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Can you avoid falling off the ‘fiscal cliff’?

Americans follow a lot of metrics on Wall Street, but right now they are closely following a situation in Washington that involves our dysfunctional Congress.

There are several dates you need to examine leading up to the “fiscal cliff,” which is creating uncertainty for business owners, investors and taxpayers in general.

What is the fiscal cliff? The term refers to a series of dates when automatic U.S. federal budget-spending cuts are supposed to begin and some popular tax cuts, already extended, should expire.
On Jan. 2, 2013, for instance, $1.2 trillion in automatic, or “sequestered,” spending cuts are set to start. Meanwhile, a series of tax cuts on dividends and capital gains enacted under President George W. Bush — and extended by President Obama — as well as reductions to payroll taxes, are scheduled to end.

Investors fear that if tax cuts are not extended again, and the government spending slows, that could knock off 3 to 4 percent of GDP next year. The U.S. economy grew at an annualized rate of 1.5 percent in the second quarter this year, so by definition our economy would once again be in a recession.

In fact a recent poll by Gallup states that 71 percent of U.S. investors think concerns about the fiscal cliff will force consumers and businesses to pull back on spending and investing — slowing the economy in the second half of 2012. (See: behavioraleconomy.gallup.com/2012/08/ryan-addition-fiscal-cliff-could-halt.html, petermontoya.com, montoyaregistry.com, marketinglibrary.)

Can you avoid falling off the ‘fiscal cliff’?

At Main Street Tax Advisory, we typically recommend deferring income until the next tax year while accelerating losses in the current year, when possible.

In 2012, however, we are advising clients to make every effort to employ tax loss harvesting. Book gains on winners in their portfolios now because it is possible that tax rates will be even higher on dividends and capital gains next year. More importantly, recognizing gains in 2012 will allow for tax-free gains when matched up against prior year’s losses.

We are advising clients to be proactive. Since new taxes go into effect in 2013 and the possibility of long-term capital gains taxes increasing to 20 percent from 15 percent, clients should develop solid scenario plans that take into account:
• Capital gain harvesting
• Roth IRA conversions
• Planning for the Obamacare health care surtax
• Exercising stock options and RSUs

Because investors don’t know what the tax rates will be, there may be an acceleration of sales in the stock market between now and the end of this year. We already know the fiscal cliff won’t be addressed before the elections. So a lame-duck Congress has only a few weeks from Nov. 6 to the end of 2012 to address the fiscal cliff.

Taxes make a difference in your portfolio’s returns. Consider that from 1926 to 2011, the average return on stocks after taxes was 7.7 percent, compared with 9.8 percent before taxes; Bonds averaged a 3.7 percent return after taxes, compared with 5.7 percent before taxes in that same period, according to data compiled by Morningstar.

Consider other income-deferral methods. This can be as simple as making sure to contribute the maximum to your 403(b), 401(k) or 457(h) at work. If you are a business owner, be sure you have the most advantageous retirement plan.

Chris Torchiana is the owner of Main Street Tax Advisory of Northern California, LLC, in El Dorado Hills. For more information visit taxplanningguy.com or call 1-888-856-6696.

 

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Posted by on Aug 17 2012.
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