New US Tax Law May Reduce Portfolio Trading

By raising capital-gains tax rates for some investors, the American Tax Relief Act alters the ground rules for tax-aware trading. If your taxable income exceeds $400,000 (single filer) or $450,000 (joint filer), there may now be less trading in your portfolio because each trade must clear a higher hurdle.

Suppose you bought stock QXY four years ago for $40 and it’s now trading at $100. You think stock ABZ in the same industry has greater long-term potential. If you sell QXY, your $60 capital gain will now be taxed at a 23.8% rate, so instead of having $100 to invest in stock ABZ, you’ll have just $85.72 ($100 – [$60 x 23.8%]). In 2012, when the top capital-gains tax rate was 15%, you would have had $91 to invest in the new stock.

A tax-aware investor would want to be sure that the expected return of the new stock justifies the tax cost of selling the old one. Since the tax cost is a certainty and the future return is merely an expectation, we think it’s smart to require an anticipated future return that’s significantly higher.

If ABZ is expected to be a strong performer, it will clear this tax hurdle. The higher capital-gains tax rate raises this hurdle for you from where it was last year. It does not necessarily raise the hurdle for your brother, if his taxable income is less than $400,000 and he still pays the 15% capital gains tax rate. Therefore, some trades that overcame the hurdle last year won’t this year, and some trades that overcome the hurdle for your brother this year will not clear it for you.

Clearly, a one-size-fits-all approach will not be helpful here. To deliver the greatest benefit to the investor, tax-aware trading should be customized to the specific tax rate that will apply. And, as we will discuss in a future blog posting, once you’ve decided that a trade clears the basic tax-cost hurdle, the next step is determining which specific tax lot(s) to sell. Customized analysis should now be extended to that decision, too.

Bernstein does not give tax or legal advice. Taxpayers should consult professionals in those areas before making any decisions.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Paul Robertson

Senior Portfolio Manager
Paul Robertson is a Senior Portfolio Manager and a member of Bernstein’s Private Client Investment Policy Group. He joined the firm in 1998 as a research associate and became a research analyst in 2000. In 2004 Robertson was appointed Senior Portfolio Manager and joined the Private Client Investment Policy Group. Between 2007 and 2009 he was also a member of the Alternative Investments team. Previously, he worked as a consultant for McKinsey & Co., Inc.; as a portfolio manager and quantitative analyst for Commonwealth Funds Management, an Australian funds manager; and as an economist for the Australian government. Robertson earned a bachelor’s degree in economics from the University of Melbourne, a law degree from the Australian National University and an MBA from Cornell University.

Tara Thompson Popernik, CFA, CFP®

Director of Research—Wealth Planning and Analysis Group
Tara Thompson Popernik was named the Director of Research for the Wealth Planning and Analysis Group in 2011 and is responsible for leading research initiatives on investment planning and asset allocation issues facing high-net-worth families, family offices, and endowments and foundations. Previously, she was a wealth management specialist, and before that she was a senior investment planning analyst. Prior to joining the firm in 2003, Popernik was a paralegal in the Capital Markets Group of Cadwalader, Wickersham & Taft. She earned a BA with honors in comparative literature from Dartmouth College. Popernik is a Chartered Financial Analyst charterholder and a CERTIFIED FINANCIAL PLANNER™ professional.

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