Upside-Down Tax Planning

Upside-Down Tax Planning

Remember “Backwards Day?”

That was that day back in high-school where if someone asked how you were, you said “bad” if you meant good, you said, “lousy” if you meant really good. People tried to walk backwards down the halls, and put as many of their clothes on backwards as they could. Up was down, low was high, and so on.

Well it’s backwards day in tax-planning, now.

Year-end tax planning usually consists of taking as many losses as possible this year, and deferring gains to the future. Sure, you have to take some gains—to rebalance a portfolio, or raise cash, or trim an over-weighted position. But putting off gains and realizing losses is typically good tax planning. But not this year.

Capital gains rates scheduled to rise from 15% to 20% by 2013, along with the Afforable Care Act’s 3.8% Medicare surtax. Tax rates are moving higher. Yes, it’s possible that Congress will once again defer the increase, but this seems increasingly unlikely. And the surtax is almost certain to go into effect in January of next year.

So when tax rates are rising, traditional tax planning gets inverted. Gains are realized, and losses should be deferred. Losses represent tax-savings—so their value goes up when tax rates rise. A $10,000 loss could save $1,500 this year, but potentially $2,380 next year. Also, converting a traditional IRA to a Roth IRA may make a lot of sense—realizing the income from the conversion at a lower rate.

Personally, I found “Backward Day” annoying. It was uncomfortable and awkward, but it was one of those things the cool kids declared to show how they were really in charge. You had to go along or seem out of it. And I wondered who decided these things. But there’s no question as to who put “Tax Backwards Day” in place this time: Congress.

Douglas R. Tengdin, CFA
Chief Investment Officer

Follow me on Twitter @tengdin

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