Most years, year-end tax planning for securities trading is fairly straightforward: Clients should consider taking losses in taxable accounts. Those losses can shelter clients' gains from tax while up to $3,000 of net capital losses can be deducted on their tax return for the year. "Any net losses above $3,000 are carried over to future years," says Roger Lusby, tax partner at accounting firm Frazier & Deeter in Atlanta. Such loss carryovers can offset future realized gains and generate annual $3,000 tax deductions, until they've all been used.

CH-CH-CH-CHANGES

In 2009, though, year-end planning may be anything but straightforward because of the extraordinary events of 2008 and the uncertain prospects for future tax rates. In 2008, stocks had their worst year since the 1930s and many types of bonds also saw significant losses. By now, many clients have amassed a sizable "bank" of capital losses.

"Capital loss carryovers are a valuable asset," says Glenn Frank, senior vice president at Wachovia, a Wells Fargo Company, in Waltham, Mass. "You want to maximize the benefit from that asset without hurting the portfolio." (Moreover, many mutual funds have realized and unrealized losses, so capital gains distributions might not be much of an issue this year.)

After a first-quarter plunge, stocks rallied sharply this year, with some fund categories-such as Latin American stocks (63%), diversified emerging markets (46%), Pacific/Asia ex. Japan (45%), technology stock funds (39%)-up more than 35% for the year-to-date through August 31, according to data from Morningstar.

"With the run-up in the market," Lusby says, "people do have some gains to help absorb the large carryovers from 2008." That is, losses may not have to be carried over for many years if they can offset realized gains in 2009.

Tax rates, including the rates on long-term capital gains, are likely to rise, most observers predict. Upper-income taxpayers are especially vulnerable. The Treasury Department's Green Book, released in May, spelled out the Obama Administration's tax proposals. If Congress adopts its program, today's top 33% and 35% tax brackets will be raised to 36% and 39.6%; taxpayers in those brackets, including many financial planning clients, will see the tax on long-term gains raised to 20%.

The Green Book puts the date for those increases at 2011. But rembmer, that's just a proposal. Congress could move tax-rate increases up to 2010, in an effort to cope with mounting budget deficits and to pay for any new healthcare plan. What's more, there is no guarantee that the capital gains rate will hold at 20%: Long-term gains were taxed at 28% as recently as 1998.

This year, taxpayers in the 10% and 15% income-tax brackets can take advantage of a 0% tax rate on long-term capital gains. Thus, single taxpayers owe 0% on long-term gains as long as their taxable income is no more than $33,950 this year; for couples filing joint returns, the cutoff is $67,900. A married couple with $50,000 in taxable income, for example, could realize $17,900 in long-term gains by year-end and owe 0% on those gains.

The 0% rate also is scheduled to run through 2010. According to the Treasury Department, the Obama Administration wants to make this rate permanent for low-bracket taxpayers. Again, there is no way to know how a future tax law will address this topic.

LOSS LEADERS

With all these circumstances to consider, how should financial planners advise clients on year-end trading? It may make sense to realize any losses from the 2007 to 2009 bear market and bank them against future gains.

"We think that the capital gains tax rate is going up so we're harvesting all the losses we can," says Kathy Stepp of Stepp & Rothwell, a financial planning and investment advisory firm in Overland Park, Kan. "We're pretty much done by now because we started last fall." With a large bank of losses, future realized gains can be tax-free, no matter how high rates may go.

Nonetheless, some planners should move cautiously to avoid taking excess losses, cautions Lisa Osofsky, a partner at Weiser, an accounting firm in New York City. "Some states, such as New Jersey, Pennsylvania, New Hampshire and Tennessee, don't permit capital loss carryovers," she says. "If the tax rates in those states are steep, investors might not want to take too many losses in one year."

Suppose, for example, John Smith takes $50,000 worth of losses in 2009 and $20,000 worth of gains. His gains will be tax-free; he'll deduct $3,000 of excess losses from income and carry over $27,000 worth of losses on his federal tax return. However, some states will not recognize the carryover so future gains may be subject to state tax. "Often, states don't have a preferential rate for capital gains," Osofsky says. "In New Jersey, for example, there are no loss carryovers and some residents have a tax rate over 10% on their income and capital gains alike."