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Sunday, November 18, 2012 - Page updated at 07:30 p.m.
‘Fiscal cliff’ throws off experts’ year-end tax advice
By Mark Davis
The Kansas City Star
At 72, Paul Nagorski likes to own stocks that come with their own payday. Dividend checks add to his income.
The Kansas City, Mo., resident soon may share more of his investing income with Uncle Sam. Like other investors, he’s heading for a tax cliff Jan. 1.
“I’ll pay more,” Nagorski said. “I can afford to do it. I don’t like to do it.”
Now that the election is over, attention has turned to how President Obama and Congress deal with the automatic tax increases and spending changes set to kick in New Year’s Day. Lawmakers had set up this “fiscal cliff” to force themselves to negotiate a long-term reduction in the federal deficit.
Failure to reach a deal would mean a sudden drop in federal spending, an end to the Bush-era tax cuts and other tax changes Jan. 1.
Dividends, stock gains, estates and even ordinary income would be taxed at higher rates — with the impact felt broadly in the investing world.
The standard advice, to sell losers to offset profits and reduce taxes, is morphing into recommendations of selling winners to take advantage of lower capital-gains rates set to rise in 2013. And, to consider saving some stock losses to take next year when they would protect income from higher tax rates.
Some companies flush with cash are cutting special dividend checks to shareholders before the year ends. Those dividend benefits may be harder to come by next year if tax rates were to climb and companies decide to pay out smaller rewards.
Most investors pay a 15 percent tax rate on stock dividends and capital gains. But investors with higher incomes also would see a new tax on their dividends and higher capital-gains rates.
Expect stock prices to suffer. “The tax side of the fiscal cliff is onerous to all stocks,” said Mark Eveans, chief investment officer at Meritage Portfolio Management in Overland Park, Kan.
One simple reason is that higher taxes mean investors will keep less of the rewards. If owning a stock is less rewarding, investors won’t be willing to pay as much.
The tax on capital gains would climb to 20 percent; stock dividends would be hit even harder.
Instead of owing 15 percent, investors who collect dividend checks would be taxed at their regular individual income tax rates. For many, the dividend bite would jump to 28 percent or higher as some tax brackets disappear and the higher tax brackets begin to apply at lower income levels.
For example, the 15 percent income-tax bracket currently extends to $70,700 of income for a couple filing jointly, according to H&R Block. Come Jan. 1, it applies up to only $58,200 in income. And the 25 percent bracket disappears, setting 28 percent as the next bracket, according to Block.
The highest tax bracket climbs from 35 percent to 39.6 percent next year.
But the tax cliff doesn’t stop there. Individuals with incomes of $200,000 or more, or couples earning $250,000 or more, would start to pay a 3.8 percent additional Medicare surtax on their investment income, including dividends.
Combined, it means higher-income investors would see their dividend tax rate jump from the 15 percent rate to 43.4 percent.
Investors inside tax-deferred IRAs and 401(k) accounts shouldn’t feel immune to the tax cliff.
Dividend stocks have become increasingly popular as interest rates on bonds have plunged to historic lows. The lower tax rate on dividends has added to their investor appeal, as interest income doesn’t qualify for the special 15 percent tax rate.
The upshot is that many investors may decide highly taxed dividends aren’t for them and sell those stocks, which could hurt the stocks’ prices. More may prefer municipal bonds that don’t trigger a federal tax bill.
“Even if you do nothing because of this, other investors will do things,” Romey said.
Jan. 1 also may bring changes to estate taxes and gift taxes, influencing the advice from estate planners.
The 2012 tax rules exempt $5.2 million from the 35 percent estate tax. Next year, the exemption falls to $1 million; the rate jumps to 55 percent.
In September, a Commerce Trust planner suggested clients “think big” in terms of gifts this year before scheduled tax changes next year make them more difficult to do.
Small gifts to charities and other regular charitable deductions, however, would be more valuable next year when tax rates are higher.
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