WASHINGTON Oct 10 It's time to watch Washington
to see just how bad your New Year's eve is going to be. Without
any action in the Capitol, the U.S. economy is said to be poised
to fall off of a "fiscal cliff."
Projected increases in taxes and cuts in spending would
throw the economy into another recession, says the Congressional
Budget Office, and it could throw your family finances over the
edge, a cc ording to analysts.
That's because of several issues all hitting at once. The
George W. Bush-era tax cuts expire on December 31, and without
any extensions personal income tax rates will rise, as will
rates on capital gains and dividends. Also expiring is the
temporary 2 percent payroll tax cut that has boosted workers'
paychecks for the last two years. Beginning on January 1,
there's a new 3.8 percent surtax on investment income for people
earning more than $200,000 ($250,000 for couples).
At the same time, $109 billion in across-the-board federal
spending cuts on everything from education to Medicare to
national park budgets are supposed to hit in January; they are
the result of a process called "sequestration" that was part of
the 2011 debt ceiling deal.
Oh, and another passel of tax breaks, including the
perennial patch that exempts some 30 million Americans from the
alternative minimum tax (AMT), already expired on December 31,
2011, and has not been extended - yet.
Does all of that make you feel like jumping off that cliff?
Don't panic. It's unlikely that everything will get fixed by
January 1, but it's also unlikely that nothing will get fixed.
(For example, the folks at Intuit Inc's TurboTax unit are so
sure the feds will eventually do that AMT patch, they are
already programming their software as if it's a done deal.)
But here in the District of Columbia, nothing is moving now
except jawbones. After the election, Congress could jump in and
enact some quick fixes - extensions to the 2011 tax breaks and
another kick-the-can-down-the-road measure to smooth the tax and
budget issues for 2013. Or not.
Meanwhile, we all have to protect ourselves. Here's how to
put up your own guardrails and then stand aside as policymakers
rush to the precipice. It's where they do their best work.
-- Sell or give away winning stocks. Right now, long-term
capital gains are taxed at a maximum rate of 15 percent. They
have a 0 percent tax rate for people with adjusted gross income
under $35,350 ($70,700 for couples).
"That is the lowest rate they have ever been in our
near-term history, and it's scheduled to go away," says
TurboTax's Bob Meighan. You can't get a better tax rate than
zero, so if you have the wherewithal to help your low-bracket
young adult kids, you might start by giving them shares of
Even if you don't have anyone in the zero bracket to give
those shares to, you could sell them yourself, locking in gains
at comparatively low tax rates. The best-case scenario for
investors would be that the 15 percent rate get continued;
nobody is predicting it will get lower than that. And folks
earning enough to be hit by that 3.8 percent investment surtax
would save by selling this year too.
-- Be very charitable. There are many scenarios in which
your charitable deductions could be worth less in the future.
Republicans have been talking about capping those deductions for
high-income taxpayers. There's some talk of a Reaganesque
rate-lowering, deduction-trimming tax reform that could reduce
the value of your contributions as tax breaks. And wealthy folks
- anyone with more than $1 million to pass on to their heirs -
could see tighter estate tax limits in 2013 and beyond.
The bottom line? If you can afford it, 2012 is a good year
to set up your own donor-advised charitable fund, or give more
than usual to your favorite cause. It's also a good year to fund
a family trust or give a large estate-tax escaping gift to
family members, but hurry up: Most estate tax attorneys have
been slammed since mid-summer.
There's one exception. Retirees over 70 1/2 who have to take
mandatory distributions from their individual retirement
accounts had been permitted to make contributions to their IRAs
without taking a tax hit. That went away at the end of 2011.
Will it come back for 2012? Experts like Meighan view that as
unlikely, but it could happen. He's telling folks who would be
affected to wait and see what happens in November and December.
-- Live below your means. Your paycheck is highly likely to
go down in January, because there's scant defense being mounted
of that temporary payroll tax cut. Assume you'll be paying 2
percent more in payroll taxes come January, so don't commit to
spending every bit of every paycheck.
-- Do the opposite of what you'd usually do. "This year we
are telling people to accelerate income and defer deductions,"
Rick Bailine of McGladrey & Pullen LLP told Reuters journalists
recently. He's expecting some tax rate increases to materialize,
especially for high income taxpayers. That means grabbing your
bonus now if you're given the option, instead of in January - if
there's a bonus to be had. His view is that tax rates are headed
up; even if that doesn't happen immediately, the very long-term
view is that we're currently in a low-rate period by historical
norms. "Even if you are wrong by six months, that still makes
good sense," he says.
-- Just wait and see. Charles Rotblut of the American
Association of Individual Investors is telling members not to do
any dramatic portfolio adjusting in advance of congressional
action because anything can happen. "People will do more harm by
placing a big bet assuming one outcome and having another
outcome appear," he says. Instead, he's telling people to look
ahead many months or years, to the long-term trend.
That trend could have you cherry-picking a different kind of
stock to hold, however. Defense and healthcare companies both
could suffer if even a portion of the across-the-board budget
cuts are allowed to phase in, and both sectors could suffer
anyway as the war in Afghanistan phases down and healthcare
reform phases in. Dividend-paying companies could take a hit,
too, if taxes are to rise over the long term on dividends.
-- Plan for a busy December. Perhaps the best news now is
that you don't have to jump on any of this. You can wait to see
whether the lame duck Congress that comes back after the
election does anything in a hurry. If the past is any guide, all
will become clear right around Christmas eve. That gives you a
week to buy, sell, write checks, make gifts and talk to your
adviser. Maybe you should make that appointment now.