Do we adjust our portfolio now that President Joe Biden is going to propose a huge increase in the capital gains tax for the wealthy? Do we avoid the asset class that had favorable tax treatment and might lose it?
We know that today’s 20% capital gains rate has attracted a great deal of money into the stock market because you can make so much more money on your money than you can on your work. It’s a fact of life that the capital gains cuts that President George W. Bush gave us amounted to an immense windfall for wealthy people. It always struck me as odd that you could keep more of the money you make in the stock market than you could keep from your paycheck. But, as my friend and colleague Larry Kudlow argued endlessly on our show, Kudlow & Cramer, the lower tax rate would spur investment by the rich who might otherwise just park their money in something that doesn’t generate jobs.
I on the other hand, argued vociferously that Bush should cut the tax on dividends because that would encourage ownership – not renting – of stocks and bring more money in to the stock market. Larry, who later became Donald Trump’s chief economic adviser, and I hammed home these cuts pretty much on every other show. We met with the President and addressed this and ultimately Bush proposed cuts on both capital gains and dividends and he told Larry that we were instrumental in his decision to do so. Larry was proud of his end, and I was proud of mine.
Now if the capital gains tax gets jacked up I think plenty of people will want to take profits now. But there are two problems with this course of action. First, President Biden could make the tax retroactive and, second, he may not be able to get the raises through Congress. I am betting that it won’t fly in the Senate and you will have sold and incurred taxes on good stocks that you don’t want to get rid of. The idea that the bandied about rates we heard today could get through seems almost fanciful. Look, I totally get the idea that rich people should pay what will basically be the ordinary rate for capital gains. Why should one form of income be treated differently than another kind of income? Many times they have been the same rate. But, unlike Kudlow & Cramer, this is not a tax policy seminar, it’s an attempt to help you make and keep profits so this might be a good time to talk about some key rules I have about stocks that I don’t emphasize enough especially because so many people have huge gains in situations that are more perilous than others and some stocks will suddenly be worth more if Biden is successful in his rather amorphous trial balloon about boosting the capital gains rate.
One of my oldest rules, from my days of helping wealthy individuals at Goldman Sachs (GS) , is pretty controversial: you must never fear the tax man. I do not care if you have a 44% tax rate or a 20% capital gains rate, if you are driven by concerns about paying that tax more than you care about the fundamentals, you might end up losing a lot more money than you would ever pay the government.
I say this is controversial because my clients just hated paying taxes so badly that they would not care if business had turned down for companies. They would own technology stocks that would shoot up in price only to see them destroyed as newer, better technologies took over. I remember trying to get people out of BUNCH because of the coming power of the personal computer. You probably don’t know Bunch. It was an acronym for Burrough, Univac, NCR (NCR) , Control Data and Honeywell (HON) , which were all computer companies that competed with IBM (IBM) in one way or another. BUNCH, at one point, were all hot as a pistol. They did survive in one form or another but you had to sell them when newer technologies emerged. Similarly you had to sell Data General and Digital Equipment, again, because of the coming power of much smaller devices. We have Intel (INTC) tonight on Mad Money
I mention all of these because I watched, helpless, as wealthy people whom I worked with were simply not going to take those gains, and, alas, they ended up not having to pay taxes on them because there were no gains. It impressed me to the point that I always said if I saw changing fortunes of companies I would not care where they came from, I would only care where they were going to.
Hence another rule of mine. I never care what your basis is, where you bought it, higher or lower than the current stock price. It means nothing to me. What constitutes a stock that should be sold regardless of the taxman? I think you need to ask yourself if the company you own stock in might be facing an existential crisis. If that’s the case, say, because it is a so-so retailer in a series of so-so malls or because it might be a company with no earnings or prospect of earnings any time soon or because the company’s out of money with no prospects of becoming profitable, then it should be sold whether Biden succeeds in changing the tax code or not.
Similarly, though, if you have been waiting for stocks to come down then I think you are getting a terrific opportunity to buy stocks that are being sold as we can’t presume that taxes will change but we can presume that it’s the same company not matter what the tax code says. This is one of those moments, as I always say to members of the actionalertsplus.com club, where you need to have your shopping list with your levels you want to buy because you are getting to buy stocks that are being put on sale by those who do fear the taxman.
It’s a good reason why I always say to have some cash around just in case some exogenous threat appears that doesn’t impact the actual businesses of the stocks people are selling.
Finally, remember we are hearing nothing about taxes going higher on companies who pay out high dividends. This morning we heard the CEO of AT&T (T) speak on Squawk Box, and the CEO of Dow (DOW) on Squawk on the Street. Both delivered excellent earnings and gave very strong outlooks, outlooks that will not be impacted by a change in tax rates. But if you truly believe that the tax code will make capital gains equal to ordinary income, then you want the non-ordinary income of dividends more than ever. That means AT&T with its 6.6% yield that I now believe is safe after today’s earnings, and Dow with its 4.5% yield will be worth more than they are now. Companies with good dividends will be at a premium even as they are being sold today.
So, even as I think that it’s highly unlikely that the tax code changes that radically for the rich, it is always important to be ready for anything. If you want to take advantage of a tax-motivated decline don’t do it all at once. If there is no retroactive feature then there could be days of selling pressure and you don’t want to catch the first wave that may have started today. But to recap, don’t fear the taxman, don’t care about where a stock came from, just where it is going to, and be ready to buy stocks that are going down because of taxes not the fundamentals and watch for stocks with good yields if you are looking for tax efficient income. View this one as an opportunity, not a penalty and, please remember most people who do own stocks own them in accounts that will be unaffected by a change in the code because they are in accounts they don’t pay taxes in anyway.
(Honeywell is a holding in Jim Cramer’s Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells HON? Learn more now.)
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