The Fiscal Cliff

With the 2012 Presidential election over and President Obama reelected for a second term, it’s imperative that our clients pay attention to how the next four years will impact their financial lives. Please read “On the Precipice: the “Fiscal Cliff” to learn more about how possible taxes and spending cuts might affect your financial position. Please don’t hesitate to contact us to discuss your options with regard to a year-end tax strategy or your investments.

Definition
The phrase “fiscal cliff” has been used to describe the unique combination of financial realities scheduled to take effect in 2013: expiring tax breaks; the imposition of new taxes on high-income individuals; and automatic deficit-reduction spending cuts.

Expiring Tax Breaks
Lower federal income tax rates, part of the tax landscape for more than ten years, expire at the end of 2012. We’ll go from six federal tax brackets (10%, 15%, 25%, 28%, 33%, and 35%) to five (15%, 28%, 31%, 36%, and 39.6%). The maximum rate that applies to long-term capital gains will generally increase from 15% to 20%. And while the current lower long-term capital gain rates now apply to qualifying dividends, starting in 2013, dividends will be taxed as ordinary income. The temporary 2% reduction in the Social Security portion of the Federal Insurance Contributions Act (FICA) payroll tax, in place for the last two years, also expires at the end of 2012, as do temporary breaks relating to the federal estate and gift tax.

Several other significant breaks go away in 2013 as well. Itemized deductions and dependency exemptions will once again be phased out for individuals with high adjusted gross incomes (AGIs); the earned income tax credit, the child tax credit, and the American Opportunity (Hope) tax credit all revert to old, lower limits and less generous rules; and individuals will no longer be able to deduct student loan interest after the first 60 months of repayment. Lower alternative minimum tax (AMT) exemption amounts (the AMT-related provisions actually expired at the end of 2011) mean that there will be a dramatic increase in the number of individuals subject to AMT when they file their 2012 federal income tax returns in 2013.

New Taxes
Beginning in 2013, the hospital insurance (HI) portion of the payroll tax–commonly referred to as the Medicare portion–increases by 0.9% for individuals with wages exceeding $200,000 ($250,000 for married couples filing a joint federal income tax return, and $125,000 for married individuals filing separately).

Also beginning in 2013, a new 3.8% Medicare contribution tax is imposed on the unearned income of high-income individuals. This 3.8% contribution tax applies to some or all of the net investment income of individuals with modified adjusted gross income that exceeds $200,000 ($250,000 for married couples filing a joint federal income tax return, and $125,000 for married individuals filing separately).

Mandatory Spending Cuts
The failure of the deficit reduction supercommittee to reach agreement in November 2011 automatically triggered $1.2 trillion in broad-based spending cuts over a multiyear period beginning in 2013 (the official term for this is “automatic sequestration”). The automatic cuts are to be split evenly between defense spending and non-defense spending. Although Social Security, Medicaid, and Medicare benefits are exempt, and cuts to Medicare provider payments cannot be more than 2%, most discretionary programs including education, transportation, and energy programs will be subject to the automatic cuts.

Understanding the “Cliff”
Many fear that the combination of tax increases and spending cuts will have severe negative economic consequences. According to a report issued by the nonpartisan Congressional Budget Office (Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013, May 2012), taken as a whole, the tax increases and spending reductions will reduce the federal budget deficit by 5.1% of gross domestic product (GDP) between calendar years 2012 and 2013. The Congressional Budget Office projects that under these fiscal conditions, the economy would contract during the first half of 2013 (i.e., we would likely experience a recession).

Refer a Friend

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matter addressed herein. Securities offered through Triad Advisors Member FINRA, SIPC. Advisory Services offered through EagleStone Wealth Advisors, Inc. EagleStone Wealth Advisors, Inc. is not affiliated with Triad Advisors.This communication is strictly intended for individuals residing in the state(s) of DC, MD and VA. No offers may be made or accepted from any resident outside the specific states referenced.

 
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2014

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Securities offered through DAI Securities, LLC. Member FINRA/SIPC. Advisory Services offered through EagleStone Tax & Wealth Advisors. EagleStone Tax & Wealth Advisors is not affiliated with DAI Securities. Financial planning, investment and wealth management services provided through EagleStone Wealth Advisors, Inc. Tax and accounting services provided through EagleStone Tax & Accounting Services.

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