn’t be inclined to sell an asset for a long period of time (say, for example, an indexed mutual fund), it might be more beneficial to wait to incur a gain. Under current law, if an investment is held until death, the capital appreciation is not subject to income tax. That said, it might still make sense to diversify a highly concentrated position of stock at these lower tax rates.

Above all else, we encourage you to consult with your financial and tax advisors to determine how these issues may impact you. Whether or not you should act on these items before actual outcomes occur depends upon your own unique situation. The policy landscape is changing and is still characterized by great uncertainty. Understanding what could happen, and what steps may be appropriate to position yourself effectively in anticipation of changes on the horizon, is critical.

If you have any questions regarding this article, please contact your client relationship partner at BSB Partners.

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