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Investors shuffling assets ahead of fiscal cliff

Some citizens aren’t waiting to find out if the White House and Republicans in Congress will be able to reach a last-minute deal to pull the country away from the “fiscal cliff.”

They are selling securities while capital gains tax rates are still low or transferring millions into trusts for the benefit of children and grandchildren before estate tax laws become more stringent. Others are getting out of the markets and parking money in less risky accounts.

Miami financial planner Cathy Pareta has been counseling her upper middle class clients — “the Johnsons, not the Rockefellers” — on whether to adjust investment portfolios, accelerate income or realize capital gains sooner than planned.

“Some people are going to get hit hard,” said John Bacci, a financial planner in Linthicum, Md., who has gone down his client list and run projections on what higher taxes would look like for them. He’s looking at tax-friendly alternatives for some clients, such as annuities or rental property.

At year’s end, the country will leap off the “fiscal cliff” unless politicians reach a compromise on mandated spending cuts and the expiration of the Bush-era tax cuts.

For most investors, the expiring cuts will mean that the tax rate for long-term capital gains will rise from 15 percent to 20 percent. Dividends also will no longer be taxed at 15 percent but treated as ordinary income, which could mean a tax rate as high as 39.6 percent. And individuals with multimillion-dollar estates will find much more of their money subject to the federal estate tax.

Estate planning lawyers say the demand is so intense that they are putting in grueling hours to set up trusts.

“It’s very stressful. We are working day and night,” said Diana Zeydel, an estate planning lawyer with Greenberg Traurig in Miami. “Were doing three times what we normally do for end-of-the-year planning.”

Zeydel said many of her clients waited until after the elections in November to gauge how the political tide would affect their future finances. This gave them little more than a month to make major decisions about their wealth.

Most observing the political jousting in Washington expect taxes will go up even if the political leaders reach a deal — they’re just not sure how much. Many aren’t taking any chances.

Jim Ludwick, a financial planner in Odenton, Md., said one client in his late 50s cashed out stock and bond funds totaling $1.7 million not long after the election and stashed the proceeds in a money market fund.

The client, anticipating a market plunge due to the “fiscal cliff” and other issues, said he spent his entire working life building up a nest egg and wouldn’t have time to wait for his portfolio to recover, according to Ludwick. The client fears it won’t be safe to re-enter the stock market for another year.

“We have a number of clients who are taking capital gains this year, expecting that if they wait until next year, they will have to pay higher taxes on those same gains,” said Daniel McHugh, president of Lombard Securities in Baltimore. Some of those clients are realizing six-figure gains but are still willing to take the tax hit now, he said.

Of course, the downside is that the stock market could take off, and these investors will miss out on even higher gains, McHugh said. But, he added: “Given the state the economy is in, that’s a very small risk.”

To illustrate these options, some accountants are working out a schedule of the return on certain assets that would be necessary to outweigh income lost if future gains are being taxed at a higher rate.

Some financial professionals say clients are worried, even if deep down they expect an eleventh-hour deal between Congress and President Barack Obama.

“They ask the question: Is the ‘fiscal cliff’ going to hurt them?” said Michael Dougherty, vice president of investments at Chapin Davis, a Baltimore financial firm. He added: “This team of elected officials has conditioned everyone to expect that kind of last-minute result.”

Denise Leish, president of Money Plans in Silver Spring, Md., said she anticipates that the stock market will temporarily tank whether a deal is struck or not. She doubled or tripled the usual 5 percent cash position in her clients’ portfolios when it became clear the president would be re-elected.

She’s not selling their securities to benefit from today’s low tax rates. “We only sell stock if we don’t like it, not for tax reasons,” she said.

But that doesn’t mean this isn’t a good time to sell, especially if investors have too much money in one stock, Bacci said. “It’s a good idea, too; the market is up.”

Bacci said some clients are facing the potential of bigger tax bills, largely because of higher tax rates on dividends. In addition, higher-income households — individuals with income over $200,000 and joint filers making more than $250,000 — will pay an additional 3.8 percent on investment income next year as part of the Affordable Care Act. Under the law, they also will pay an extra 0.9 percent on wages in Medicare taxes.

One client has $200,000 in annual investment income and could see his tax bite go up by 270 percent next year, Bacci said.

Many of the affluent also are trying to beat the clock on the estate tax.

Currently, an individual can give away in life or bequeath at death up to $5.1 million without any federal gift or estate tax consequences. That’s set to drop to $1 million next year, and amounts above that could be taxed at a rate of up to 55 percent.

Lawyers are busy setting up trusts that allow clients to reduce the size of their estates and take advantage of the high gift-tax exemption. Zeydel, who advises people wealthy enough to at least consider gifting $5 million, said she’s having this conversation with about 80 percent of her clients

“They don’t want to feel financially imprudent,” she said.

One constraint is the time crunch for federal agencies that have to respond to overwhelming demand for tax IDs or other information necessary to set up a trust or other accounts at the last minute.

With a considerable amount of uncertainty hanging in the last few business days of 2012, Miami tax lawyer Hank Raatama is cautioning clients to be prepared without overreacting to fiscal cliff fears.

“Whatever agreement we end up having at the end of the year it probably going to be tweaked going down the road,” he said.

The Baltimore Sun contributed to this report.