Lawmakers avoided making some key tax decisions before they left Washington to hit the campaign trail. There will be time in the lame duck session after the election, but if they take no action, the Bush tax cuts enacted in 2001 and 2003 will expire at the end of this year. The news has been filled with all sorts of speculation as to what might happen; no action, a partial roll back, or a one- or two-year extension of the tax cuts. Bottom line: even if Congress takes no action, you may still want to take some action of your own to ensure your investment portfolio is prepped for tax season.
The tax cut extension debate has no effect on this year’s tax rates, so you can still consider some strategic portfolio sales. Going into end-of-the-year is a good time to review your portfolio and do some tax planning. If you have capital losses, they can be used to offset capital gains. The losses are worth even more if you are using them to offset short-term gains. Short-term gains are taxed as regular income, as high as 35% this year, as opposed to 15% for long-term gains. If you book more capital losses than you have gains, up to $3,000 can be used to reduce ordinary income. Capital losses that are not used in the current year can be carried forward to later years until absorbed.
If lawmakers do nothing and the Bush tax cuts expire, long-term capital gains will be taxed at 20% in 2011 versus the present 15%, which is a 33% increase. Top ordinary income rates will go from 35% to 39.5%. Capital losses will be even more valuable from a tax standpoint if this happens, so it may be helpful to see if harvesting your losses next year would be more profitable from a tax perspective.
My suggestion is to focus less on the political debate and more on individual strategies you can take regarding your own financial portfolio. What questions do you have about investing that we should consider for future installments?