Strategies for a Rising Tax Environment

Now that “Tax Day” 2012 has come and gone, it is important to understand and prepare for the possible tax rate increases that are on the table for 2013 and beyond.

At the end of this year (2012), the decade-old Bush tax cuts are set to expire and if legislation is not passed to address these issues by year end, have a look below at the tax rate increases that will take affect at midnight on December 31, 2012.


Income Tax 25%

Top Rate Rises from 35% to 43.4%

Capital Gains Tax 60%

Top Rate Rises from 15% to 23.8%

Dividend Tax 300%

Top Rate Rises from 15% to 43.4%

Estate Tax 55%

Estate Tax Rates Rise from 35% to 55%

(Exemptions Decrease from $5 million to $1 million)

Source: taxfoundation.org  Figures include new 2013 3.8% tax on investment income for families making over $250,000 per year under the health care reform law.


If the Bush tax cuts are not extended, taxes on earned income, dividends and capital gains will return to pre-2003 levels. This means that individual investors will likely be paying much higher taxes.  Another big risk of these looming tax hikes is the direct impact it would have on the current anemic economic recovery by reducing US GDP (Gross Domestic product).  According to the National Bureau of Economic Research, the possible tax increases could pull more than 2% to 3% from US GDP as Investment falls sharply in response to exogenous tax increases.

There is no doubt that politicians in Washington are gearing up for a battle as Obama and Democratic lawmakers look to be preparing for a campaign against the extension of the Bush tax cuts, or a major modification.  If the past year is any indication of what we can expect, this debate promises to be filled with plenty of political rhetoric and will of course be divided along party lines.  What all of this means for you and I is that there is a lot of uncertainty as to what the outcome will be and if you are like my clients and myself, we are very concerned.  By the way, I haven’t even gotten into how this expected political gridlock will most likely cause adverse market volatility in both the equity and fixed income financial markets.

As a wealth strategist, my clients look to me for guidance and I am now reviewing client strategies so that they can be better prepared for the impact of these potential changes.  I am doing this by advising them on tax efficient and tactical investment allocation strategies with the goal of preserving and continuing to grow their wealth.

For your perusal, below area 7 tax efficient investment strategies that we are now discussing and if appropriate, are implementing with some clients.  Of course, every individual’s circumstance is different and therefore not all of the below may be appropriate for them or you.  If you have questions or would like to discuss how we can possibly help you, contact me directly.

  1. Consider selling appreciated assets to take advantage of existing capital gains tax rates.
    Investors who are considering selling a business, dissolving a concentrated stock position, or who otherwise have significant unrealized long-term gains, should consider selling assets while the top capital gains tax rate remains at 15%. A recent study determined that, if asset values grow by 4% per year and the capital gains rate increases as scheduled from 15% to 23.8%, an investor will have to hold assets for an additional fifteen years to be better off than he would be had he sold the assets initially and paid tax at the lower rate.1 The lower capital gains rate is likely to remain in effect throughout 2012. However, as the year goes on, a market sell-off could occur as investors become aware of an impending tax increase. Thus, it might make sense to undertake sales sooner rather than later.By selling this year, investors can lock in gains and redeploy the assets to investments that may offer stable growth and perhaps downside protection. Other investors who wish to keep their investments can sell a security, recognize the gain and immediately repurchase that security to reestablish the position. The “wash sale” rule, which requires investors to wait thirty days before repurchase, applies only to recognition of losses, not gains.
  2. If possible, receive ordinary income in 2012 rather than in a later year when tax rates may be higher. 
    With ordinary income rates expected to rise, investors might act to receive additional taxable income in 2012 rather than in later years. For instance, executives could consider exercising non- qualified stock options this year so that the resulting income is taxed at prevailing rates.
  3. Defer discretionary deductible payments (such as charitable contributions) to later years when they may be worth more due to higher tax rates.
    The tax benefit of a deductible expenditure increases as tax rates increase. With a tax increase expected, it may be worthwhile to defer deductible payments until the higher rate takes effect. For instance, at the current top federal tax rate, a charitable contribution of $100 yields a benefit of $35. If the federal rate rises to 40%, making that contribution next year would save $40 in taxes.
  4. Keep more of what you earn. Give increased consideration to tax exempt municipal bond investments. 
    Interest from Municipal bond investments is tax exempt from Federal income taxes, and if you purchase Municipal bonds issued by the state where you reside, the interest may also be exempt from state income taxes.2  If income tax rates increase as expected, demand for municipal bonds will increase as more people wish to reduce their tax liability.  Similarly, as tax rates rise, the effective interest rate on municipal bonds increases. For instance, a municipal bond paying 3% interest pays a tax-equivalent yield of 4.6% in a 35% tax rate environment. But if the tax rate rises to 43.8%, the tax-equivalent yield on the same bond rises to 5.3%. In short, all other things being equal, rising tax rates can signal possible rising municipal bond values.
  5. Consider tax-efficient investments that pay attention to harvesting losses, such as mutual funds and other professionally managed tax-advantaged investment strategies.
    A rise in tax rates can meaningfully reduce the net returns provided by tax-inefficient investments. Thus, a professional management strategy that seeks to enhance after-tax returns by balancing investment and tax considerations becomes increasingly important in a rising tax environment. Tax management techniques include purchasing stocks with a long-term perspective to delay recognition of taxable gain, reducing turnover to minimize short-term gain, investing in stocks that pay qualifying dividends, harvesting tax losses and selectively using tax-advantaged hedging techniques as an alternative to taxable sales.
  6. Consider investing in annuities and life insurance that offer tax deferral on earnings.
    Life insurance provides tax deferral on increases in cash value during life and a tax-efficient way to pass wealth to future generations. If the policy is held until death, the death benefit is not subject to income tax. If the purchase is properly structured, the death benefit may also be free from estate tax.  For tax deferral, many investors turn to variable annuities.  Earnings accumulate tax deferred, however, when withdrawn; earnings are taxed at ordinary rates and if taken prior to age 59 1/2, may incur a tax penalty. In a rising tax environment, the tax deferral feature of annuities becomes increasingly valuable.
  7. Convert a traditional IRA to a Roth IRA.
    All individuals are now eligible to convert their traditional IRA to a Roth IRA, which permits future investment earnings to be received tax-free. In an era of rising tax rates, converting to a Roth IRA may provide significant value. Investors who expect to be in the same or a higher tax bracket in future retirement years should consider this option this year seriously.If assets are held in a Roth IRA for at least five years and the account holder is at least age 59 1/2 (or has died or become disabled), then all Roth withdrawals–including withdrawal of earnings–are received entirely tax free.3 Moreover, while assets held in a traditional IRA must begin to be distributed when the holder turns age 701/2, no such distribution rules during life apply to a Roth IRA. Rather, a Roth IRA holder may choose to maintain assets in the Roth, where they can continue to accumulate tax-free.


1. Pay Now or Later? Making Investment Decisions in a Changing Tax Environment, Parametric Portfolio Associates, LLC (Spring 2008), updated December 22, 2011.

2  Municipal Bond interest may be subject to Alternative Minimum Tax (AMT).

3. When an owner of an annuity contract dies prior to surrendering the contract or choosing to begin lifetime payments, a death benefit– typically the greater of the contract’s cash value and the initial investment–is paid to his designated beneficiaries. Unlike death benefits paid by life insurance, annuity death benefits are subject to income tax, although a beneficiary can choose to defer that tax by “stretching” the payment of the annuity death benefit over his life.

4. If the five-year tax holding period is not met, then withdrawals of earnings from the Roth IRA are subject to tax. However, in that case withdrawals are treated as coming first from non-taxable contributions and previously taxed amounts; only after those amounts are withdrawn is tax imposed. If the holder is not over age 591/2 (and does not meet one of the other exceptions), then withdrawals of earnings, and of amounts converted from a traditional IRA within the prior five years, also are subject to a 10% penalty tax.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>