As the end of the year approaches, investors are keeping a close watch on Washington, D.C.

The reason: The tax cuts enacted under president Bush are scheduled to expire unless lawmakers intervene. If the cuts take place as scheduled, investors and those with higher incomes would face a significant impact.

For the highest earners, the ordinary income-tax rate would rise to 39.6% from the current 35%. And the current tax rate on dividend income would jump from 15% to as much as 39.6%. Furthermore, the rate for long-term capital gains is would increase from 15% to 20%.

Meanwhile, a new 3.8% Medicare-contribution tax will go into effect next year under the Affordable Care Act. The tax will not only apply to ordinary income above $200,000 for individuals and $250,000 for joint filers, but it will apply to dividend income for those whose earned taxable income exceeds those thresholds.

The details can get a bit complex, but the basic idea is that taxes could go way up soon—so it’s important to prepare now.

Every individual’s situation is different, of course. But the key decisions for those looking to limit the impact of potentially higher taxes revolve around whether to sell or hold appreciated assets.

A strategy for the owners of stock, for instance, is to sell winners this year—while rates are still low—and buy similar stocks to replace them. Within that strategy, there are decisions to be made. One decision: whether to sell everything at once, or to stagger the trades in order to hedge against the risk of selling at the wrong time.

On the other hand, investors with well-balanced, diversified portfolios may be best off standing pat. Such portfolios are already positioned for events such as big tax increases. Likewise, owners of tax-deferred retirement accounts and annuities aren’t immediately affected by the tax increases, so there’s no advantage to selling.

Investors who are more focused on wealth transfer than retirement income probably don’t need to act. That’s because inherited stock is valued at its current market price, and if your heirs sell right away, they’ll owe little or no capital-gains tax.

In today’s polarized political climate, no one is really sure whether the Bush tax cuts will be allowed to expire. But because of what’s at stake, the possibility of a tax increase is a good enough reason to review your portfolio.

Smart investors will get their plans squared away soon. Because of the December holidays and other factors, those who find they need to do some selling should do so by mid-December at the latest. >