Throughout its history, the U.S. economy has experienced periods of strain and weakness. Although the most recent crisis that provided such massive downward movement has subsided, plenty of questions remain as to what the future holds. Until recently, equity markets had recovered at an impressive rate, though many observers wondered whether we had come too far too fast. Some economic indicators show promise on the horizon, while other factors point to challenging times ahead.
One clear factor that points to challenges is the size of the federal deficit, which has increasingly become a bone of contention among economists. Many commentators assert that the inability to reduce the deficit may derail the recovery that investors believe is well underway. So what is the solution that economists most commonly recommend for reducing the deficit? Curtail government spending and increase government revenue.
As of this moment, the reduction of government spending appears to be next to impossible; programs intended to stimulate economic activity and weather periods of heightened unemployment will be a significant drain against government coffers. Because increased government spending seems likely to continue into the foreseeable future, the remaining option would be to increase government revenues. How can the federal government increase the amount of revenue? The answer to this question is simple: raise current taxes and/or institute new ones.
Taxes are bound to go up for your high-net-worth clients
With the Bush tax cuts set to expire at year-end and recent legislation enacted with a goal of paying for social programs, it is easy to forecast the direction of your high-net worth clients’ marginal tax rates. The current administration has its eyes on these individuals as a potential source of additional tax revenue. In fact, many of your clients who would not be defined as wealthy will see an increase in the amount of taxes owed. Those who earn more than $250,000 per year, for example, will likely be faced with a notable uptick in their marginal ordinary income, as well as in capital gains, rates.
The Patient Protection and Affordable Care Act
Though your high-net-worth clients may be sharply focused on what will happen when the tax cuts expire, as mentioned above, they must also stay alert to legislation that includes new or increased taxes. One example is The Patient Protection and Affordable Care Act (PPACA), or health care reform, which includes provisions to pay for the mounting costs of health care in the U.S. and social programs, including health care, supported by the federal government.
Politicians can debate whether PPACA is the answer to our health care issues, but the bottom line for wealth managers is the impact that this legislation will have on their clients. One PPACA provision, for example, which takes effect on January 1, 2013, levies a 3.8% surtax on the lesser of net investment income or the excess of a client’s modified adjusted gross income (MAGI) above $250,000 for married taxpayers filing jointly ($200,000 for individual filers).
A few safe havens from the new surtax are available. For example, distributions from IRAs and qualified plans are not subject to it. But investment income, including interest, dividends, capital gains, nonqualified annuity distributions, rents (if passive income), and royalties, is.