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Dan Nestlerode: The Fiscal Cliff Patch

by on February 03, 2013 8:17 AM

In true Indiana Jones fashion we ran to the edge of the fiscal cliff and promptly fell over, only to be saved by action of Congress on Jan. 1 and President Obama’s signature the next day. What a thriller! It was so exciting that even the Republican House of Representatives decided to vote to expand the debt ceiling well before we got to another fiscal confrontation. Even the politicians are tiring of the confrontational games.

So what did the government pass to avoid the fiscal cliff? There are two parts to The American Taxpayer Relief Act of 2012. The first and most reported part is composed of the new tax rates and rules that will be in effect for 2013 and should put to bed any references to the Bush tax cuts. The second part is made up of goodies passed out to Hollywood and hedge fund managers, luxury condos for Wall Street and more “green” giveaways. What is missing from the bill is any effort to deal with continuing trillion dollar deficits or the looming problems of the ballooning expenditures for medical expenses and Social Security. On these issues we kicked the can down the road yet one more time.

For most folks, this new tax law changed nothing. Tax rates on dividends and capital gains for those making less than $400,000 for individuals and $450,000 for those married and filing jointly remains at 15 percent, much lower than the tax rate on earned income. For those in the lowest two tax brackets (10 and 15 percent on earned income), capital gains and dividends are not taxed at all. For those earning above the aforementioned income levels, the rates climb only to 20 percent, which is half the rate (39.8 perent) on regular earned income. For all investors, investing is still a tax advantaged activity.

Furthermore, the federal tax-free income arising from holding municipal bonds survived, providing investors with a continued source of federally tax-free income. Of course, the Taxpayer Relief Act is not the only law affecting tax rates. The Affordable Care Act levies a 3.8 percent extra on investment activities (capital gains and dividends and more) for individual filers making more than $200,000 and $250,000 for joint filers. Furthermore, the payroll tax holiday was not extended and therefore all wage earners will see the rates for Social Security jump back to 6.2 percent of gross wages, up from the 4.2 percent charged in 2011-2012.

The part of the Act that was not widely reported included the following goodies for specific groups and amount to about $63 billion in 2013. For all the “Pay Their Fair Share” folks, here are the deals for the special few: First, tax breaks for offshore loans are extended allowing large companies like General Electric, Ford and J.P. Morgan to lend monies to foreign entities and avoid the corporate tax rates in the United States.

Next, Congress continues to favor offshore jobs by allowing major U.S. Corporations to shift activities to offshore tax havens, thereby avoiding all domestic taxes on these activities. The Act also extends the Liberty Zone tax breaks for the area around the World Trade Center helping to finance luxury condos and Goldman Sachs’ new headquarters. The new law extends for one year the tax credits for railroads to do maintenance on their own lines and provides for special expensing rules for certain film and television productions, allowing these producers to deduct up to $15 million if 75 percent of the project takes place in the United States. Hedge fund managers and private equity managers continue to get their tax rates held at 15 percent for carried interest instead of the 39.8 percent on earned income.

Other giveaways include a 2.2 cent per kilowatt hour for all wind generated electricity (which equates to roughly $1 million for every large wind turbine), training credits for mine rescue teams, accelerated depreciation for qualified restaurant buildings, improvements and equipment, an election to expense mine safety equipment as well as a temporary increase in limits on cover-over rum excise taxes and an American Samoa economic development tax credit.

These benefits are targeted to certain companies and areas and do not benefit taxpayers or our citizens in general. It’s business as usual in Washington. Smart folks do not listen to the rhetoric of our politicians, but to their actions: bills passed, signed and made into law.

In my opinion, the bill is still a good deal for investors. It maintains investing as a tax-advantaged activity. So hold your nose and stay invested.

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Dan Nestlerode is the Director of Research and Portfolio Management at Nestlerode & Loy Investment Advisors in State College. A graduate of Penn State University, Nestlerode has been an investment advisor since 1965. He can be reached at danielj@nestlerode.com.
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