By Jill Schlesinger
Tribune Media Services
With less than three months before the end of the year, time is short to plan for the much-dreaded “fiscal cliff.” What is the fiscal cliff, you ask? It’s the combination of tax increases and spending cuts that are scheduled to go into effect in January of 2013.
On the tax side of the ledger, the Bush-era tax cuts are set to expire, which will bring taxes back to 2001 levels; President Obama’s 2 percent payroll tax cut will expire; and a series of other temporary tax cuts for businesses that Obama enacted will end, including the enhanced dependent care credit, the enhanced child credit, the enhanced adoption credit, a portion of the enhanced earned-income credit, the repeal of the personal exemption phase-out, the repeal of the limit on itemized deductions, the enhanced student loan interest deduction and the exemption for mortgage debt forgiveness.
Additionally, the following tax cuts have already expired, but they are up for renewal in 2013: the Alternative Minimum Tax (AMT) adjustment, the deduction for state and local sales taxes, the IRA charitable donation provision for taxpayers 70 1/2 and older and the educator’s classroom deduction.
If all of the planned cuts were to occur, it’s estimated that 80 percent of Americans would see some form of tax increase next year. The Bush tax cuts alone would impact 100 million Americans. The Tax Policy Center estimates that the average U.S. household would face an average of a $3,700 jump in taxes.
The tax increases, along with the broad spending cuts set to occur as a result of last year’s debt ceiling deal, could throw the country into another recession. Maybe lawmakers will get their acts together and come up with a plan, but with less than two months after the election to strike a grand bargain, it seems unlikely. Many expect lawmakers to hatch a temporary deal that would prevent jumping off the cliff on January 1; however, just in case they don’t, here are a few potential actions to take:
Take capital gains this year.
Investors should be aware that the current capital gains rate of 15 percent will rise to 20 percent in 2013. Additionally, the new health care reform will levy an additional surtax of 3.8 percent on certain investment income (which includes capital gains).
Given these potential tax increases, if you are sitting on ample gains in a taxable account, it could make sense to sell the position and lock in the 15 percent capital gains rate this year. Even if Congress averts jumping off the cliff, most economists believe that capital gains rates will likely rise over the next five years. Additionally, this could be a great opportunity to rebalance your portfolio with lower cost assets, like no-load index funds.
Review your estate plan.
Right now, each tax payer is entitled to a federal tax exemption that wipes out the estate tax due on the first $5,120,000 of an estate. The top tax rate above that threshold is 35 percent. When the Bush tax cuts expire, the exemption will drop to $1 million, and the tax rate will increase to 55 percent. If you haven’t reviewed your estate plan in a few years, it’s a good time to dust off the file and make an appointment with your estate attorney.
Prepare to spend more on health care.
While the debt ceiling deal removed Social Security, Medicaid, supplemental security income, refundable tax credits, the children’s health insurance program, the food stamp program and veterans’ benefits from the chopping block, Medicare is facing a 2 percent cut to providers and insurance plans. Some of those cuts are going to be passed on to consumers, so prepare to allocate more of your annual budget to health care costs.
Jill Schlesinger, CFP, is the Editor-at-Large for www.CBSMoneyWatch.com. She covers the economy, markets, investing or anything else with a dollar sign on her podcast and blog, Jill on Money, as well as on television and radio. She welcomes comments and questions at askjill@moneywatch.com.
This was printed in the November 4, 2012 – November 17, 2012 Edition
