The Election of 2012; Reset, Recovery or Recession in 2013?

What happened November 6, 2012, and what does it mean for us in 2013?

Let’s start with some home cooking here in Florida.  Although maintaining a majority in the State House and Senate, the GOP failed to convert its two statewide races, namely those for President, with the “OB” team slipping past the “RR” team 50% to 49%, slightly closer than the national popular vote result of 51% to 48%.  Also, U.S. Senator Bill Nelson smoked challenger Rep. Connie Mack.  The GOP symbolic effort to not retain sitting State Supreme Court Justices also failed, although that was really just about making a statement.  Of the various State Constitutional Amendments put forward, only Amendments Nos. 2, 9, and 11, all related to specified constitutional expansions of the homestead property tax exemption,  passed with the requisite 60% or greater voter approval.  I’m smart enough to draw any definitive, long term conclusions from Florida’s own 2012 election results, except to say that the national division in opinion as to top leadership for our country is also shared by Floridians.

In looking at the national scene, President Obama clearly and convincingly won the electoral vote over Gov. Romney, 332 to 206.  That was a little surprising based on prior polling, which reinforces our natural suspicion of the political pundits and prognosticators filling the airwaves.  The U.S. Senate remains essentially in control of the Democrats, with a 53-45-2 advantage, and the Republicans control the U.S. House, with a 234-198 advantage (with 3 seats still too close to call).  The results in both chambers reflected slight gains for the Democrats over the now lame duck 112th Congress.  Summary:  we’re pretty close to status quo.

The November 12, 2012 issue of Barron’s pictures President Obama and Speaker Boehner driving over the Fiscal Cliff you’ve been hearing a lot about lately, in a sporty new red Camaro convertible.  The headline reads: “ARE WE HEADED FOR A RECESSION?”  Candidly, I can’t really picture the President and Speaker spending even that much time together between now and the seating of the next Congress.  The November 14, 2012 issue of The Wall Street Journal reported the President was seeking $1.6 Trillion (not a misprint) in additional tax revenues over the next ten years, while the Speaker favors a more “balanced” approach, matching additional tax revenues generated under a revised tax code with spending reductions in entitlement funded programs.  In their last formal discussions in 2011, the President had requested $800 Billion (again, not a misprint) in increased tax revenues over the same time period, so the current proposal has doubled since 2011.  I guess that’s what a stronger than expected electoral showing will do for a second-term President’s bargaining position!

The so-called Fiscal Cliff is the anticipated and legislated effect of the sunset of the Bush tax cuts and our current favorable estate and gift tax planning environment, by a return to 2001 federal tax laws on January 1, 2013, coupled with automatic spending cuts under the 2011 Budget Control Act in fiscal year 2013, and thereafter.  The spending reductions are supposed to affect defense and nondefense programs equally.  However, the overall effect on federal government spending is projected only to increase at a slower rate, due to the continuing increase in domestic entitlement program expenditures.  Sound like a mess?  It is, and all concerned hope for a solution, but inevitably, after a strong electoral showing by the President, and a predictable entrenchment by the other side, a whole lot of politics has to take place prior to reaching a solution.

To start with “the known” first for 2013, and barring a miracle inside the beltway this year as a result of the preliminary talks starting between the administration and Congressional leadership on November 16th, ordinary individual income tax rates will be topping out at 39.6% in 2013, up 4.6% over the 2012 top end rate.  Capital gains rate will be going up to 20% for high income earners, as will the tax treatment for dividends, which will be at ordinary income tax rates for 2013.  There is also the new 3.8% Medicare surtax on net investment income for certain taxpayers.  CPA Robert Keebler of Green Bay, Wisconsin, has correctly pointed out that for those taxpayers affected by the surtax, their higher marginal rates are in effect increased by another 3.8%, generally starting at the 31% tax bracket for 2013.  In addition, more Social Security benefits will be taxed, and prior phase outs of itemized deductions and personal and dependency exemptions will be reinstated for higher earners.  Summary:  See your CPA or tax advisor early in 2013, not only to file for 2012 taxes on time, but also to do some real income tax planning for 2013.

Known on the estate and gift tax planning side for 2013, we will be leaving behind the gift and estate tax planning “sweet spot” we enjoyed in 2012 of a $5.12 million effective exemption amount, with a 45% top end tax rate, to a $1 million effective exemption amount, with a 55% top end tax rate.  In addition, we are leaving portability behind, which means traditional “A-B” marital deduction planning trusts will be more popular than ever in estate planning documentation.   In addition, irrevocable trusts, leveraged lifetime gifting, and split interest trusts, will be very much in demand for single clients whose net wealth and life insurance exceed $1 million, and for married couples with net worth and life insurance totaling over $2 million.  “Clawback” is the unknown in this area for 2013, which would effectively try to “true up” the estates of decedents in 2013 and beyond if the taxpayer took advantage of the higher current individual lifetime gift tax exemption amount of $5.12 Million by making completed gifts in 2012.  There’s real doubt that clawback will happen, but pay attention to 2013 estate and gift tax updates and announcements from the IRS as we go into 2013.  This practice area can be very confusing, to say the least, and detailed planning with your CPA, estate and gift tax advisor, estate planning attorney, and insurance or financial advisor, is in order in early 2013.

A very real economic concern, expressed by many, is that the Fiscal Cliff, if unaddressed, could plunge the U.S. into a full-fledged recession in 2013.  As if we needed some more bad news!   I mentioned that talks between the President and Congressional leaders are supposed to start on November 16th to attempt to establish a framework for addressing and avoiding the potential problems we might otherwise encounter if no Congressional action (with Presidential approval) otherwise takes place.  Although stated beginning points of that negotiation are far apart, there does seem to be agreement that the so-called “middle class” taxpayer (i.e., $200,000 AGI or less if single, $250,000 AGI or less if married) should receive a continuation of the Bush tax cuts on the income tax side, and that the effective estate tax exemption should be set at least at $3.5 million per individual.  However, the Republicans generally favor no income tax rate increases for anyone, preferring instead to tighten up loopholes and exemptions.  Also, the Republicans favor a repeal of the estate tax, but would probably see the light to continue the current $5 million individual effective estate tax exemption level, increased annually for the cost of living.  Keep this in mind:  if nothing happens as a result of the discussions between the President and the Speaker, then the tax changes discussed in the two prior paragraphs take place automatically, without any further Presidential or Congressional action.

It’s really hard to see the Tea Party Republicans, who are now on the defensive more than ever, and the liberal wing of the Democratic Party, who are now more empowered than ever, sorting this out on their own.  Facing the possibility of a GDP decline in 2013, or worse, if the President and Speaker don’t lead their respective camps to get a budget and tax deal in place, we’d all better hope that cooler heads prevail, and that some kind of an acceptable tax and budget reset can be made in early 2013, to give us some chance at a continued, albeit slow, economic recovery.

If you are having trouble absorbing this information, and deciding what it means to you, you are not alone.  Thousands of attorneys, CPAs, insurance agents, and financial advisors and planners will be studying this and arriving at a range of options and contingency plans for their 2013 income, estate, and gift tax planning clients.  You need to plan to visit with your own advisor as soon as you can in 2013, to set your own planning goals and consider appropriate strategies and contingencies.

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