- Fiscal Cliff: Mass spending cuts and tax increases will take effect in January if the President and Congress can’t agree to stop it. That could mean a tax hike for some 90% of Americans, and perhaps another economic recession in the first half of 2013. Spending cuts are concentrated on national defense but also include some other areas including Medicare reimbursements. Compromise will probably not come easy or fast. Strategy: either way taxes are going up and spending will come down. Bad for stocks and other "risky" assets.
- Taxes Go Up: Taxes on capital gains, dividends, and income taxes are scheduled to go up on January 1st. Rates are supposed to reset to pre-2001 levels with the highest rate on income and dividends shooting up to 39.6%. We have already started to see special dividend distributions by corporations to get ahead of the higher dividend tax. Expect to see more before the end of 2012. Additionally, if you will receive less money from an investment it is worth less. Dividend stocks should fall in value to reflect the higher tax. Strategy: use a comprehensive asset location strategy. Shift income producing investments such as dividend stocks and treasury/corporate bonds to tax protected accounts like your 401k, IRA, etc. In taxable accounts use municipal bonds. Max out retirement contributions.
- New Taxes: A new 3.8% Medicare tax on regular income above specified levels and "unearned income" begins in 2013. The tax is applied to income above $200,000 for single filers and $250,000 for married couples. What is considered unearned income? Unearned income is very broad and includes: taxable interest, dividends, net capital gains, annuities, rents (non-trade/business), and royalties. Strategy: Contribute or convert to Roth IRA/401k accounts. Distributions, required and otherwise, from traditional IRA/401k's are figured into adjusted gross income and subject to the new Medicare tax.
- Growth will be harder: With higher taxes, more regulations and slower economic growth corporate earnings and revenues corporations will suffer. Companies will cut costs to stay profitable leading to layoffs and creating more efficient ways to do business through technology. Higher unemployment will put a strain on household finances. Strategy: Lower your expectations, save more, review your asset allocation to stocks.
