Chicken Little is not the only one saying the sky is falling. Today many tax professionals and investment advisors are looking at January 1, 2013 as a financial apocalypse. The reason is simple; there is a very good chance a variety of taxes will increase starting in 2013. If you are considered a “high income” taxpayer, with income in excess of $200,000 (single) and $250,000 (married filing joint) you are subject to two new taxes:
- 0.9% tax on earned income, including wages and self-employment income in excess of the thresholds indicated above
- 3.8% tax on “net investment income,” such as interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property
Both of these taxes fund the new Medicare/Medicaid expenses under the “Affordable Care Act” better known as “Obamacare”. In addition, the Bush era tax cuts are scheduled to lapse on December 31, 2012. Under this scenario, the highest federal income tax rate rises from 35% to 39.5% and long term capital gains and dividends increase from the current maximum rate of 15% to 20% and 39.6% respectively. There is also a change to estate and gift taxation. The estate tax exemption drops to $1 million from the current $5.12 million ($10.24 million stacking lifetime exemption) and the maximum rate rises from 35% to 55%.
So, what does this really mean? For 2.4% of the US households (or roughly 4 million households), long term capital gains rate will increase by 5% or $5,000 per $100,000 in gains. Short term capital gains, salaries, pension income, interest and royalties increases from a maximum of 35% to 39.6%. So the extra tax on $100,000 more of short term capital gains and interest income at the highest rate is $8,400 ($ 4,600 income tax rate rise and $3,800 surcharge to pay for Medicare/Medicaid increased costs). For a $100,000 of qualified dividends the difference is greater: $28,400 ($24,600 in increased income taxes and $3,800 surcharge for Medicare/Medicaid increased costs). The tax increase on $100,000 of pension income and/or IRA distributions is $4,600 as only the rate rise comes from the loss of Bush era cuts changes.
Be prepared for a drop in demand for dividend paying equities and a move to more tax exempt securities, such as municipal bonds. Other than this, the effect on the market should be kept to a minimum in comparison to the volatility from Congress doing nothing about the debt ceiling or the disruptions from Eurozone credit crunch. However, we believe the likelihood of this fiscal cliff is small. The more likely scenario is a deal to keep taxes at current levels for another year by extending the Bush tax cuts.
We continually monitor the political situation for planning opportunities that could benefit you. In the meantime, you may want to consider accelerating income to 2012 from 2013 and delaying deductions to 2013 when the deductions may be more useful. It may also pay to make taxable gifts while the exemption amount is still $5.12 million per grantor rather than waiting to see what happens in 2013. Taking some capital gains in 2012 when the rate may be lower may also be prudent. We are not pushing these strategies as it is still too murky to determine what, if anything, to do!
