The Tax Cuts and Jobs Act makes significant progress toward its goal of reducing taxes for American families and businesses, simplifying the tax code, and encouraging a more competitive tax environment for job creators.
However, among the many details that the conference committee had to address is a “first in, first out,” (or FIFO) provision whose disposition remains unknown as of Wednesday afternoon. FIFO was contained in the Senate’s version of the bill, and does not reflect the priorities of simplicity and competition. Rather, it complicates things for many average Americans investing or saving for retirement, reduces choice for individual retail investors, raises the taxes on the returns on savings, and further widens the disparity between professional investors and average retirement savers.
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FIFO would deprive shareholders of the ability to choose which of their shares they want to sell when calculating the capital gains tax. Instead, it would require them to sell their shares in the order that they were first acquired (hence the name), generally resulting in the highest earning shares being sold first.
This change is intended to prevent investors from avoiding capital gains taxes by selecting securities to sell that were originally bought at a higher price. It is projected to raise some revenue, but only around $2.6 billion over ten years — a sliver of the overall $1.5 trillion cost of the overall bill. Further, this change creates a number of problems that disproportionately affect long-term retail investors.
Under the current system, if a retirement saver wants to sell some shares of a security to meet retirement needs (hopefully while minimizing their capital gains tax burden), they simply instruct their broker to sell the shares and the broker does it. Under FIFO, those same retirement savers would be required to pull up investment records from the first shares deposited into their account, possibly dating back several decades and several brokers. It’s not clear if this burden’s revenue savings justify it.
Second, requiring investors to follow FIFO denies them the ability to manage their investments strategically to keep their taxes low and will instead, in most cases, require them to sell first the shares that will increase their tax burden. More often than not, the oldest shares in a brokerage account were purchased at a lower price than the newer shares in the account. If the early shares were purchased at $10 and the later shares were purchased at $100, selling the earlier shares would result in a $90 extra capital gain that would be taxed as such. If the investor were able to choose to sell the later shares, he would be able to avoid a steep capital gains tax of up to 23.8 percent of that $90.
Finally, the provision further exacerbates the disparity between individual retail investors, such as many retirement savers, and big institutional investors that run, for example, mutual funds. Specifically, FIFO would exclude regulated investment companies from its requirements. If middle-class savers are barred from managing their investments in such a way as to minimize their tax liability, it would stand to reason that professional investors should be subject to the same rules.
Among the many differences and priorities facing the conferees, FIFO may not rise to the level of producing headlines and constituent phone calls. It should, however, be carefully considered based on whether it helps achieve the bill’s underlying goals of promoting economic growth, eliminating loopholes, and simplifying the tax code. It may very well fail this test, and should therefore be deliberated along with the other, more high-profile differences between the House and Senate bills.
Meghan Milloy is director of Financial Services Policy at the American Action Forum.
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