Despite iffiness of tax reform, year-end stock strategy still applies
If your only income comes from wages or salaries, there's not much you can do about deciding when to take that money. But investors often do have a choice. After the merits of the investment itself, the most common reason behind that decision is taxes. Taking investment income this year or next will not usually eliminate taxes. But a delay may reduce them somewhat, either because something was held long enough to qualify for long-term capital-gains treatment or because the investor was in a lower bracket.
With the added uncertainties of tax reform, however, the decisions become more complex. First, an investor has to decide whether tax reform is going to pass at all and if so, whether it will make it this year.
``It seems very clear now that there's not going to be a bill in '85,'' says Donald Flannery, a tax partner in the Washington office of Peat, Marwick, Mitchell & Co., an accounting firm. While the House Ways and Means Committee may complete its work before Thanksgiving, that doesn't leave enough time this year for full House consideration, Senate committee work, Senate passage, joint congressional action, and a presidential decision, he believes.
Assuming a tax bill won't pass or take effect until next year, then, how much consideration should investors give this year to what might happen? Not too much, most tax advisers say. The usual recommendations about holding out for long-term capital gains, taking short-term losses quickly, and deferring income until the following year still apply for the most part, they say.
Normally, for example, it makes more sense to hold an investment at least six months to qualify for long-term capital-gains treatment. The taxes on long-term gains are 20 percent for individuals and 28 percent for corporations, compared with a tax on short-term gains of 50 and 46 percent, respectively.
Some investors, however, may want to ``hedge their bets as to whether they are taxed now or in '86,'' says Thomas Ochsenschlager, a tax partner in the Washington office of Alexander Grant & Co., another accounting firm.
One way to do this, he said, would be to elect an installment sale. If you're thinking about selling a large amount of property or other investments, an installment sale can spread the gain out through 1986 and later years. If a final tax-reform package makes it more advantageous to sell this year, the investor can elect to have the gain taxed at 1985 rates instead.
If you want to dispose of a stock this year but defer the gains until next year, there are a couple of ways to do it. One is a technique called ``short sale against the box.'' Here, instead of selling stock from your portfolio, you borrow the same amount, which is delivered to the buyer. You then close the sale by making actual delivery of your stock next year.
Another way to postpone gains is to buy put options. If there is any decline in the price of the stock, it will probably be offset by an increase in the price of the put option. Both of these idea are useful if you want to postpone gains until next year but believe the stock's price may drop before then. But puts can't be used to change short-term gains into long-term gains.
One of the big question marks in tax reform is what Congress might do about the alternative minimum tax (AMT), that complicated formula that is meant to keep people from avoiding all taxes through various deductions and low-tax treatment of their income. The AMT that became effective in 1983 applies only if it is larger than the income tax calculated in the usual way. Right now, it is 20 percent of alternative minimum taxable income over $40,000 for married couples and $30,000 for singles.
Under one tax-reform proposal, Mr. Ochsenschlager says, the AMT would be raised to 25 percent. This would mean an investor using a variety of tax shelter deductions, long-term gains, and exercised incentive stock options to reduce taxes could trigger the AMT more quickly, making the tax-saving parts of those investments less useful.
An investor who thinks there is any chance he or she may be close to either the 20 or 25 percent AMT limit should consult a tax or financial adviser. You might want to sell something before year-end or find a way to unload it now but take the profit later.
Not all investments, of course, make a profit. Sometimes we have to swallow a loss and move on. If taxes are part of deciding when to take your lumps, remember that short-term losses can help offset any short-term gains you may have taken this year. So you may want to take those losses up to the $3,000 limit before they become long-term.
If you have long-term losses, try to take them in a year when they can be used against any short-term gains that would otherwise be taxed as ordinary income.
Finally, watch the calendar. If you are selling a stock at a profit, it generally takes five business days to record the sale. So any transactions made after Dec. 24 this year won't be recorded until 1986. Losses, on the other hand, can take place as late as Dec. 31 and be reported this year.
Many of the accounting firms mentioned in this and last week's columns on year-end tax planning have produced booklets that give more details and additional tips. Two of them are available to the general public. For Arthur Young & Co.'s ``1985 Year-End Tax Planning for Individuals,'' send a check for $2.50 to Eileen Ivers, Arthur Young & Co., 277 Park Avenue, New York, N.Y. 10172. For Coopers & Lybrand's ``Strategies: Year-End Tax Planning,'' send $1 to Kay Gentile, Coopers & Lybrand, 1800 M Street, NW,
Washington, D.C. 20036.
If you have a question that would make a good subject for this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. No personal replies can be given. References to investments are not an endorsement or recommendation by this newspaper.