Beyond the Fiscal Cliff – An Independent Perspective on the Road Ahead

Beyond the Fiscal Cliff – An Independent Perspective on the Road Ahead

The solid performance of the financial markets in 2012) serves as a salient reminder of how difficult it is to consistently predict the overall market’s direction over time. We believe it is ‘impossible’ and that the data supports that contention. One of the more interesting myths in the investment world is that large financial institutions (with their access to mountains of data pored over by teams of staff economists/analysts) can determine where the markets are going and profit accordingly. Below are a few examples of how these institutions fell short this past year:

Adam Parker, who serves as the U.S. equity strategist for Morgan Stanley, boldly predicted that the S&P 500 index would fall 7.2% in 2012 – it actually rose13.4%. He recently said that he underestimated the impact of central bank stimulus. Credit Suisse's strategist Andrew Garthwaite, Wells Fargo’s strategist Gina Martin Adams, and Bank of America/Merrill Lynch’s strategist Savita Subramanian all forecast essentially flat returns for U.S. equities – the broad US market was actually up 16%. David Kostin of Goldman Sachs, meanwhile, predicted that the S&P 500 would drop 25% in the midst of a Euro collapse while John Paulson, founder of a now famous fund that forecasted the housing crisis in 2008, told clients in April that he was wagering heavily against European sovereign bonds. In fact, Greek bonds surged in value in 2012, and the Euro itself strengthened about 9.4% from its July 24th low against the dollar.

These data points reinforce our perspective that maintaining a disciplined approach to keeping your portfolio diversified and re-balancing to customized portfolio targets over time provides investors the best chance to ‘buy low and sell high.’
As we start the year, we thought it would be helpful to first take stock of 2012 and shed light on the Fiscal Cliff Act, now known as the American Taxpayer Relief Act of 2012. Please find below information we hope you will find helpful as to how this legislation may impact you:

1.) Definition of the “rich”: The “rich" are now defined as having more than $400,000 (single) or $450,000 (joint) of taxable income. For taxpayers whose taxable income falls below those thresholds, the temporary Bush-era tax cuts have been made permanent.
· This means that for most taxpayers, the marginal tax rates will remain the same this year as they have been for the past twelve.
· Taxpayers who fit this new definition of "the rich" will experience a new 39.6% upper tax bracket.
The rich will also be required to pay taxes on capital gains and dividends at a 20% tax rate. (The 15% rate still applies to taxpayers below the thresholds.)

2.) Retirement Savings Plans: Contribution limits rose in 2013 for all plans and income ceilings rose as well.
· 401(k), 403(b), and 457 plans: maximum 401(k), 403(b) and 457 contributions are $17,500 this year, a $500 increase over 2012. Individuals born before 1964 can put in as much as $23,000 into 401(k), 403(b) and 457 plans.
· SIMPLE plans: SIMPLEs rise to $12,000. People age 50 or older in 2013 can put in additional $2,500 to a SIMPLE plan.
· IRA and Roth IRA plans: the 2013 pay-in limits for IRAs and Roth IRAs will increase to $5,500 ($500 more than 2012). Those born in 1963 or earlier can put in an extra $1,000 per year.
o The income ceilings on Roth IRA pay-ins go up as well. Contributions phase out at Adjusted Gross Incomes (AGI) of $178,000 to $188,000 for couples and $112,000 to $127,000 for singles.
o The deduction phase-outs for regular IRAs start at higher levels, ranging from $95,000 of AGI to $115,000 for couples and from $59,000 to $69,000 for singles. If only one spouse is covered by a plan, the phase-out zone for deducting a contribution for the uncovered spouse begins at $178,000 of AGI and finishes at $188,000.

3.) Estate and Gift Tax Exemptions: The tax bill also makes permanent the current $5 million estate and gift tax exemptions ($10 million for couples), but raises the tax rate for money transferred to heirs above that amount from 35% to 40%.
· The portability of the estate tax exemption between spouses also survived.
· For 2013, the estate and gift tax exemption is $5,250,000.
· The annual gift tax exclusion rises to $14,000 per donee.
· Up to $1,070,000 of farm or business realty can receive discount estate tax valuation.

4.) Itemized Deductions: Itemized deductions and the personal exemption will once again begin phasing out for individuals with more than $250,000 in adjusted gross income (AGI), or couples with more than $300,000 AGI by 3% of the “excess” AGI over those limits. At $372,501 (single) or $422,501 (joint) of AGI, personal exemptions are phased out entirely.

5.) Social Security and Medicare Surtax: Congress also eliminated the 2% reduction in the Social Security payroll tax--a stimulus measure enacted in 2010. A 0.9% Medicare surtax on earned income kicks in for higher-incomers as well.
· This is likely to be the biggest impact of the legislation on most taxpayers as the payroll tax rises from 4.2% last year to 6.2% this year.
· The Medicare surtax levy applies to wages as well as self-employment income. Singles and heads of household will owe it once total earnings exceed $200,000. Couples over $250,000 and Marrieds filing separately over $125,000. For those over these levels, the effective Medicare tax rate will be 3.8% - the usual 2.9% rate plus an extra 0.9%.
· Social Security’s wage base rises this year to $113,700, a $3,600 boost, while social security benefits go up 1.7%, less than half of 2012’s hike
· Earnings limits for Social Security increased – individuals who turn 66 this year do not lose any benefits if they make $40,080 or less; people who are > 62 and < 66 years can make up to $15,120 before they lose benefits.

6.) Alternative Minimum Tax (AMT): AMT exemptions went up for 2013. They increase to $80,750 for couples and $51,900 for singles and household heads, raising by $2,050 and $1,300 respectively. These will automatically increase in future years, based on the rate of inflation.

7.) Medical: The threshold for deducting medical expenses jumps to 10% of AGI for singles under 65 and is the same for married couples who file a joint return, and annual ceilings on health savings accounts (HSA) moved slightly up in 2013.
· Annual ceilings on deductible payins to HSA are $6,450 for account owners with family medical coverage, $3,250 for single coverage
· Payins to health flexible spending accounts are now capped at $2,500

8.) Mileage Allowances: Most allowances went up slightly.
· The standard mileage allowance for business driving is 56.5¢ per mile, up a penny.
· The allowance rises to 24¢ a mile for travel for medical purposes
· The allowance for job-related moves also went up to 24¢ a mile.
· The rate for charitable driving remains stuck at 14¢ a mile.

The new tax law makes $24 billion in federal spending cuts, giving Congress two additional months to decide what to do about $109 billion of automatic spending cuts that were scheduled to begin taking effect at the start of this year.

In February, we plan to sit down with all of our clients and their tax preparers to assist with tax return preparation for last year and tax planning for the current year to ensure that their investment plan is properly integrated with the latest tax considerations. We believe that staying on top of such changes and customizing portfolios to take into account client specific tax, estate, and insurance planning issues (while keeping fees low), will have a much more profound impact on our clients’ ability to achieve their goals than trying to predict the unpredictable markets.

Please call or write if there is anything we can do to help, or if you just want to exchange other ideas or observations.

The information herein represents the opinions of the author. Much of the material is based on data gathered from what are believed to be reliable sources. It is not guaranteed as to accuracy. It should not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.