The old adage "don't let the tax tail wag the investment dog," may be a little out of context over the next two months. Scheduled to expire, the Bush tax cuts lowered taxes for almost all Americans. If they are not extended, everyone will see a tax increase next year. There is, however, light at the end of the tunnel, but investors must be watchful.
The Obama administration is considering extending the Bush tax cuts permanently for those who earn less than $250,000. They may even consider extending the cuts for those above that income threshold. Vice President Joe Biden has said, "We're open to speak to the Republicans, if they really mean it, if they're talking about deficit reduction, if they're willing to move."
So where does that leave investors?
In short, if the tax cuts do not get extended for you, you may want to consider how that change will affect several common investing situations.
First, for investors considering selling a security, a business, or even a piece of investment real estate, the current long-term capital gains rate is 15 percent for investments held over twelve months. If the tax cuts expire, that rate goes to 20 percent. That means if you are lucky enough to have an investment with a $100,000 gain, your tax would go from $15,000 to $20,000.
Second, for those considering converting a traditional IRA or retirement account to a Roth IRA, the tax implications of this decision could be significant. Remember, all tax brackets are scheduled to increase to a higher tax liability. Many people have considered the Roth conversion principally because when converting in 2010, the investor can spread the tax liability over 2011 and 2012. However, if the Bush tax cuts are not extended, tax rates in those two years will be higher and paying the tax in 2010 would be more beneficial.
Finally, tax planning in a higher tax environment has greater significance. This holds true for those exercising stock options or cashing in restricted stock. It is also important to consider when deciding to take money out of a qualified retirement plan as a distribution versus taking income from non-qualified (taxable) assets. The implications also extend to when (and how) to take deferred compensation plan income, as this can trigger a high income tax.
Consider the facts. The upcoming election could go either way, as could the extension of the tax cuts. It is certainly time to be more proactive about your tax planning.
Kelly Campbell, Certified Financial Planner and Accredited Investment Fiduciary, is founder of Campbell Wealth Management, A Registered Investment Advisor in Fairfax, Va. Campbell is also the author of "Fire Your Broker," a controversial look at the broker industry written as an empathetic response to the trials and tribulations that many investors have faced as the stock market cratered and their advisors abandoned their responsibilities to help them weather the storm.