Blog with MAE Capital

Fiscal Cliff, what is it?

December 3rd, 2012 4:04 PM by Gregg Mower

Well most of all it is media hype for most people. However, this is a typical political conundrum as no matter what happens, unless they just leave it alone and extend the current Bush era tax cuts and make that the tax code from here forward. We all know this will not happen as the current administration wants nothing to do with the status quo on anything it appears. So first of all we have to break down what this really is and take the hype out. The “Fiscal Cliff” is the sun setting or expiring of the Bush Era tax cuts. What is this you ask? Well to keep this simple, the Bush administration in efforts to stimulate the economy in 2001 and 2003 cut taxes to all across the board. The tax cuts lowered federal income tax rates for everyone, decreased the marriage penalty, lowered capital gains taxes, lowered the tax rate on Dividend income, increased the child tax credit from $500 to $1,000 per child, eliminated the phase-out on personal exemptions for higher-income taxpayers and eliminated the phase-out on itemized deductions and eliminated the estate tax.

What does all this mean? Well come December 31 2012 this goes away and the problem is there is no direction as to what it would go back to as this was a layer on another layer of tax code changes. So investors have no idea what happens if Congress and the President let the current code lapse or expire. Lawmakers don’t know how to interpret the old tax codes as they would apply in today's world. Either way taxes would go up for everyone that much is known and how much that will be is not known. The way this has been explained to me from my investment people is that capital gains tax, for one, that is currently at 15%, no matter what you income bracket, will revert back to some prior tax code which is either 35% or taxed as regular income tax brackets. What did I just say? Let’s see if I can give you an example of just the capital gains portion of the “Fiscal Cliff”.

With regards to capital gains the current rate anyone pays is 15%. Capital Gains are those gains you realize above your initial investment capital minus depreciation. Clear as mud right, let’s say you bought a house as an investment, not your home you live in a rental, and you bought that house for $90,000 you put $20,000 of improvements into the house and it has been depreciated $10,000 your basis is $100,000 for tax purposes. Now you sell that house for $200,000 in 2012, you will have to pay 15% on the gain of $100,000 or $15,000 no matter how much regular income you had be it $0 or 1 million. Problem with the “Fiscal Cliff” is that we have no idea how much this will change come December 31, 2012 for tax year 2013. This same concept works for stocks and bonds and this is why you are hearing of major companies declaring dividends in December of 2012. Another reason companies are declaring dividends this year is to cut 2012 profits as companies are taxed at a far greater rate than individuals. Furthermore, corporations don’t know what might happen to the change in tax code for 2013. So with all this uncertainty you are seeing the stock market fluctuate wildly as different plans are proposed by the Democrats and Republicans. These fluctuations are being seen in the interest rate world but just not as pronounced as rates are low and have to stay low to keep the economy from going into another tailspin.

My opinion is that the lawmakers and the President need more time to digest all the ramifications of changing the current tax code. They need to extend the current code one more time to the end of 2013 and get the right formula. This last year and half has been wasted from all sides campaigning so knowing this was coming it was not addressed for election purposes now they all have their collective backs against the wall and are playing the political game for the media. Problem is the media needs to spin the lack of progress on this away from the election and back to the good of the people. We all know that if such a big change in the tax code was tackled in an election year the tides of the election may have turned out differently.   People really don’t look ahead they look back and live in the now, and the politicians know this.  Hence a self-created crisis like a kid waiting to last day before a big homework assignment is due and asking the teacher for an extension. Difference is, as we all know, that you can’t get away with that in school but in real life we can, if we just spin it right.

Chime in let me know your thoughts.

Posted in:General
Posted by Gregg Mower on December 3rd, 2012 4:04 PM

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