Cliff Notes

After November 6th the indices dropped 5% but since have recovered most of their losses.

It's a reasonable supposition that the November 6 election results were disappointing to the investors who hoped that a Romney victory would continue the favorable tax treatment afforded to long-term capital gains and dividends. Instead, avoidance of the "fiscal cliff" will now probably entail higher tax rates on capital gains (from November 11th: "the prospect of higher taxes on capital gains is prompting many to unload some of their winning stocks") and possibly much higher rates on dividends.

Unsurprisingly, the equity indices fell for the ten days following the election but have since rebounded. The likely causes of this brightening outlook are favorable noises emanating from both sides in Washington, plus signs that growth has not stalled in China.

Meanwhile, what is the small investor to do? One great feature of capital gains is that the timing of income recognition is largely under the control of the individual taxpayer. Barring situations where one has to sell, it's not unusual to hold well-chosen stocks for many years. The patient investor may be able to hold off realizing gains for four more years, when the Republicans stand an excellent chance of capturing not only the Presidency but Congress as well (remember how everyone was so sick of George W. Bush after eight years that the Democrats didn't really need a platform in 2008? I wouldn't bet against the country feeling the same way about Barack Obama and the Democratic Party in 2016.)

Another strategy is to manage one's financial affairs to keep income below the levels where higher rates kick in. For example, one spouse may now choose to quit a good-paying job to stay at home with the kids and fill the traditional role of the wife to an executive (your humble observer is personally acquainted with many professional women and men who have opted for less money, less stress, and more time with their families).  Staying home is not a new phenomenon, but higher tax rates may finally sway some on-the-edge dual-income couples.

For gains on capital assets that are not securities there is every indication that tax-planning deferral tools, such as Section 1031 exchanges, will continue in their present form. While the tax regime will be a bit more unfavorable, take heart, investors, history shows that you will figure out ways to adapt.  Which means, of course, that the higher receipts that the government will collect will be far short of what higher-tax advocates will expect, a surprise to no one but themselves. © 2012 Stephen Yuen