Here we are again, standing at the edge of the unknown.
This administration and Congress were unable to put together a tax policy that would provide some stability of expectations. In addition, they have kicked the can down to road ... and the road ends on Dec. 31, 2012. Does anyone wonder why businesses have not been hiring at a greater rate over the past few years?
This coming perfect economic storm is known as the "fiscal cliff." It's a series of events that are scheduled to take place by the beginning of next year. These could have significant effects on our economy and our wallets. Many economists expect a reduction in our country's gross domestic product by up to 4 percent if all events occur.
The events
Let's take a look at a few of the more prominent tax and spending events that are scheduled to take place:
- The Bush Tax Cuts have been in effect for 10 years. With the expiration of these tax rates at the end of this year, 83 percent of U.S. households would experience a $3,700 average increase in taxes paid. Taking this amount of money out of a family's pocket not only immediately hurts the family, but will likely have a stifling effect on the economy. Because the individual/family can spend their money more efficiently than the government, this transfer of funds to the government could ultimately reduce our GDP. Those individuals in the higher tax brackets should begin to consider alternate methods of investment that are more tax efficient.
- In 2011, the government provided for a 2 percent reduction in the Social Security Taxes paid by each individual. This 2 percent rates reduction is expected to expire December 31, 2012. There appears to be little interest within the government to extend this reduction. Those paying the Social Security Tax should expect to be paying 2 percent more starting in January.
- There are a myriad of new taxes imbedded within the Affordable Care Act. One tax that is specific to investors and possibly home owners is the 3.8 percent Medicare Tax on unearned income. Unearned income is derived from investing capital. This may include capital gains, rents, dividends and interest income. This tax should only affect those with adjustable gross income over $200,000 for the individual or $250,000 for married couples filing jointly. These individuals will be paying 3.8 percent more taxes on their realized unearned income.
- Investors in stock will have a decision to make as the new year approaches. Should they sell their current stock that have appreciated in value and be taxed at the lower rate, or wait until after the new year in hopes that their holdings will increase beyond the extra 3.8 percent tax that will be levied after Jan. 1? This precipice could trigger a sell off by individuals being subjected to this tax. Those that will be affected by this tax going forward should also consider alternate investment options that may reduce their tax liability.
This same tax could also affect those selling their homes since any gains resulting from the sale of a home are considered a capital gain.
- On the spending side, there are a number of events that will also take place starting Jan. 2. The most notable is the budget sequestration. These forced spending cuts, in the amount of $1.2 trillion (over ten years), are a result of Congress not being able to come to an agreement for specific spending cuts. As a result, an across-the-board cut will occur. Approximately half of this cut will be applied to defense spending. Although these spending cuts may help reduce our national debt, a more immediate effect will befall the defense contractors. We are already beginning to hear suggestions of layoffs in this industry due to the expected spending cuts. In the short term, this may decrease our gross national product.
- Tax Relief and Job Creation Act of 2012 extended emergency unemployment benefits through 2012. This is due to expire Dec. 31. This will have a direct impact on many individuals struggling to find employment.
- Congress has routinely provided a periodic fix for Medicare Payments for Physicians. By an act of Congress in 1997 a formula is used to establish reimbursement rates. The formula has triggered projected pay cuts in past years and has become very controversial. Each time before these cuts are to occur, Congress has provided a fix. It is likely they will do so again. However, if they can not find common ground for this fix at the end of the year, health care access for Medicare patients could be reduced.
Seek help
In addition to the events described above, there are numerous smaller but similar events that are also scheduled to occur after the New Year.
It is not likely that all of these events will come to fruition. However, with a Lame Duck Congress and the strong polar encampments between our two political parties, a combination of these events could upend our fragile recovery. As an investor, you must stay on top of these events and be ready to make decisions concerning your invested capital as needed. Your investment adviser and/or accountant should be able to help steer you through this turbulent time.
HERMAN KRUG is an accredited asset management specialist designee with Stourbridge Capital Partners LLC in Honesdale. He can be reached at hkrug@stourbridgecapital.com.