No one knows whether 2013 will indeed bring a reversion to 2001 tax rates, or whether there will be a new law, perhaps agreed to late this year in a lame-duck session of Congress. In any event no one I know expects rates to drop, and most tax practitioners expect them to go up. Why is that?
First, over the past 100 years maximum capital gains rates (pdf) have averaged 28% with a range as low as 12.5% (1933) and as high as 77% (1918). Second, each citizen's share of the U.S. National Debt is $50,000.00.
Assuming the Bush tax cuts expire on December 31, 2012, a reversion to 2001 tax rates will increase the maximum tax rate to 21.2% on long-term capital gains and 40.8% on short-term capital gains. The extra 1.2% is due to the return of the 3% disallowance of itemized deductions for income earned above a threshold.
In addition, beginning in 2013, the Obama Health Care bill imposes a 3.8% tax on the investment income (including capital gains) of high income taxpayers.
These two changes would result in a combined 66 2/3% increase in the maximum federal long-term capital gains rates on the sale of stock in 2013 compared with a sale in 2012 (a 25% rate compared with a 15% rate).
In other words if you have owned stock in a public or private held company for at least a year and you don't sell it before January 1, 2013, the after-tax gain will immediately be worth 13.3% less.
Liquidity Consideration for Private Company Shares
While the shares of stock in publicly traded companies like Wal-Mart (NYSE:WMT) and Netflix (NASDAQ:NFLX) can be converted to cash quickly, it may take between six and nine months to sell a privately held business. If you are considering selling shares in a private company before the December 31, 2012, deadline, I would recommend contacting an investment banker and tax advisors as soon as possible.
Dividend paying stocks
If you own a dividend paying stock, that income would be taxed as ordinary income with a top rate of 39.6 percent, instead of 15 percent now.
A Real Life Example
I bought my first shares of Apple stock (OTC:APPL) in middle school. The company went public on December 12, 1980, at $22.00 per share. Since then shares have split three times, so on a split-adjusted basis the IPO share price was $2.75.
Let's assume I have 1,000 shares at $2.75 so my cost basis is $2,750 dollars.
If I sell them for $610 dollars a share before December 31, 2012, I gross $610,000 dollars on a pre-tax basis. If I sell them for $610 a share after December 31, 2012, I also gross $610,000 dollars on a pre-tax basis.
In both examples I have a gain of $607,250. Assuming a 15% long-term capital gains tax rate my after-tax profit would be $516,162. Assuming a 25% long-term capital gains tax rate the after-tax profit would be $455,437.
This means if I wait until after the ball drops in 2012 to sell, I'll lose $60,725 dollars, which happens to be about the same amount it would take to buy 475 bottles of Dom Pérignon on Amazon (NASDAQ:AMZN) and ship them to Uncle Sam via FedEx (NYSE:FDX) .
What is the best time to sell?
Many private business owners who are planning to sell their company over the next several years may accelerate their plans in order to maximize the after-tax cash payout at closing. This may result in an unusually large number of private businesses offered for sale during 2012.
Similarly the increase in long-term capital gains rates may trigger large amounts of tax related selling in public companies, which would likely depress prices.
The Bush tax cuts refers to changes to the United States tax code passed during the presidency of George W. Bush that generally lowered tax rates and revised the tax code legislating taxation in the United States. These were the:
- Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)
- Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA)
While each act has its own legislative history and effect on the tax code, the JGTRRA amplified and accelerated aspects of the EGTRRA. Moreover, since 2003 the two acts have often been spoken of together, especially in terms of analyzing their effect on the U.S. economy and their political ramifications. The Bush tax cuts had sunset provisions that made them expire at the end of 2010.
Whether to renew the lowered rates and how became the subject of extended political debate, which was resolved during the presidency of Barack Obama by a two-year extension that was part of a larger tax and economic package, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.