The fiscal cliff, once a seeming imaginary event far off on the horizon, is looming large as we approach the beginning of 2013 with a divided government. The cliff, a combination of tax increases and government spending cuts, threatens to send the country deeper into another recession, according to economists from the Congressional Budget Office.

In the immediate aftermath of the election, House Speaker John Boehner had indicated a willingness to work with President Barack Obama to avoid January's fiscal cliff, and said that he was open to the idea of increased revenues if it can be accomplished without raising tax rates. President Obama said that he intended to work with Congress to avoid tax hikes on the middle class, but refused to rule out increasing taxes on the wealthy.

The stark differences between the two parties means that a compromise will be difficult to achieve, according to Larry Peck, a New York-based tax specialist and estate planner. For that reason, many of the well-to-do are planning for a sunset of the Bush tax cuts: "Many of my clients, for example, are transferring up to $10.24 million (per couple) of assets to trusts for their heirs before the gift tax exemption is dropped to $1 million."

 

RACING THE YEAR'S END

While many wealthyclients are concerned about making large gifts that will diminish their liquid assets and cash flow, Peck indicated that with proper planning, the high exemption benefit can be preserved while still satisfying liquid net worth and cash flow concerns: "This can be done through 'spousal lifetime access trusts' or SLATs -- a trust which permits each spouse to create a trust from which the other spouse can receive distributions, and at the same time remove the trust assets from both of their taxable estates."

Others will consider selling their business, real estate or stocks before year end to capitalize on the lower capital gains tax rate, he predicted. "Investors with dividend-paying stocks may consider selling them in favor of growth stocks because of the potential tax increase on dividends from 15 percent to 39.6 percent. Employees who have the option of receiving their bonuses in 2012 may want to take advantage of that," he said. "The bottom line is that year-end tax planning has taken on a special significance this year given the potential for significant tax increases next year."

Although the president's victory was decisive, the margin does not necessarily give him a mandate, according to Jim Daniels, managing director at UHY Advisors NY in Albany. "We're already seeing signs that the Republicans may soften their prior stance regarding tax increases in order to avoid being viewed as obstructionist," he said. "In regard to individual taxes, the so-called payroll tax holiday of 2 percent expires on Dec. 31, 2012. This tax savings approximated $2,000 a year for an individual making $100,000. The loss of the payroll tax holiday would affect all individuals ... . There is a good possibility this could be modified or extended given the fragile economy."

There is a possibility that the rate increases caused by the expiration of the Bush cuts could be delayed for six months or a year, Daniels said. "Given the desire not to derail the economy, there should be some action.I believe a compromise will be reached, because at this point, both parties have nothing to gain by seeing the economy derailed again given the recent slight upturn."

 

PLANNING FOR BUSINESSES

From a corporate tax perspective, there has been talk about lowering the federal rate to 25 percent, said Chuck Sockett, managing director at UHY Advisors in Manhattan, N.Y.

"Such a move would put the federal tax on par with most of the rates in the Westernized world and may be the catalyst needed for companies to invest in the U.S. and not overseas," he said. "On the job-creation front, we're watching to see if Congress will extend and expand the research and experimentation credit, which has the potential for job creation through continued investment of capital into developing new products and technology."

Joe Falanga, a managing director at UHY Advisors in New York, believes that the Obama administration's proposed legislative initiatives to close estate and gift tax loopholes will all be up for negotiation. "If Congress does nothing, on January 1 the estate tax will revert to pre-Bush-era law. The exemption will be $1,000,000 and the top tax rate will be 55 percent," he said. "At this point, the GOP does not want to be seen as obstructionist. We're already hearing that the current $5,120,000 exemption and 35 percent tax rate will be in play. The administration has consistently supported a $3,500,000 exemption and 45 percent tax rate. Any new exemption and tax rate will have to be negotiated and will likely be overshadowed by the looming fight over income tax rates."

The current political environment is highly perilous, said Stephen Breitstone, tax partner with Mineola, N.Y.-based Meltzer Lippe, Goldstein & Breitstone LLP. "There are such strong philosophical differences at the extremes and an apparent unwillingness to compromise."

At a recent panel on tax policy that he chaired at the New York University Institute on Federal Taxation, Breitstone noted that some of the leading policy experts "could not come to a consensus as to a fix to the fiscal cliff and looming budgetary crisis. There does not seem to be a neat and practical fix," he said. "I fear that the country will not get serious about tax and budgetary reform until we reach crisis mode. That will not be pretty."

That said, there are some things that simply have to be done immediately, Breitstone said. "I am not sure we can avoid going over the fiscal cliff, but the lame-duck Congress needs to work hard to put it off at least for a little while. A short-term extension of certain Bush tax cuts is warranted, as well as the Alternative Minimum Tax patch. If the AMT patch is not passed for 2012 by year end, people subject to the AMT will have to pay higher taxes for 2012 than they budgeted for."

"It will be very difficult for the IRS to implement the patch retroactively," Breitstone cautioned. "It really should be for the new Congress to make the bigger changes - if they can figure out what to do. But we need a package that involves some additional revenues, cuts in spending and, most importantly, growth. The only way we can change the course is to stimulate growth in the economy -- and right now the uncertainty and divisiveness is not conducive to stimulating growth."

 

PROMISE OF COMPROMISE?

Dean Zerbe, national managing director of alliantgroup LP, agreed. "Washington is still clearing its head from the election night, but comments by Speaker Boehner against any increase in tax rates suggest both a hard road ahead and a path to deal," he said. While the Republicans will continue to fight against rate increases, it may be a signal of a willingness to limit deductions for wealthy individuals - as was proposed by Governor Romney in his campaign and put forward by the Republicans in the Super Committee deliberations. It would be helpful to the economy and jobs if Washington could make a decisions now on taxes and have it be permanent.

Although most in the profession were hoping that the election would give some clues about the future of tax policy, with the election over we find we are right where we started, said Roger Harris, president of Padgett Business Services.

"Before the end of the year, much needs to get done and the same people are in charge," he said. "The only positive is that we are as far away from the next election as we will ever be, so will somebody emerge as a leader and get us out of this mess? The results seem to make it more likely that tax rates could rise on high-income taxpayers, though the House Republicans have promised they will not allow that to happen. But something must be done or taxes will go up on everybody, and nobody wants that to happen."

"If there is an attempt to find a long-term, bipartisan solution to our tax mess, some type of tax reform may provide that opportunity, particularly if it is combined with a serious attempt to reduce the deficit," said Harris. "Tax reform could provide the revenue the Democrats insist on and give cover to the Republicans that refuse to raise rates. But this too will take leadership from somebody."

"The good news is that if all else fails, we are only two years away from the next election," he added.

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