Will capital gains tax changes tank the stock market?Article added by Roccy DeFrancesco on September 19, 2012
Roccy Defrancesco

Roccy DeFrancesco

MI

Joined: May 24, 2006

If Obama is re-elected (meaning taxes will be going higher), I think that there will be a massive stock sale. What will happen to the stock market late in the month of December if billions of dollars in stocks are suddenly sold?

If you knew that the long-term capital gains tax rate on the sale of stock was going to skyrocket on January 1, 2013, would you sell stocks before the tax increase?

It’s seems like a simple question, doesn’t it? The answer is, "of course."

If everyone who owns stocks also has this point of view, what do you think is going to happen at the end of 2012?

Why the end of 2012? As most people know, under the current state of the law, capital gains taxes are going to increase on January 1, 2013. The following is an excerpt from Forbes Magazine discussing the upcoming tax increase:
    In 2013, the Bush tax cuts are scheduled to expire and this will increase the maximum tax rate to 21.2 percent on long-term capital gains and 40.8 percent on short term capital gains. (The extra 1.2 percent is due to the return of the 3 percent disallowance of itemized deductions for income earned above a threshold.)

    In addition, beginning in 2013, the Obama Health Care bill imposes a 3.8 percent tax on the investment income (including capital gains) of high-income taxpayers.

    These two changes would result in a combined 66 2/3 percent increase in the maximum federal long-term capital gains rates on the sale of stock in 2013 compared to a sale in 2012 (a 25 percent rate compared to a 15 percent rate).
I can tell you what I think will happen at the end of 2012. If Obama is re-elected (meaning taxes will be going higher), I think that there will be a massive stock sale. I think that a good percentage of people who have stocks they are not planning on holding for the long term and who have gains on those stocks will sell them at the end of the year (this does not include stocks/mutual funds in IRAs or tax-deferred qualified plans).

What if this actually happens? What will happen to the stock market late in the month of December if billions of dollars in stocks are suddenly sold?

I think it could cause the stock market to tank. What does "tank" mean? Who knows, but it could be a 20 percent or more downturn.

What can you do to help clients? That’s a tough one. You might counsel them to sell well prior to year end (right now the stock market is at a four-year high, so it’s not a bad time to sell). Or, you might have them hedge their stocks with different types of options that will be inexpensive as compared to the risk you are hedging against.

I am writing this article not because I have a real crystal ball that tells me something that others do not know; I’m sending it to remind everyone that it might be a good idea to have a discussion with your clients about this.

Advisors who are proactive in discussing this with clients will be in much better shape if a crash takes place than those who do not. Those who don’t discuss this with clients run a huge risk that their clients will fire them after a crash. And there is no downside to discussing this with your clients. Even if you don’t have great answers for them, they will appreciate the effort and interaction.
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