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Understanding the Potential Impact of a Fiscal Cliff Compromise
12-11-2012 |It seems as though you can’t turn on a news channel these days and not hear some discussion about the impending Fiscal Cliff. These discussions generally involve some type of doomsday scenario where the economy, and stock markets, “fall off of a cliff” as a result of the draconian spending cuts and tax increases that could take place if changes are not made by the end of 2012 as they relate to the expiration of the Bush Tax Cuts and the spending cuts proposed under the Budget Control Act of 2011.
While many doubt the ability of Democrats and Republicans to come together and reach a compromise to prevent such a doomsday scenario from occurring, we, at Hennion & Walsh, believe that the potential doomsday scenario, at least in the immediate/short-term perspective (perhaps the “Fiscal Slope” is a more appropriate term for the situation), has been overplayed by the media and that a compromise will occur prior to the end of the year. However, it is in the details of that compromise that investors need to be aware as these details could play a large role in how their portfolios are managed, and taxed, in 2013 – and beyond.
Aside from the spending cuts that we believe will, and should, be a part of any compromise, and another potential adjustment to the federal debt ceiling, tax areas that could be impacted by these Fiscal Cliff negotiations include, but are not limited to, the following:
- Income Taxes
- Long-Term Capital Gain Taxes
- Tax Treatment of Qualified Dividends
- Estate Taxes
- Payroll Taxes
With credit to Wells Fargo Advisors in a November 2012 article entitled, “Tackling the Fiscal Cliff” there are the potential tax treatment changes to these areas if Washington does not reach some form of a compromise on them accordingly.
- Income Taxes
Current Tax Rate
New Tax Rate if Congress Does Not Act
10%
N/A
15%
15%
25%
28%
28%
31%
33%
36%
35%
39.6%
- Long-Term Capital Gain Taxes
Tax Bracket(s) Affected Current Tax
New Tax Rate if Congress Does Not Act
10%-15% Tax Bracket 0%
10%
25% – 35% Tax Bracket 15%
20%
- Qualified Dividend Taxes
Current Tax
New Tax Rate if Congress Does Not Act
0% & 15% (consistent with current long-term capital gain taxes as seen in (2) above)
15% – 39.6% (would be treated as regular income)
- Estate Taxes
Estate Exemption/Tax Rate Current
New Levels if Congress Does Not Act
Exemption $5.12 million
$1 million
Tax Rate 35%
41%-55%
- Payroll Taxes
Salary Additional New Tax if Congress Does Not Act
$25,000 $500
$50,000 $1,000
$100,000 $2,000
$110,100+ $2,202
While it is not clear, at this point in time, what the ultimate outcome will be from the on-going Fiscal Cliff debates and negotiations, based on our analysis of the publicly stated positions of both parties, we believe that the ultimate compromise that will be reached in 2012 will more than likely involve multiple levels of tax increases, though some elements of the tax increase and spending cut negotiations may be diverted/postponed to a future point in time.
As a result, we recommend that investors sit with their Financial Advisors, and Estate Planning Attorneys, to help ensure that their portfolios are prepared for these new potential tax treatments if, and when in certain cases, they come to fruition.