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Stocks Close Down for the Week – Meanwhile the Fiscal Cliff Approaches

In this weeks column we update you on this weeks market activity and take closer look at the upcoming "Fiscal Cliff" and how much more you will pay in taxes. See how this affects you.

 

USA Markets Suffers Worst Week Since June

This week, stock markets in the USA gave back some of their recent gains from the past few weeks.  The market got off to a slow start on Monday as the World Bank lowered it’s growth projections for the Asia region.   On Tuesday, the entire financial sector of the markets traded lower on news that the US Attorney had filed a civil mortgage fraud lawsuit against Wells Fargo in New York.  The financial stocks acted as a drag on the market which ended closing  lower by 1% for the day.

On Wednesday, Alcoa the largest aluminum company in the world reported earnings.  Alcoa provides an excellent window to view the current economic situation across the globe as it’s aluminum is used in aerospace, automobile and commercial trucks, commercial building materials and beverage cans.  In general, Alcoa lowered future growth rates for China and the rest of the Asia region along with Europe.  For the USA, Alcoa forecast a slight increase in demand for it’s products.

One area where Alcoa reported strong demand for it’s products is in the aerospace industry.  Global demand for aluminum for aerospace is projected to increase by 12%.  This is excellent news for people in the greater Seattle, Renton and Everett areas as one of the largest employers is Boeing.  Alcoa’s report of an increase in demand for aluminum products that are used  for airplane manufacturing signals that near term prospects for Boeing and it’s employees remain bright.

On Friday, the University of Michigan Consumer Sentiment Survey reported that consumers had not felt this well about the economy since September, 2007.  This good news in consumer confidence though  failed to move the markets higher.  For the week the S&P 500 lost 33 points or 2.3% to close at 1,428.  The 2.3% loss was the worst weekly showing by the S&P 500 since June, 2012. 

In The Photo Section is a chart of the S&P 500 for 2012 that illustrates the road that the USA markets have traveled this year in order to reach their 14% year to date gains:

 

(See Image of Chart of the S&P 500 in The Photo Section)

 

We had been commenting to readers for the past 3 weeks that markets in general had gotten very over-bought on a technical basis.  Much of that over-bought condition has been worked off, especially in the technology sector of the market.

 

The “Fiscal Cliff” Approaches – Congress Has Yet to Act – An Everyone Gets to Pay

By now, most everyone has heard of the up-coming “Fiscal Cliff” but many people are unsure of what exactly the Fiscal Cliff  is and what is going to be it’s impact.  We would like to use this weeks commentary to provide an explanation and answers.

To begin with, the most complete analysis of the Fiscal Cliff that we have seen is the 25 page report from non-partisan, Tax Policy Center.  The title of the report from the Tax Policy Center is “Toppling of the Fiscal Cliff  who’s taxes rise and how much”?   This report is the source for the analysis that we present below.

The Fiscal Cliff consist of the expiring of legislative actions which reduced individual taxes and also the introduction of new taxes.  The Net effect of the expiration of all of these tax cut (which combined together is what becomes the “Fiscal Cliff”) will be an increase in Income Taxes of $536 billion in 2013.

The components of the Fiscal Cliff consist of:

  1. Bush Era Tax Cuts from the Recession of 2001 -2003.
  2. Obama Era Tax Cuts from the American Recovery & Reinvestment Act of 2009.
  3. Estate Tax Cuts
  4. Payroll Tax Cut – the cutting of the Social Security payroll tax from 6.2% to 4.2% in 2011.  This gave every American an extra $1,000 in their paychecks for every $50,000 that they made.
  5. New Taxes that are resulting form the 2010 Health Care Legislation.
  6. Several smaller taxes and programs such as the expiration of the Alternative Minimum Tax patch.

 

The Tax Policy Center has determined that the combined effects of the entire “Fiscal Cliff” calculates out to the following:

  • Annual Income Taxes will increase by $536 Billion in 2013.  That is a 20% increase over 2012.
  • The average income tax burden per household will increase by $3,500 in 2013.
  • Taxpayers in the top 20%  would see and increase in income taxes of $14,000 in 2013.  Taxpayers in the middle income will see an increase in income taxes of $2,000.  Taxpayers in the lowest 20% will see an increase of $412.
  • Average Marginal Tax Rates will increase by 5 percentage points for Labor Income, by 7 percentage points for Capital Gains income and by 20 percentage points on Dividend income.

 

The tax increases listed above assumes no legislative action is taken by congress.  Right now for example, it appears that the payroll tax cut will be allowed to expire in 10 weeks (see #4 above).   This will reduce each persons annual paycheck by $1,000 for every $50,000 that they earn.

The Tax Policy Center research found that the net effect of the fiscal cliff is that over 90% of all Americans will see an increase in income taxes next year.

To determine the impact of the Fiscal Cliff on all taxpayers, the institute has categorized the tax paying citizens of the USA  into five income brackets (top 20% to Bottom 20%).   In The Photo Section is a chart that shows the increase in taxes for everyone on a percentage points basis.  In the Blue is the current tax percentage rate for the income category.  In the Orange is the projected increase in 2013 on percentage points basis.

 

(See Image of Graph Impact of Fiscal Cliff in The Photo Section)

 

As you can see in the chart – the Average increase for everyone is 5.0 percentage points – for the top 20% of earners, their tax rates will increase by  5.8 percentage points.  For the bottom 20% of earners, their tax rates will increase by 3.7 percentage points.  For the top 1% of earners, their tax rates will increase by 7.2%

Using the same format as above, we have one more chart.  This chart shows the each of the Fiscal Cliff components impact on the projected increase tax rates that nearly every American can plan on paying next year.

 

(See Image of Impact of Fiscal Cliff Tax Components in The Photo Section)

 

The chart clearly demonstrates that the expiration of the 2001 – 2003 low\middle class tax cuts and the 2011 payroll tax cuts are the two components of the Fiscal Cliff that have the greatest tax impact on 80% of the American tax payers.  For the top 20%, and 1%, the expiration of the 2001 capital gains and dividend tax cuts will have more of an impact.

For those readers who would like to read the entire 25 page Impact of the Fiscal Cliff report from the non-partisan Tax Policy Center, we provide a link to a PDF copy of the report In The Photo Section.   

 

Closing Thoughts

With just 10 weeks to go in 2012, and with the prospect of higher taxes in the upcoming years, we recommend that investors review their taxable portfolio’s to see what actions may be prudent to limit their future tax liability before the end of 2012.

One strategy that could make sense for many people would be to review your taxable accounts and look for equities that you owned  for longer then 12 months that currently have  a sizable gain.  It might make sense to consider selling these long term equities with gains in 2012 and paying the 15% capital gains tax this year.  According to the Fiscal Cliff report  – Long term Capital Gains Tax rates can be 7% higher in 2013 – that would mean an extra $7,000 tax bill on a $100,000 capital gain if you sold the stock in 2013 instead of 2012.

Now if you executed this potential tax saving strategy but still wish to own the security, you can by it back immediately after you sell it as their are no 30 day wash rules that apply to capital gains.

With all investment decisions we recommend that you consult with your financial advisor to be certain that each investment decision is suitable for you before  proceeding.  Please contact us if you would like more information about this and other tax saving strategies for equities that you own that have long term gains.

Remember, time is running short for being able to execute this potential tax saving strategy that could save many people thousands of dollars in future tax bills.

With the USA budget deficits at all time highs and Long Term Capital gains tax rates at all time lows it would appear that a higher tax rate for long term capital gains is much more likely outcome in the future than a lower tax rate and sound financial planning should recognize this.

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John Patrick Bray, CPA, is president of Bellevue-based Reliance Investment Management LLC .

 

This communication reflects the opinions of Reliance Investment Management LLC and is being provided for informational purposes only and is not intended as a recommendation, an offer or solicitation for the purchase or sale of any security referenced herein or investment advice. It is being provided to you on the condition that it will not form the primary basis for any investment decision.  We recommend that you consult with your investment advisor before the purchase or sale of any securities. The information contained herein is of the date referenced and Reliance Investment Management LLC does not undertake an obligation to update such information. Reliance Investment Management LLC has obtained all market prices, data and other information from sources believed to be reliable although its accuracy or completeness cannot be guaranteed. Such information is subject to change without notice. The securities mentioned herein may not be suitable for all investors.

 

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