Starting in 2018, the taxes millions of Americans pay on selling shares of stock could go up significantly, thanks to a provision in the Senate tax reform bill. No one knows if this provision will be in the final bill agreed to by the House and Senate, let alone become law, but it’s best to be aware of what this will mean for you. If the provision is included in the final bill (something we should know soon), you are then ready to decide whether it makes sense to take action in 2017.
Currently, for tax year 2017, investors can specify which group of shares they want to sell, in order to minimize their overall tax bill. The Senate proposal would end that choice. It would require that you sell the shares you’ve held the longest first, in what is known as “First-In, First-Out” or FIFO. Because the longest-held shares have usually gained the most in value, the result is higher capital gains taxes. Here’s an example:
Say you bought 1,000 shares of Amazing Corp. at $10 a share in 2000, and another 1,000 shares at $100 in 2005. Amazing’s shares have since doubled to $200 and you want to sell half to fund a purchase. Under current law, you could choose to sell the more expensive, second batch of shares for a capital gain of $100,000. Under the Senate provision, you’d have to report the first block bought as sold, almost doubling the gain reported ($190,000).
If the FIFO-only provision becomes law, it’s estimated that investors would end up paying $2.7 billion more in taxes during the next 10 years.
Strategies for 2017
It is never a good idea to make major financial decisions based on speculation about what Congress might do. However, if you were planning to do certain things soon anyway, it might make sense to review your situation and take action sooner, rather than later.
- Were you planning to raise a significant amount of cash in 2018?
- Where you planning to donate stock to charity in 2018 and are open to pushing that donation into 2017?
In these or similar circumstances it could make sense to trade in 2017 in order to minimize the tax consequences from raising cash or donating stock from 2018 onwards:
- To raise cash, sell the shares with the lowest gains during 2017.
- Donate appreciated stock to charity in 2017, using shares with the highest capital gains.
- Invest new money in securities that you do not currently own, but which still meet your criteria (industry, region, etc.). This establishes a separate investment instead of two tax lots of the same security (that would be subject to FIFO treatment).
- Rebalance portfolio allocations by selling tax lots with the lowest capital gains.
Be sure to consult with your accountant when taking any action for tax purposes. The final tax proposal is forthcoming, and you do not want to act prematurely. At LNWM, we have been keeping a close eye on tax legislation as it winds its way through Congress and will be writing extensively on the new tax law (if it passes) in the January 2018 issue of Navigator, LNWM’s quarterly e-newsletter.