News Column

Possible Tax Increases Sets Off Scramble to Avoid Them

Nov. 20, 2012

Nathaniel Popper, Nelson D. Schwartz

accountant with adding machine

Business owners and investors are selling stocks, seeking alternative investments and holding off on hiring until the U.S. government has addressed looming tax increases and spending cuts.

Business owners and investors in the United States are rapidly maneuvering to shield themselves from the prospect of higher taxes next year, a strategy that is sending ripples across Wall Street and broad areas of the economy.

Take Stephen A. Wynn, the casino magnate, who has been a vocal critic of higher tax rates. He and his fellow shareholders in Wynn Resorts, the company announced, will collect a special dividend of $750 million Tuesday, a payout timed to take advantage of current rates. Experts estimated that taking the payout this year instead of next could save Mr. Wynn, who owns a sizable stake in the company, more than $20 million.

For the wealthy like Mr. Wynn, the overriding goal is to record as much of their future income this year as they can. That includes profits from activities as diverse as sales of businesses, one-time dividends and the sale of stocks that have been big winners.

"In my 30 years in practice, I've never seen such a flood of desire and action to transfer a business and cash out," said Kenneth K. Bezozo, a partner in New York with the law firm Haynes & Boone. "We're seeing a watershed event."

Whether they are small-business owners or individuals saving for retirement, investors are being urged by their advisers to reconsider their holdings. Along the way, many are shedding the very investments that have been the most popular over the past year and contributing to sell-offs in formerly high-flying shares like Apple and Amazon.com.

Investors typically take profits from their own portfolios at the end of the year, but the selling appears to be more specific this year. Stocks with large dividends, for instance, are seen as less attractive because of the perceived likelihood of a sharp increase in the tax rate on dividends.

All of that is weighing on the broader financial markets, as worries mount about the economic drag from the combination of higher tax rates and reduced government spending set for January if President Barack Obama and Senate Republicans cannot reach a budget compromise before then.

Fears about the fiscal impasse in Washington, along with anxiety about fading corporate profits and weakening economies abroad, have pushed the Standard & Poor's 500-stock index down about 5 percent since the election. On Friday, major stock indexes had their best showing of the week, after Mr. Obama and Republican leaders signaled that a compromise was possible.

Even if many of the tax breaks scheduled to expire survive a new budget deal, some business owners and investors are bracing for substantial increases in specific areas of the tax code.

The top rate on dividends, for example, could climb to 39.6 percent from 15 percent if no action is taken. Capital gains taxes, which now top out at 15 percent, could rise to more than 20 percent, many financial advisers say. Most investment income will also be subject to a 3.8 percent charge to help pay for Mr. Obama's health care law.

Stocks that pay big dividends have been popular in recent years among investors eager for an alternative to the meager returns on bank savings accounts and Treasury securities. Since October, though, the two sectors that provide the most generous dividend payments -- utilities and telecommunications stocks -- have been among the worst performers (though part of the damage was done by the storm known as Sandy on the East Coast). Utility companies in the S.&P. 500 have fallen 9.4 percent from their highs in October. Telecommunication stocks in the index have dropped 11.3 percent from theirs, compared with the broader index's 6.8 percent decline from its recent high.

John Moorin, the founder of a medical equipment company near Indianapolis, said he had sold about $650,000 in dividend-paying stocks like McDonald's and Coca-Cola a few days after the election, worried about the potential increase in taxes.

"I love these companies, but I'm so scared that now all of the sudden I'm going to get taxed at such a rate with them that they won't be worth anything," Mr. Moorin said.

Mr. Wynn has declared special dividends at the end of the year before -- most recently in 2011 -- but in a call with analysts last month, he hinted that higher taxes would cause him and other chief executives to rethink big payouts in future years.

In the meantime, he added, it was "very difficult to do long- range planning with a government that moves as much as this does on so many issues."

Leggett & Platt, a diversified manufacturer based in Carthage, Missouri, decided to move up payment of its fourth-quarter dividend to December from January so shareholders could take advantage of the lower rate.

"If we can help our shareholders avoid taxes and keep more of their dividends, we'll do it," said David M. DeSonier, senior vice president for corporate strategy and investor relations.

While negotiators are trying to find ways to raise more revenue for the long term, some experts expect a substantial bump in tax collections in the short term as investors take a multitude of steps now that they would have taken in future years. After the top tax rate on capital gains rose to 28 percent from 20 percent at the end of 1986, the U.S. government's receipts from such gains doubled to $52.9 billion in 1987, as sales surged at the end of the previous tax year.

The potential jump in tax rates has been telegraphed for months, but many investors say they did not respond sooner because they were waiting to see whether Mitt Romney would defeat the president and move forward with his commitment to keeping rates at current levels. Mr. Obama, since defeating Mr. Romney, has continued his call for an increase in marginal tax rates on the wealthy. A growing number of Republican leaders have conceded that some increase is likely.

Kristina Collins, a chiropractor in McLean, Virginia, said she and her husband planned to monitor the business income from their joint practice closely to avoid crossing the income threshold for higher taxes outlined by Mr. Obama on earnings above $200,000 for individuals and $250,000 for couples.

Dr. Collins said she felt torn by being near the cutoff line and disappointed that U.S. tax policy was providing a disincentive to keep expanding a business she founded in 1998.

"If we're really close and it's near the end-year, maybe we'll just close down for a while and go on vacation," she said.

Of the potential changes in the tax code set to take place Jan. 1, the scheduled increase in the tax rate on capital gains would hit a particularly broad range of investments.

Business owners, for instance, can lock in the current top rate of 15 percent on capital gains if they sell their company before the end of the year. The capital gains tax also applies to increases in the value of stocks and other securities, encouraging some investors to sell holdings that have done well. That is one of several factors cited in the recent plunge in the price of Apple shares. They have dropped 26 percent since mid-September after rising 73 percent earlier in the year.

The coming changes have not hurt all assets. Municipal bonds have become more attractive because they are exempt from most U.S. taxes, including the new surcharge related to Mr. Obama's health care law. Frank Fantozzi, a financial planner in Cleveland, is recommending that his wealthy clients increase their allocations to municipal bonds from about 30 percent to about 40 percent.

But the potential effect of the scheduled tax increases and government spending cuts has been mostly negative. Many market strategists have suggested trimming overall holdings of risky assets like stocks, and business executives are proceeding very cautiously.

Some business owners say they are holding off on hiring plans because they expect tax rates to rise. Dyke Messinger, chief executive of Power Curbers in Salisbury, North Carolina, said he would like to fill four slots at his company, which makes construction equipment, but would hire only three people because he anticipated that his tax bill would rise by $100,000.

"It's not a huge amount of money," Mr. Messinger said. "But it's enough money that you don't want to make a misstep."



Source: (C) 2012 International Herald Tribune. via ProQuest Information and Learning Company; All Rights Reserved


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