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FIFO Update #3: FIFO Requirement Out, AMT Still In, but Stay Tuned for Further Developments

Active Tax Management
December 20, 2017

As many of you already know, the tax bill that passed today removed the proposed new rule mandating use of the FIFO (first-in, first-out) method for all asset sales. Thus, the existing system that allows specific lot identification will remain in place. However, a number of other changes will affect top-bracket taxpayers.

First, the top federal rate in the bill drops from 39.6% to 37.0%. In addition, state and local taxes will effectively no longer be deductible for high-bracket investors. The table below shows the new and existing rates, highlighting how taxable investors in states with no income tax will see their top rate drop, whereas those in high-tax states will see higher rates.

fifo - state tax rate

In the passed bill, the alternative minimum tax (AMT) has survived, albeit at a higher threshold. However, the distinction between the AMT and conventional tax rules will be far less pronounced. In fact, one could view the proposed package as something of a blend of the current AMT and the current conventional rates. Since the AMT calculation kicks in only when it’s higher than conventional tax liability, there may be situations where investors who had been subject to AMT would no longer face those rules and rates.

For example, one of the biggest differences between AMT and conventional taxation under current rules is the deductibility of state income tax. Now that such taxes will effectively not be deductible for high-bracket investors under either AMT or conventional rules, some investors previously subject to AMT will revert back to the conventional system. In fact, some investors may see a significant jump in the tax rates they pay on short-term capital gains. For taxpayers in the highest bracket who are currently subject to the AMT but who in future will be paying under the regular rules, the federal rate on short gains could jump from 28.0% to 37.0% for marginal investment income.

Since the FIFO requirement has been pulled from the bill, Aperio will not be providing any further analysis for that impact. We will, however, update the benefits of tax-advantaged strategies and our state-by-state tax guide.

Finally, one change that made it into the bill will affect certain tax-exempt university endowments, which will become subject to a new 1.4% excise tax. While this will affect only very large endowments, we’re still intrigued that the title of our article of a couple of years ago in the Financial Analysts Journal, “What Would Yale Do If It Were Taxable?” may now change in verb mood from the subjunctive to the indicative. For further details on taxable foundations and endowments, see also our piece, “When Tax-Exempt Isn’t Really Tax-Exempt—Minimizing Excise Tax on Private Foundations.”

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