Keith Fitz-Gerald (Money Morning):
Millions of investors who bought gold in the last 12 months are undoubtedly very happy at the moment – considering that the yellow metal has risen 60% since last November to a recent close of $1,138.60 an ounce on Monday.

But chances are good that many won’t be smiling when they discover just what the taxman has planned for their gains.

Unbeknownst to most investors, gold is considered a collectible not a capital asset. In plain English, this means that despite the fact that many people believe they are investing in gold, the Internal Revenue Service (IRS) believes that they are collecting it.

This is no small distinction and hurts investors because it means that gold does not qualify for the 15% maximum tax bite that most of us employ as a matter of routine when we mentally calculate profits earned on investments held for more than a year. That 15% cut for Uncle Sam is the long-term capital gains tax rate that applies to most stock or mutual fund investments.

Precious metals are a completely different story. Profits from these “investments” can be subject to a 28% maximum tax rate if held for more than 12 months. And if they are sold in less than a year, the profits count as ordinary income.

The long and the short of it “is that as a result of gold’s spectacular run-up, many investors may have a tax problem they haven’t counted on when they go to sell,” said Gary E. Ham Jr., of the Oregon-based accounting firm of Jones & Ham PC

This may be especially true for investors who have piled into such asset-backed, exchange-traded funds (ETFs) as the SPDR Gold Trust (NYSE: GLD), the iShares Silver Trust (NYSE: SLV) and the iShares COMEX Gold Trust (NYSE: IAU), for example, because precious-metals ETFs are set up as something called a “grantor trust.” According to Barron’s, ETF investors are treated as owning undivided interests in the actual metal that’s owned by the fund. Therefore, when an investor sells shares in the ETF, the tax code treats that investor as having sold a share of the metal backing the fund.

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This from Investment U:

Investment legend John Templeton insisted that everyone’s long-term investment goal should be the same: maximum total return after taxes.

In my experience, investors spend plenty of time thinking about risk and return, but not enough about taxes. That’s unfortunate. Especially since – unlike the stock market, interest rates or inflation – taxes are controllable.

Yet too many investors are surrendering far more to the taxman than they should. A Vanguard study, for example, found that the typical investor is giving up 2% a year to the IRS.

That’s nearly 20% of the long-term return of the S&P 500. How can you stop this and still remain a law-abiding, civic-minded individual?

It starts with tax-managing your investment portfolio…

Tax-Managing Your Investment Portfolio – 5 Basic Steps

Here are the five basic steps for tax-managing your investment portfolio:

• 1) Use your retirement account for short-term activity. If you like to trade for short-term profits, do it in your qualified retirement plan. That way all those short-term gains compound tax-deferred. (The downside in a bad market, however, is that losses in a retirement account are not tax deductible.)
• 2) Minimize turnover in your non-retirement accounts. Realizing gains on investments held less than a year means subjecting yourself to short-term capital gains taxes as high as 35%, depending on your tax bracket. As Warren Buffett once said “the capital gains tax is not a tax on capital gains, it’s a tax on transactions.” Hold winners for at least a year, if possible. If you do, you’ll qualify for long-term capital gains treatment at the maximum rate of only 15%.
• 3) Offset capital gains with capital losses. The IRS allows you to offset all of your realized capital gains with realized capital losses. And you can take up to $3,000 in additional losses against earned income. If you want to take the deduction for 2008, you need to sell your losers by the end of this month.
• 4) Reduce your taxes on interest income. Use your IRA, pension, 401(k) or other tax-deferred account to own corporate and Treasury bonds (since interest income is taxed at the same rate as earned income) and real estate investment trusts (since REIT dividends are taxed the same way).
• 5) Cut your management fees. If you invest in mutual funds, use index funds rather than actively-managed funds in your non-retirement accounts. Index funds tend to be highly tax-efficient because changes to the index are rare. Managed funds often have high turnover and Federal law requires them to distribute at least 98% of realized capital gains each year. You can get hit with a big capital gains distribution even when you haven’t sold a share and even if the fund is down for the year. That hurts on April 15.

Take these steps and you will substantially lessen the government’s tax bite on your investment portfolio. The few remaining choices are simple ones like owning tax-free rather than taxable bonds if you reside in a high-tax state like New York or California. (That is especially true today, since tax-free bonds are yielding more than Treasuries.)

While tax-managing your investment portfolio, if you’re looking to reduce your taxes further:

• Buy business equipment this month
• Pre-pay businesses expenses for 2009
• Fully fund your IRA, 401(k) or other retirement accounts.

Tax-Managing Your Investment Portfolio – Fine Art Donations

Consider investing in fine art and donating it to a charity to tax-manage your investment portfolio. The 1995 Tax Act allows you to donate to any IRS-approved charity works of art at their fair market value, not at their cost basis. Moreover, you can deduct the charitable gift’s fair market value on your return without being subject to the dreaded alternative minimum tax.

This is not just for fat cats, by the way. You can invest in art with just a few thousand dollars. (For more information, contact Mike Kuschman, president of Fine Arts Ltd, at 800.229.4322 or 407.702.6638.)

Too many investors are oblivious to the tax ramifications of their investment moves. Using the government tax breaks and tax-managing your investment portfolio can change that.

Tax savings should never be your sole consideration, however. In December 1996, for example, I sold my shares of Best Buy (NYSE:BBY) at a small loss, solely to offset some capital gains, then watched in horror as the stock rose nearly 30-fold over the next few years. (I still consider that one of my most bone-headed investment moves.)

Managing taxes is essential. It should be a priority. But it is not your most important one. Risk and return are your primary concerns. Taxes and expenses come next.

Focus on these four factors and your long-term investment success is virtually assured.

Source: Tax-Managing Your Investment Portfolio: There’s Still Time to Cut Your 2008 Taxes

Unless the cynical premise of Rush Limbaugh’s “Operation Chaos” is realized, and the Democrat presidential wingding continues to move forward at an increasingly vitriolic level through that party’s national convention in Denver in late August, whomever wins the Democratic nomination is pretty likely to be our next President. So, as investors – whether Democrat or Republican – which of the two candidates should we be rooting for?

The Case for Clinton

Our initial reaction would probably be that this question looks like a no-brainer. The Standard & Poor’s 500 Index rose from 427 to 1,342 during the eight-year administration of Hillary Clinton’s husband, giving investors an average annual total return of 17.4% – the highest of any presidency since World War II.

That huge market run-up – and the hefty yearly returns – were pretty much justified. President Bill Clinton was committed to a balanced federal budget, raised taxes only once, and that in a moderate fashion, reformed welfare and signed the North American Free Trade Agreement (NAFTA).

All of those policies were immensely beneficial to the U.S. economy – and to investors – as, in the short term, were the monetary expansion policies of the Alan Greenspan-led U.S. Federal Reserve (although we may well be paying the long-term price for that now). If we could be sure that Clinton would follow her husband’s policies, and that the economy was in a state fairly similar to that of 1993, we could as investors be confident that a Hillary Clinton presidency would contribute significantly to our collective net worth and, on balance, would serve the entire country equally as well.

When it comes to taxation, Sen. Clinton wants to reverse the George Bush tax cuts, and favors increases in the Social Security tax for those at the top of the income scale. She also favors a higher capital gains tax – all measures that tend to reduce both economic growth and investor returns. She also favors windfall taxes on oil companies, and has a healthcare plan that would be very expensive and that must be paid for somehow.

Perhaps the biggest difference between the two Clinton’s is Hillary Clinton’s economic populism. When Bill Clinton ran for president in 1992, he campaigned on the catchy platform, “It’s the economy, stupid.” But he was notably free of the economic redistributionist and corporation bashing that had weakened the credibility of such presidential campaigns as Walter Mondale’s in 1984 and Mike Dukakis’s in 1988. When Bill Clinton was president, his treasury secretaries – Lloyd Bentsen, Robert Rubin and Lawrence Summers were notably centrist and business-friendly. Economic populism only returned to the Democratic mainstream with the Al Gore campaign of 2000, and that may well be why he narrowly and unexpectedly lost to current President George W. Bush.

Sen. Clinton, on the other hand, already has proposed an economically nonsensical but populist idea – a gasoline-tax “holiday” for the peak summer driving season between Memorial Day and Labor Day, to be paid for from the profits of big oil companies. Such a tax change would tend to increase oil consumption, driving up prices, worsening any global warming and benefiting largely the mega-wealthy oil states of the Middle East and Venezuela.

The Sen. John McCain version of this proposal, without the attack on the oil companies, would be a subsidy from U.S. taxpayers to the oil sheiks; the Clinton version is a subsidy from the U.S. oil majors to the oil sheiks. Neither version makes much economic sense.

Obamanomics

Obama shares the Hillary Clinton flaw (from an investor viewpoint) of wanting to increase taxes – including capital gains taxes – at the top end of the scale. However, his healthcare plan would be somewhat cheaper (because it would mandate coverage only for children, not for everybody). And he’s more dovish on the Middle East, which may or may not be good policy, but is certainly likely to save money. On trade, Obama has echoed Clinton in protectionist Pennsylvania, but is believed to be generally more trade-friendly. He has notably failed to endorse the gasoline tax cut, describing it as a “classic Washington gimmick.”

When it comes to policy, then, Obama beats Clinton in investor-friendliness, albeit not by very much.

However, the really difficult question to consider is the current state of the U.S. economy.

In 1993, the U.S. economy was emerging from a recession, with only the federal budget deficit as a major worry. On the positive side of the ledger, there were signs that the economic reforms of the 1980s had made the United States more competitive with the rest of the world. In that situation, government mostly needed to get out of the way and allow the boom to billow, and that’s essentially what President Bill Clinton did.

The 2008 version of the U.S. economy is much less clear. Indeed, the outlook is downright cloudy. Commodity and energy prices are at record levels and are likely to produce substantial consumer price inflation in the months ahead. Interest rates already are at exceptionally low levels – more than two percentage points below the rate of inflation – in order to cope with the U.S. economy’s continued financial crisis.

Housing is in a deep recession, with prices dropping more rapidly than at any time since the early 1930s. The dollar is weaker against other currencies than it has ever been, yet the United States still has a huge balance of payments deficit, suggesting it is less competitive than it should be. Stock prices, which in 1993 were at moderate levels, are today within 10% of their record highs, yet corporate earnings are declining, led largely by the disappearance of earnings from the financial sector.

Even if he – as the BBC puts it – “stood up on budget day, said nothing and then sat down again” there would still be more than 30 changes to deal with, some announced in last year’s budget and some in Darling’s pre budget report. Some aren’t particularly interesting. Others are. And the most interesting of all, or the most controversial of all –depends how you look at it – are the changes to capital gains tax.

At the moment about 250-260,000 people a year end up paying CGT with the total take coming in at not far off £5bn. However they pay it in an absurdly complicated way based on a variety of taper reliefs and inflation related indexations. This is changing: from April CGT will be applied at a flat rate of 18%. The only exception will be for entrepreneurs who will have a life time allowance of £1m of profits they may make from selling businesses. This will be taxed at just 10%. We’ve written endlessly in MoneyWeek about our feelings on this (we don’t think it is much of a big deal to be honest – see: Why you should ignore the CGT whiners) but the question now is what investors should do about it.

Prêt a profits

If you aren’t ever going to have capital gains of more than £9,200 a year the answer is probably nothing – it makes no difference to you either way. So that’s most of us safe. If you are, it might be worth selling up now. Business owners all over the country are doing just that (their CGT goes up from 10% to 18%) with accountants reporting huge work loads in the run up to April.

Even the biggest of private companies have found themselves under pressure: Prêt a Manger had been planning a £400m float but has ended up selling in a buy out for a mere £345m instead. That means that they’ve taken a hit of a possible £55m on the price (though in this environment £400m was probably pushing it) but that they’ve paid only £34.5m (10% of £345m) in tax instead of £72m (18% of £400m).

The next group of investors who need to have a think are those with large numbers of shares held in Save as You Earn (SAYE) schemes – i.e. a number worth more than the £9,200 capital gains tax limit. Consider, says Neil MacGillivray of James Hay in the Independent, the case of someone with £20,000 worth of SAYE gains. Even if you have only held the shares for a few years you should be eligible for 75% taper relief. That leaves only £5,000 as taxable income which is under the limit and not a problem. Under the new regime things are simpler but not so good: £10,800 would be subject to 18% tax and you’d end up with a bill of £1,944. So selling under the old might be a good idea if the prospects for your company don’t look too hot at the moment (which given that we are headed for recession they probably don’t).

Why not just sell now?

Finally there are the buy to let investors. There is no longer any pretending that the UK housing market is not a mess. It is. According to the Royal Institute of Chartered Surveyors 64.1% more surveyors across the country are reporting falls in house prices than are reporting rises. This figure is close to the record reported in June 1990 when 64.5% reported falls. A clear majority of surveyors are also reporting a fall off in the number of buyers around while the stock of unsold property is rising fast. So will you get a better price after April 5th than you will now? I doubt it. So why not just get out now and save what you can?

You will say that this seems mad given that if you sell right now you’ll end up paying 40% on your gains, whereas if you wait you’ll pay only 18%. And in that sense you’ll be right. But what if you think not of the tax but of the price itself? Right now you might have a chance of getting rid of your buy to let at a reasonable price. That may well not be the case in April when all the other buy to let ‘investors’ who are having trouble meeting their mortgage payments suddenly rush to sell in a effort to salvage something from their properties.

Say you have a house you think you can sell for £150,000 making gains of say £100,000. Dump it now – and you’ll pay a maximum of 40% on £90,800 assuming you are a higher rate tax payer, a total of £36,320 leaving you with £54,480. I say a maximum because you’ll probably pay less if you’ve held the property for some time (under current regulations you get taxed on only 95% of the gain after three years rising to 60% after 10 years). If you’ve held the house for ten years, your tax bill will be not much more than £21,000.

Sell the next tax year for the same price and you’ll pay 18% on the profits – £16,344 – leaving you with a nice £74,456. But only if you sell for the same price. Which you might. But you probably won’t. If I had a flat I’d held for ten years I’d be very sorely tempted to forego the chance of a slightly lower tax bill and rush to the market now. Indeed even if I’d only had it a couple of years I think I’d be thinking about it: there’s always something satisfying about getting out before the rush particularly when that rush is likely to savage prices.