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Investing for the Fiscal Cliff



September 13, 2012 – Comments (2)

Board: Macro Economics

Author: yodaorange

There has been a lot of press coverage for the upcoming “fiscal cliff” (FC) that is facing the US in 2013. My crystal ball is a little cloudy on how/when the various issues will be resolved. There are so many different scenarios; it is difficult to assess which FC items will be amended, halted, or allowed to become law.

I have seen a lot of commentary on the overall GDP impact if all of the FC items become law. The Congressional Budget Office did a study projecting GDP growth of 4.4% if all of the FC changes are CANCELLED. If all of the FC cuts are allowed to become law, the GDP growth will fall to 0.5%. [1]

We can stipulate that that many investments will be affected if the FC is allowed to be become law. I am NOT going to cover those issues. What I am going to cover is some items METARites might consider taking in 2012 due to the uncertainty. Clearly, all of the FC items will impact each investor differently, so one size does not fit all. First let’s review the main FC items that are scheduled to become low in 2013.

1. Marginal tax rates. Today they are 10, 15, 25, 28, 33 and 35 percent. Unless Congress acts, they will revert to 15, 28, 31, 36 and 39.6 percent.

2. Long-term capital gains - currently 15 percent for people in the upper tax brackets and zero for folks in the 10 and 15 percent brackets - will increase to 20 percent for most people and 10 percent for those in the 15 percent bracket.

3. Today, the rate on most U.S. stock dividends is the same as the capital gains rate. Next year, this preferential treatment will end and dividends will be taxed like ordinary income (such as wages from a job) at rates up to 39.6 percent.

4. Higher-income people will see their itemized deductions reduced and their personal exemptions reduced or eliminated.

5. More couples will be subject to the marriage penalty, which means they will pay more on a joint return than they would if they each filed as singles.

6. Parents will get a smaller tax credit for their dependents and can deduct fewer child-care expenses. Many college-related deductions will be reduced.

7. More middle-income families will become subject to the alternative minimum tax.

8. The top estate-tax rate will rise to 55 percent from 35 percent, and the amount exempt from the estate tax will drop to $1 million from $5 million.

9. Obamacare 3.8% surtax on investment income for >$250k household income.

10. Temporary 2.0% increase in employee social security withholding expires, meaning a 2.0% increase in 2013.

Possible investment actions

1. Standard personal income tax strategy is normally to defer income into later years. Stated differently, why pay taxes today that you can pay later. The FC would have you do the opposite.

2. A small number of employees might have the possibility of pulling income into 2012 that would normally be taken in 2013. If you can do that, you will save the 2% SS tax increase. Most employees cannot change when they receive income, so this is of limited benefit.

3. LARGE AND CONTROVERSIAL ITEM! Consider taking capital gains in 2012 that you had planned taking in the next year or two. Let’s say you are sitting on a large gain in a stock but likely would sell it in 2013. You can sell it in 2012 and get the lower capital gains tax rate. NOTE that you can REPURCHASE the same stock the same day. Unlike wash sell rules on losing positions, there are NO limitations on repurchasing shares with gains. So you can continue holding the investment until you would have otherwise sold it.

If you plan on holding the stock ad infinitem, I would NOT sell it for tax reasons. I would take the chance that over the very long term >5 years, you will come out ahead by not paying taxes early. For example, maybe your income drops and puts you into a lower tax bracket when you decide to sell it. Or maybe you plan to pass it along to your heirs in your estate which would qualify for a stepped up basis.

4. Alternate Minimum Tax is a NIGHTMARE because it is not settled for 2012. Typically Congress passes the AMT “patch” towards the end of the year or early the next year. Then they tell the IRS how to implement it. Maybe this is the year that Congress does NOT pass the AMT patch. I don’t know and personally would not recommend any investment action that presupposes one way or the other.

5. “Throw mama from the train” is here once again with the uncertainty in estate tax rates and the exemption amount. This came up back in 2010 when estate taxes went to zero for one year. Recall that George Steinbrenner was able to pass down literally billions in assets without paying any estate tax. With estate taxes set to rise dramatically in 2013, it creates some perverse incentives. For estates less than $ 1 million, it will not make any difference. If your estate is > $ 1 million, I recommend you consult an estate attorney. They are easy to spot these days with their frazzled looks around the law firm. The estate attorney can discuss the alternatives you have. It is beyond the scope of this post to address all of the possible alternatives.

BOTTOM LINE is that we do not know how the fiscal cliff tax issues will be resolved. (At least Yoda does not!) With this uncertainty, each investor will have to decide which tax minimization actions to over 2012 and 2013.

Good luck and may the force be with you. . .


[1] Congressional Budget Office study on Fiscal Cliff impact on GDP

2 Comments – Post Your Own

#1) On September 13, 2012 at 10:39 PM, awallejr (41.30) wrote:

I learned something here.  Not being a tax expert I didn't realize that the 30 day "wash" rule applied only to losses. I thought it to be a general rule for reseting a stock's basis.

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#2) On September 14, 2012 at 12:27 AM, Imperial1964 (93.81) wrote:

"The Congressional Budget Office did a study projecting GDP growth of 4.4% if all of the FC changes are CANCELLED. If all of the FC cuts are allowed to become law, the GDP growth will fall to 0.5%."

ROFL!  4.4& GDP growth?  In what year??? 

It sounds more to me like around 2% vs. -2% for 2013.

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