By Laura Saunders
Some of the largest fund companies in the country are pushing back against a little-noticed provision in the Senate tax bill they argue will cost investors millions.
The provision would prevent investors from minimizing taxes by choosing the specific shares that are being sold when they sell part of a position. Instead, investors would have to sell their oldest shares first.
If the provision becomes law, "markets will work less well. Our fund managers will have their hands tied, and our shareholders will owe more in taxes," said Thomas Faust, chief executive of Eaton Vance Corp., a fund firm that manages more than $419 billion.
The provision included in the Senate bill requires investors who are selling partial positions to assume that lots of securities bought at different prices are sold on a "first-in, first-out" (FIFO) basis. The provision would affect "passive" index funds and exchange-traded funds, as well as actively managed ones.
"Vanguard is concerned with language that requires funds to sell their oldest shares first -- mostly likely increasing significantly the amount of taxable distributions made to investors every year," a Vanguard spokeswoman said in a statement.
Here's how the provision works: Say an investor owns two lots of one stock bought at different prices, and they are held in a taxable account rather than a tax-deferred retirement account. If the stock is trading at $100 now, each share acquired five years ago for $60 would have a $40 taxable gain.
But each share bought two years ago at $110 would have a $10 loss.
Current law allows investors, including fund managers, to choose which shares they part with. So selling shares bought for $110 would yield a loss that could offset other gains, while selling shares bought for $60 would produce a taxable gain.
If the provision takes effect, the first shares sold would be deemed to have a cost of $60 each, and an investor couldn't sell the $110 shares until all $60 shares were gone. The change would take effect for sales in 2018. It is estimated to raise $2.7 billion over 10 years.
Supporters of the change say it would simplify a complex record-keeping issue. "Having all these choices is harmful to taxpayers and to the tax system," says Steven Rosenthal, a tax attorney now with the Tax Policy Center. The summary does contain language that seems to allow fund investors using "average cost" to continue. The wording of the statute isn't yet available.
The proposed change would affect individual investors who have taxable accounts and holdings of one security bought at different times as well as funds.
The provision would make it more difficult for investors to "harvest" losses by selling specific shares that have gone down in value. Many investors consult their adviser's annually about such sales.
It would also affect taxpayers' ability to maximize the value of charitable donations of appreciated securities.
Under current law, taxpayers often don't owe long-term capital-gains tax on shares they donate while getting a deduction for their full market value. The best shares to give may not be the oldest shares they acquired.
"People who want to maximize tax savings by donating specific lots that aren't their oldest ones should do it before year-end," says Robert Gordon of Twenty-First Securities, a tax strategist in New York
Write to Laura Saunders at [email protected]