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June 9, 2014

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THE NEW YORK TIMES, FRIDAY, AUGUST 3, 2012What Some Investors, Are Doing to Anticipate a Tax IncreaseBy PAUL SULLIVANONE thing is certain this fall: there will be a lot of talk abouttaxes. But without a broad agreement, a series of automaticincreases will take effect next year. What are investors to do?While there are still three months until Election Day,recent action in Washington did little to suggest the spirit ofcompromise is in the air. The Senate has voted to raise taxeson the wealthy, while the House has voted to keep taxes lowfor everyone.I was curious to see how people affected byany increases in the tax on investment incomewere dealing with the uncertainty. That tax is setto go up by at least 3.8 percentage points – theamount of the surtax on high earners in PresidentObama’s health care legislation. But it could goup much more if lawmakers do not come to anagreement.I decided to call a few wealthy investors to askhow the prospect of the increase was affectingtheir investment decisions. More on them in abit.First, what are the increases? The 3.8 percentsurtax will be levied on investment income forindividuals who earn more than $200,000 ayear, or $250,000 for a couple. The Republicanpresidential candidate, Mitt Romney, has said hewill repeal the health care law on his first day inoffice. But his first day, if he wins, won’t be untilJan. 20, 2013, and even then, the most he coulddo would be to send legislation to Congress.So it is best to plan as if that tax will be levied.The more difficult taxes to estimate are on capital gains and dividends.The capital gains tax is 15 percent and is set to go to 20 percentnext year if the tax cuts from the George W. Bush administrationexpire. (Counting the 3.8 percent surtax, the capital gains taxwill be either 18.8 percent or 23.8 percent for high earners.)The dividend tax is also 15 percent, but could go as high asthe income tax rate. If the Bush tax cuts expire, the rate for thehighest earners would be 39.6 percent. But those people wouldalso be subject to the additional 3.8 percent surtax, bringingthe total dividend tax to as much as 43.4 percent. (Until 2003,dividends were taxed as income.)It is easy to see how the dividend tax could quickly wipeout the benefit of holding dividend-paying stocks. The capitalgains tax is trickier because it is paid only when someone sells a security that has appreciated. Still, the addition of the3.8 percent to the existing capital gains tax can be a big numberon any transaction that results in a large capital gain. MichaelE. Goodman, a certified public accountant and president ofWealthstream Advisors in New York, said he had a client whowas trying to sell an apartment in Manhattan for a price thatwould result in a taxable gain of $2 million. This year, she wouldpay $300,000 in capital gains taxes.But if she cannot sell the apartment until next year, she wouldpay at least an additional $76,000 because of the 3.8 percentsurtax. If the capital gains rate goes up to 20 percent as well, hertotal tax bill on the sale of the apartment would be $476,000, ornearly 60 percent more than today.So what should people do? I spoke to several members ofTIGER 21, an investment club that requires its members to havea minimum net worth of $10 million. TIGER 21 members havesubstantial wealth, and they spend time each month going overone another’s portfolios. They raised three points that could helpany affluent person.One strategy is to use the prospect of increased taxes toexamine all long-held investments and sell any with big gainsbefore the end of the year.That is what Leslie C. Quick III says he is doing. His wealth came from the sale of Quick & Reilly, the discount brokeragefirm that was started by his family and bought by Fleet FinancialServices in 1997. After subsequent mergers, his Fleet stock isnow Bank of America stock. That stock peaked at nearly $55 inlate 2006 but is now trading around $7 per share.”Our basis was zero, so even at $7 you still have a gain,” hesaid. “You keep hoping against hope that it’s going to recover,but it’s going to be a long slog.”Mr. Quick said he was focusing on cleaning up variousportfolios of securities that he had neglected over the years.”Some have done well, so I’m thinking before the end of theyear I should sell some of these positions before taking another3.8 percent hit,” he said.The TIGER 21 members also recommended that the wealthymodify their investments to reduce the impact of the increase.Randy R. Beeman, who made his fortune buying and sellingbusinesses and is now a financial adviser with Baird, a wealthmanagement firm, said he was looking to buy more municipalbonds. For the last couple of years, he has owned more taxablecorporate bonds because their yields were high enough to offsetthe tax-free benefits of municipal bonds. Now, he said, the taxincrease makes municipal bonds more attractive.He is making a bigger change with his real estate holdings.Mr. Beeman said his wife would start to actively manage theproperties they rent out. He says he believes that by doing this,the rents will no longer be categorized as passive income, whichis subject to the surtax.”If you have one town house generating a couple of thousanddollars a year, it’s probably not worth it,” he said. “If you have10 properties and each one is generating $15,000 in net income,then it is worthwhile. It’s a matter of size and if you have thetime and ability to do it.”For the most part, though, the TIGER 21 members said theirbigger concern was finding investments that actually rose invalue, regardless of what tax they might eventually pay.Reginald K. Brack, the former chairman and chief executiveof Time Inc., said he was now more focused on making long-term investments.”I sell these investments when there is a profit to be made,”he said. “Now, if the capital gains tax is changed dramatically, that might change things. But it was higher at one time. We’lllive through it.”Michael Sonnenfeldt, who became wealthy in real estate beforestarting TIGER 21, said a poll of the group’s 192 members afterthe second quarter found that, on average, they had increasedtheir allocation to private equity by four percentage points. Heinterpreted this as meaning members were more concernedabout getting a return on their money than about any tax theymight later pay.Personally, he said, the increased investment tax would affecthis thinking only on investments that had a low return or that hewas hesitant about in the first place.”If someone came to me and said, ‚ÄòI have a software programthat rivals Facebook and you can put $1 million into it today andwe’ll have one billion customers in eight years,’ the 3.8 percentdoesn’t matter,” Mr. Sonnenfeldt said. “But when you get downto investments where the risks are lower and the returns arelower, then the 3.8 percent will make more of a difference.”How any tax increases will cause investors to act is, in manyways, anyone’s guess. Taxes on capital gains and dividendshave been much higher in the past. The wild card is the weakeconomy.”There is some evidence that when you raise the capital gainsrate, people hold on to assets longer,” said Eric Toder, co-directorof the Tax Policy Center, a nonpartisan research group. “Fifteento 18.8 percent is not a big deal; 23.8 is somewhat bigger. But,in historical terms, it’s not a particularly big tax.”Mr. Goodman noted that people could lose out on high returnsif they fixate on taxes. Real estate investment trusts, for one, payout high dividends, but they are taxed at the income tax rate. Herecommends that people put high-tax assets into tax-deferredretirement accounts.In reality, most people are better at complaining about taxesthan calculating the actual impact on their lives. So theirreaction to the increases may not register until 2014, when thetaxes come due.”Some people are saying, ‚ÄòOh, it’s only 3.8 percent,’ ” Mr.Goodman said. “But if you have a large portfolio and youget that call next year from your accountant saying you owe$15,000, $20,000 more, I think it’s going to surprise people.”