Sunday, October 31, 2010

Impact of capital gains tax on U.S. investments

The reduced 15% tax rate on qualified dividends and long term capital gains is currently scheduled to expire on December 31, 2010.

Unless the U.S. Congress extends the reduction (which seems increasingly unlikely, given the lack of a bipartisan consensus on this and other tax reduction extensions), this means that in 2011, dividends will be taxed at the taxpayer's ordinary income tax rate, regardless of his or her tax bracket; and the long-term capital gains tax rate will be 20%.

All eyes will be on the lame-duck session of Congress after the November 2 elections. Even though President Obama and the Democrats have indicated this is one tax reduction they might consider extending (as well as the tax reduction for those earning less than $200,000, or $250,000 for couples filing jointly), it is possible that gridlock and partisanship will set in.

Thus, if you have been considering selling shares or other investments that have a considerable capital gain, it might be to your advantage to do this before December 31st.

There is a similar situation with the estate tax, which will jump from 0 % on Dec. 31st to 55 % on Jan. 1st, barring Congressional action. Other than emulating the plot of "Through your Momma off the train", the only option to get around this is through a donation, which is taxed at a 30 % tax rate.

It is possible that avoiding the increase in the capital gains tax will lead to a significant bear market in the coming two months in the United States, as investors rush to sell before the tax increases. Of course, if the fall in the share price exceeds the difference in the tax rate, it would not be to your advantage to sell.

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