The “Fiscal Cliff” – Part II

The New Year is now only five weeks away, bringing with it dramatic tax changes that will affect us all unless those in Washington can come to an agreement. I’m referring to the “Fiscal Cliff” about which Kathy Spray wrote last week. So how likely is it that we will plunge over the Fiscal Cliff? Well, it depends on who you talk to!

Most observers believe that our political leaders will find a way to at least reduce the size of the cliff, which in turn will soften its expected negative effects on our economy. A “Gang of Eight” Senators representing both parties has been working to develop a proposal, and President Obama met with Congressional leaders on November 16. Both sides signal a willingness to consider new ideas and express hope in reaching a compromise before the end of the year.

What that compromise will look like is anybody’s guess. It will certainly include spending cuts, some of which will replace currently-required cuts to defense and Medicare funding (the so-called “sequestration” cuts). Many think it will also include income tax rate hikes on the highest earners, plus tax rate hikes on capital gains. The top gift and estate tax marginal rates, which are currently 35%, may increase to as much as 55%. The gift and estate tax exemptions, which are currently $5.12 million each, are expected to drop.

While we can’t know what shape the ultimate solution will take, we can do some things in anticipation of it. High-income earners should consider accelerating income and bonuses into 2012 and delaying deductions until 2013. Those planning to convert a traditional IRA to a Roth should consider doing so this year.

If you have appreciated capital assets to sell or give away, do what you can to complete those transactions before the end of the year. If you are making a gift of a business interest, remember that you will need to substantiate the gift with an appraisal to be attached to your gift tax return.

If you have investments, talk with your financial advisor about the wisdom of rebalancing your portfolio before year end. If you have tax-deferred investments, including retirement plans and education savings plans, consider maximizing your contributions in 2012.

Finally, be prepared for uncertainty and year-end volatility as the solution may not be reached until the 11th hour, or perhaps even until the New Year!

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