The Senate tax reform proposal includes a provision that would require the cost basis of any security sold, exchanged, or otherwise disposed of on or after January 1, 2018, be determined on a first-in first-out (FIFO) basis. This would take away taxpayers' ability to identify specific shares when selling an investment. For tax planning purposes, it often makes sense to identify which shares you are selling, particularly when you are dealing with shares that have a wide range of cost basis figures.
Many observers have questioned whether opening separate brokerage accounts to hold different share lots might avoid the application of these rules. While this aspect of the rule is very much up in the air, our belief right now is that they would likely require you to aggregate your shares across all accounts. The logistics of implementing this rule could be a nightmare for brokerage firms so it remains to be seen what form it will ultimately take. It is important to note that this provision is not in the House version of the tax reform bill, so we still need to see if it survives the committee reconciliation process.
Many of our clients have concentrated stock holdings, often from employer stock purchased over a career. This provision would prevent investors from minimizing their taxes by choosing the specific shares that are being sold, since it requires them to sell their oldest shares first. It would also affect taxpayers’ ability to maximize the tax deduction for charitable donations of appreciated securities.
From an investment standpoint, we generally encourage clients to reduce concentrated stock positions. This lowers the risk of having too much of your net worth tied to a single company, which could have a substantial negative impact on your overall financial situation if the stock loses significant value. There are many cases of very successful companies that ran into trouble and suddenly lost much or all of their value (think Enron, Bear Stearns, etc.). We believe a more prudent approach is to gradually reduce this exposure while managing the tax liability as much as possible. It has always been important not to “let the tax tail wag the dog,” although we understand the concern about paying capital gains taxes to accomplish this. We also encourage our clients to envision a "worst case scenario" and how their financial situation would be impacted if that company were to go through a difficult time. This can help bridge the gap between the emotional ties to a company and the need to reduce your risk to meet your financial goals.
So what can you do if these new rules do become law, and when do you need to take action? Here are a couple of initial thoughts:
- Sell your high basis shares now to diversify closer to your target allocation for the stock holding. Under the proposal, you can still allocate on a LIFO (last-in, first-out) basis until December 31.
- Make charitable gifts of low basis stock directly to charities or to a Donor Advised Fund before year end. You can use this to offset capital gains on sales this year.
- Gift high basis shares to a non-grantor trust for the benefit of your heirs. This would be a taxable gift so you need to consider how much of your lifetime exemption has been used, but it shifts the holding to a new account which would be treated as a separate taxpayer.
- Move some of the stock to a Family Limited Partnership or other entity that can be a vehicle for accumulating wealth for your heirs. This is a more complex planning strategy and there are many aspects that should be considered.
- Shift high basis shares that you may want to sell in the near term to your spouse. From our interpretation of the current version of the bill, we think you would be able to then isolate these shares in future sales but you might needs to file your tax returns as ‘Married Filing Separate’ in order to support that it should be separate from the other shares.
We are continuing to watch the development of this law, as well as the rest of the tax reform proposals, and we will continue to provide updates throughout the reconciliation process. This provision is a great example of why tax planning needs to be part of your overall financial planning. The impact of this ties together your investment strategy, income tax planning, estate planning goals, and your overall financial plan.
Let us know if we can help you think through the impact of this or other aspects of tax reform.
-Lyle K Benson, Jr, CPA, PFS, CFP
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.
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