Helping clients navigate a minefield

Nov 4, 2012 @ 12:01 am

By Liz Skinner

The uncertainty over where tax rates will end up for wealthy Americans next year has many advisers and tax strategists recommending that clients take protective measures and other moves that could be reversed next year if looming tax increases are evaded.

Washington experts predict that it's likely to come down to the final days of the year before the nation knows whether Congress is going to extend the Bush-era cuts on income tax rates, capital gains and dividends, and continue other tax breaks that are set to expire at the end of the year.

The Tax Policy Center estimates that 90% of U.S. households would see taxes increase next year if all the elements of tax relief were allowed to run out and the new health care taxes were implemented.

In this worst-case scenario, the average family would see a $3,500 increase, while the wealthiest 20% would see an average $14,173 boost in taxes. The top 1% of earners would pay an extra $120,537.

In order to prevent this, Republicans and Democrats in Congress, as well as President Barack Obama, must agree on new rates. Given that Congress hasn't even been able to agree on increasing the thresholds for the alternative minimum tax — a concept with bipartisan support — some worry that a deal isn't in the cards.

“It's troubling that we're not seeing progress on things that fall into the less controversial policies,” said Suzanne Shier, director of wealth planning and tax strategy at Northern Trust Corp. “Even the nuts and bolts of tax policy aren't making it through the process.”


Without an agreement, income tax rates would increase, the phasing-out of personal exemptions would begin, the child tax credit would be cut in half, taxes on capital gains would rise to 20%, from 15%, and dividends again would be taxed as ordinary income. Many short-term tax provisions such as a deduction for qualified college expenses also would disappear.

“Since we don't know what will happen, it's best to be proactive,” said financial adviser Rick Rodgers, principal at Rodgers & Associates Ltd.

Mr. Rodgers, as well as many other advisers, recommends that clients harvest capital gains this year at today's 15% rate, because even if the rate doesn't reset to the scheduled 20%, capital gains rates for upper-income taxpayers will go up to 18.8% for 2013 because of the 3.8% health care tax that appears set to take effect no matter who wins the November elections.

Mr. Rodgers also recommends that some clients consider converting individual retirement accounts to Roth IRAs, a step that must be taken by Dec. 31 but can be undone as late as Oct. 15, 2013.

For anyone turning 701/2 and who will be required to take a minimum distribution from their IRA, regardless of whether they need the income or not, a Roth conversion may be an effective way to avoid some or all of that mandatory distribution by reducing the value of the original IRA and the size of the required distribution.

Mr. Rodgers also said people who itemize should try to accelerate medical expenses this year because the amount that someone must pay before medical expenses can be deducted will rise next year to 10% of adjusted gross income, from 7.5%.†

A potential increase in capital gains taxes makes it worthwhile to consider selling concentrated stock positions, businesses, real estate or other taxable assets, said Andrew Friedman, a principal at The Washington Update LLC, which provides political and legislative analysis for investors and advisers.

Art Graper, a financial planner and managing director of Atlantic Trust Private Wealth Management, a unit of Invesco Ltd., recommends buying municipal bonds, using Roth IRAs and seeking rental real estate that typically generates passive losses because of depreciation deductions.

He also recommends structuring businesses as S corporations, which don't have to pay self-employment taxes (which also rise next year under the health care bill), and considering oil and gas investments that have “very favorable” tax preferences.

“The tax planning of old is going to be turned on its head this year,” Mr. Graper said. “For the remainder of this year, throw out the window all the usual advice and do the opposite.”


Under the best-case tax scenario, Congress would extend the Bush-era tax cuts, agree to an AMT patch, reinstate full deductions and continue the payroll tax break for another year.

“If I had to make a prediction today, it's that there will be some extension on a temporary basis for about six months to a year so there will be time to work things out in a firm and thoughtful manner,” said financial adviser Bill Losey, who runs an eponymous retirement planning firm.

In this case, everything would remain pretty much the same.

However, that doesn't mean there's nothing for clients to act on, according to advisers.


Lance Drucker, president of Drucker Financial Group, said the best advisers make investment decisions based not merely on tax code but on economic and business viability contentions.

“Potential for growth and preservation of principal will always trump tax benefits,” Mr. Drucker said. “We make plans based on what things are right now, but we make those plans using a pencil.”

Most advisers expect Congress to hammer out an agreement that limits the increase in the dividend tax rate so it will come out somewhere around the capital gains rate, which is scheduled to go to 20%. That's still an advantageous rate for wealthy Americans, compared with owing a tax on dividends equal to their regular income tax rates.

Many also believe there will be a compromise on extending Bush tax cuts on earned income for lower- and middle-class families. Mr. Obama originally said he'd support continuing the cuts for those couples earning $250,000 or less and individuals earning $200,000 or less, though the administration has talked more recently about a $1 million cutoff.

“I think we will have some sort of relief, but it won't be for all taxpayers,” Ms. Shier said. “High-income taxpayers continue to be at risk.”†

Advisers find clients don't seem too worried about the fiscal cliff, some doubting that Congress will let it happen and others thinking the nation faces even scarier economic worries from the European debt crisis, as well as the unrest in the Middle East.

Clients are willing to take limited steps to ward off potential harm from these increases.

“They're willing to take action as long as it's not a big thing,” Mr. Rodgers said. “There's lots of resistance to big change.” Twitter: @skinnerliz


What do you think?

View comments

Recommended for you

Upcoming Event

May 02


Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in four cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video


The power of data

Your clients have financial news and data at their fingertips, but donít know how to interpret it. Katy Gibson of Envestnet|Yodlee and Blake Kannady of Envestnet discuss the power of leveraging aggregated data.

Recommended Video

Path to growth

Latest news & opinion

Tax reform: 7 essential strategies for financial advisers

While advisers face the difficult task of analyzing the law's impact, they will also have a significant opportunity to prove their value by implementing money-saving strategies for clients as well as their own businesses.

Bill requiring fiduciary disclosure reintroduced in New Jersey

Measures would obligate financial advisers to tell clients they do not have to act in their best interests.

Merrill Lynch to let advisers text with clients

Texting has been a popular mode of communication for years, but in the past the firm's regulations have prevented advisers from using it.

Bear market for bonds has arrived, Gross says

10-year Treasury rate's move above 2.5% confirms outlook for fixed income, legendary bond manager says.

Mary Beth Franklin's advice for optimizing Social Security claiming strategies

InvestmentNews' retirement guru Mary Beth Franklin offers strategies you can put into place that may significantly increase your clients' Social Security draw.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print