Advisers to clients: Prepare for likely tax increases

They're divided on whether to act now or wait for the dust to settle

Nov 16, 2008 @ 12:01 am

By Lisa Shidler

Advisers are working to protect their clients against the likely tax increases President-elect Barack Obama and a Democratic-controlled Congress could bring as early as Jan. 1.

Advisers are anticipating that the Obama administration will kill the Bush tax cuts for households with $250,000 and said they are also bracing for capital gains rate hikes.

As a result, they are torn on how to approach the possible changes. Some say it's better to be proactive and are working with clients now to sell appreciated stocks to reduce the capital gains tax bite.

Others are taking a more wait-and-see approach.

Time is of the essence, said Mike Martin, founder of an eponymous financial planning firm in Independence, Mo., that manages about $75 million in assets.

Mr. Obama has already said he plans to increase the capital gains rate to 20% for households earning $250,000 in income. Advisers said clients are worried that the rate could go even higher, to 28%. The current rate is 15%.

The rate on long-term capital gains is the percentage levied on the profitable sale of stocks, bonds and mutual funds held more than one year.

"We think now's the time to voluntarily take some gains while you know the rate is no higher than 15%, rather than gambling that it won't happen in 2009," Mr. Martin said. "They might retroactively raise the capital gains rate. It's been done before."

He's also anticipating that Mr. Obama and the Democratic-controlled Congress will push to get the rates increased as of the first of the year.

"I don't want it to catch us unaware, and the better thing is to do it now," Mr. Martin said.

Still others say it's better to wait because it's possible that Mr. Obama will focus on other projects and the rate hike could come later.

Earl McMahan, an adviser with Secaucus, N.J.-based United Advisors LLC, said he believes that the Obama administration might wait before increasing capital gains rates, simply because of the vulnerable economy. He's based in the Novi, Mich., office, which manages about $110 million in assets.

"I don't think they will raise the capital gains rate now with the tender market," he said. "And I'd be really surprised to see it go above 20%."

Even though Philip J. Tortorich, an attorney and partner in the trusts and estates department at Katten Muchin Rosenman LLP of Chicago, would prefer that his clients waited, he said they're anxious about the new administration and want to make changes now.

"My clients believe there will be a substantial increase in capital gains," Mr. Tortorich said. "Despite what I think and what I tell them, they want to incur capital gains taxes now."

He has told them that even if there's an increase, waiting usually is the better approach. "If we can defer capital gain pickup, that's historically been the best advice," Mr. Tortorich said. "However, that's not swaying the client."

He's been working closely with clients who hold stocks in grantor trusts to sell the stocks or mutual funds to trigger the capital gains tax, but to sell it to a non-grantor trust. Even if the beneficiaries are the same, the original grantor pays the tax, and this ultimately reduces the person's estate. It's also not taxed as a gift.

In addition to capital gains tax planning, advisers, accountants and attorneys are working with their clients to try to anticipate steeper income tax rates.

Mr. Obama has said he'll kill the Bush tax cuts on families earning more than $250,000 annually, which would mean tax rates would go up to 39.6%.

Mr. Tortorich said he's suggesting that clients, if they can, increase their earnings this year by signing contracts or deals this year rather than waiting for them to go into effect in 2009.

"I don't want to use the word paranoid, because it's too strong, but there is a level of that going on," he said. "You try to dissuade your clients, but there's only so much you can do."

Selling appreciated assets in the portfolio right now is something that David Weiss, a certified public account and certified financial planner with Ruggie Wealth Management LLC in Tavares, Fla., is advising his clients to do while the capital gains rate is currently 15%. His firm manages about $220 million in assets.

"What we're telling clients is, let's sell some assets you may have had in the portfolio for a long time," he said. "You can always buy it back."

Regardless of President-elect Obama's plans, many advisers are also preparing their clients for a 2010 conversion to a Roth individual retirement account.

Right now, anyone with a modified gross income of $100,000 or more can't convert to a Roth. But in 2010, there will be a one-year opportunity to avoid the income cap, and advisers are encouraging their clients to prepare to convert.

Mr. Weiss said he's encouraging all of his clients to start IRAs now so that they can convert them in 2010. "We're telling them to fund an IRA now even if it's non-deductible so we can convert it in 2010," he said. "The income caps will be gone in 2010."

In fact, Mary McGrath, a CPA and CFP with Cozad Asset Management Inc. in Champaign, Ill., is working with clients to move money from 401(k) plans to an IRA in preparation for 2010. Most employees can pull money out of their 401(k) once they turn 60, even if they're still working. She's encouraging those individuals to do so to create an IRA.

Ms. McGrath is also pointing out to investors who currently have IRAs and earn less than $100,000 annually that now is a good time to make a conversion.

"With IRAs looking so pathetic, what's a better time to move the money over and make it non-taxable," she said. "If you believe this is a good time to buy into the market, it's also a good time to do an IRA conversion." Ms. McGrath's firm manages about $1 billion in assets.

Encouraging clients to look closely at all the ways they can reduce taxes, including putting more money in retirement, is important, said Gary Hager, founder and president of Edison, N.J.-based Integrated Wealth Management, whose firm manages about $500 million in assets.

"The clients we deal with are concerned about what's going to happen to them in regards to dealing with an Obama administration," he said. "What I've always [told] them is, [whether we're governed by] a Republican or a Democrat, make use of every credit and savings that's possible."

E-mail Lisa Shidler at


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