Year-End Tax Tips - Moves to Make When Tax Rates May Be Going Up

Normally, when you engage in year-end tax planning, you might tend to sell stocks on which you have incurred losses to offset those where you have gains, in order to pay as little capital gains tax as possible. In general that still applies. But the capital gains tax rate is scheduled to go up in 2011 from 15 to 20% and further in the ensuing years. This is unless Congress steps in and changes the law to continue the low rate that has been in effect since 2003.

Given this, it may make sense to sell more of the high gaining stocks now, if you were planning on selling them over the next year anyway. Certainly, if any of the following reasons are true you may want to sell your gainers now instead of later:

1) You intended to take some money out of the stock market in the near future.

2) You don't like the future prospects of the stock.

3) You need to re-allocate your portfolio.

4) You have a large gain, you're neutral on the prospects of the stock, and you have enough losses on other stocks to offset the gains now.

However, you should not do this if you would not have otherwise have sold your stocks over the next several years. This is because you do have to pay tax on any net gains, and if you delayed paying the tax for a few years or more, you wouldn't have to pay any tax at all now. Delaying a capital gain for a number of years could make the net investment worth more by enough down the road to justify paying the higher capital gains rate then. In other words, even if the gain is taxed at a higher rate then, the compounded gain on the stock and 20% of the earnings (what would have been taxed away) will likely earn more than the difference in the capital gains tax rate.

The "higher capital gains rate next year" concept also creates the reverse logic on the stocks where you've had losses. Normally you might want to sell them to offset gains and accrue additional tax benefits. But now the losses may be worth more next year if you have gains to offset then. Some of your actions may be guided by your expectations of next year's stock market performance. But a good strategy might be to only use the amount of stock losses this year that leaves you with enough expected losses next year to cover your expected gains next year.

And so the overall point would be to shift inevitable realized overall gains to this year, and losses to next year.

Of course, none of this advice trumps standard investment considerations. You should buy stocks you believe will go up and sell those you think will go down. But for those subject to the above conditions, these rules may leave more money in your pocket.