Agreement On Taxes/Spending Possible By Year-End

President Obama secured a second term in office November 6, 2012, in the end winning the Electoral College by a wide margin. The President’s re-election now sets in motion what will likely be difficult negotiations between Democrats and Republicans over the fate of the Bush-era tax cuts, nearly $100 billion in automatic spending cuts, and the more than 50 expiring tax extenders, which include the alternative minimum tax (AMT) patch for tens of millions of taxpayers. The President’s re-election has also significantly changed the dynamics for reaching an eventual agreement over long-term tax reform.

Impact

Year-end tax strategies will demand more urgent attention from higher-income taxpayers as the result of President Obama’s re-election. The President has consistently called for higher tax rates on individuals with incomes above $200,000 and families with incomes above $250,000 and continuation of the current lower tax rates for others. He campaigned on reinstatement of the 36 percent and 39.6 percent income tax rates for higher-income individuals. The President also advocated a maximum capital gains rate increase from 15 percent to 20 percent and a dividend rate rise from 15 percent to 36 percent or 39.6 percent for higher-income taxpayers. His re-election also ensures that the 3.8 percent Medicare contribution surtax on net investment income will go into effect on January 1, 2013, and continue into the foreseeable future.

Before the election, President Obama had predicted Democrats and the GOP could reach a “grand bargain” that permanently resolves the fate of the Bush-era tax cuts, lowers the corporate tax rate and takes a serious step toward deficit reduction with revenue raisers within four to six months. In the interim, both sides may have to settle for a temporary extension of some of the expiring provisions, including some income tax rates, and leave the long-term fate of the Bush-era tax cuts and more to the 113th Congress, which will meet in January 2013.

Our take

Less than 24 hours after the results were in, House Speaker John Boehner, R-Ohio, said Democrats and Republicans should focus on “common ground” to address the so-called “fiscal cliff.” Lawmakers are due back in Washington on November 13. They will break for Thanksgiving later in November and will return in early December. Although the scheduled work period is short, there have been reports of lawmakers engaging in behind-the-scenes discussions about taxes and deficit reduction in the weeks before the election. These discussions could help kick-start serious negotiations between the White House and the GOP.

Whether any eventual compromise hammered out between Congress and the Obama Administration would extend lower income tax and capital gains/dividends rates for one more year, into 2013, or allow the higher top rates in 2013 to start at temporarily higher income levels than initially proposed, remains speculative. In the meantime, higher-income taxpayers must decide whether to wait-and-see … or secure the benefit of current rates now, through accelerating income, postponing deductions/credits, harvesting appreciation/capital gains, having closely-held corporations declare special dividends, closing business sales/acquisitions, and executing family gift-giving strategies—all before year end 2012. While it is not absolutely certain that tax rates will rise in 2013, it is more than certain that rates will never drop lower than they are now in 2012 for most higher-income taxpayers.

To understand the possible impact to you, contact one of our tax experts.