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D.C.-watcher expects Congress to fix easy fiscal cliff issues, punt on others

By Warren S. Hersch

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As the president and Congress prepare to negotiate contentious questions associated with the fiscal cliff–across-the-board spending cuts and Bush-era tax cuts that are due to expire at year-end–expect a quick resolution of non-controversial issues, but a potentially months-long delay addressing the politically charged ones.

This is the near-term political outlook of Leon LaBrecque, a managing partner and founder of LJPR, LLC, a Troy, Mich.-based financial planning firm that serves individuals and business owners. The following are excerpts from LaBrecque’s interview this month with NUL Senior Editor Warren S. Hersch

Hersch: How do you foresee the president and Congress approaching the year-end fiscal cliff? Will they reach agreement on the key issues to be debated?

LaBrecque: Let’s start with what will probably be easily be fixed: Medicare reimbursements for doctors and the alternative minimum tax or AMT. In respect to the first, the $15 billion in Medicare reimbursements that doctors received in 2012 will very likely be extended in 2013.

As to the alternative minimum tax, I anticipate that Congress will reset the AMT exemption or patch for next year. That’s good news for some 30 million Americans who, without the patch, would be subject in 2013 to the AMT–a horrendous tax for those who have to pay it.

See also: 3 fiscal storms brewing

Hersch: What fate awaits the payroll tax and the Affordable Care Act’s unearned income Medicare contribution tax?

LaBrecque: The payroll tax has been relatively unsuccessful in stimulating the economy. It’s possible that Congress and the President will agree to extend the payroll tax holiday before year-end. As to the UIMC, I’m 100 percent certain this is tax will remain law because the president got reelected and because the Democrats retain a majority in the Senate. In my opinion, there is virtually no chance that Omamacare, or any of its provisions, will be repealed or modified anytime soon.

Hersch: How do you expect that Congress will deal with the budget sequestration–the $1.2 trillion in automatic spending cuts mandated by the 2011 Budget Control Act?

LaBrecque:  The current lame-duck Congress will extend the sequestration deadline to the first or second quarter of next year, when the new, 113th Congress is in session. Neither Republicans nor Democrats like the sequestration’s sledgehammer approach to resolving the nation’s budget problems, but each party also doesn’t like like the other side’s solution for avoiding the fiscal cliff. So I expect they’ll agree to disagree for three to six months before debating this issue again.

Hersch: How do you expect that Congress will deal with the debt ceiling and the Bush-era tax cuts? 

LaBrecque: Neither side of the aisle wants to address the debt ceiling now, so the debt ceiling deadline will also be extended. I believe the Democrats will also vote to extend the Bush tax cuts if Republicans agree to raise tax rates on wealthy individuals. The only question will be at what income level–whether $250,000 or a higher income level higher–the new tax brackets will kick in.

Because Democrats and Republicans have opposing positions on this issue, it’s possible the Bush income tax cuts will not be resolved by year-end. But a return to the pre-2001 income tax regime could be devastating economically, pushing us back into a recession.

Unfortunately, this issue may not get resolved because of quibbling over two numbers: income levels that invoke the highest two tax brackets. But if both sides can agree on cutting tax loopholes and raising tax rates in a revenue-neutral way, then compromise might be achieved.

Hersch: What future awaits the estate tax, capital gains tax and dividends tax under the next Congress?

LaBrecque: I think it unlikely that the estate tax individual exemption will not revert to [the pre-2001 exclusion amount of] $1 million. Earnings from capital gains and dividends will probably continue to enjoy tax-preferential treatment, though the tax rate may rise to, say, 20% from the current 15%.

What I’m telling everyone is, “prepare for a tax increase.” Even under the best case scenario, if you’re a high income earner, you’ll see your taxes go up. 

Hersch: To the extent that Congress continues to delay resolution of politically contentious tax issues, is the resulting uncertainty a danger to the economy because individuals and businesses can’t do long-term planning?

LaBrecque: I concur completely that ongoing uncertainty about the nation’s tax rules makes long-term planning very difficult. Consider the Affordable Care Act, which I don’t like at all, but at least I know that I have to plan for it. But if I can’t tell you whether the individual estate tax exemption will continue to be $5.1 million or revert to $1 million, then what I am to tell clients who want to do estate planning? This presents a challenge.

Hersch: Does the lack of certainty therefore translate to fewer planning opportunities for life insurance and financial service professionals? Or does the uncertainty only make your more difficult?

LaBrecque: It makes our jobs much more difficult. It’s tough to plan when we don’t know what will happen. Under the current $5.1 million individual estate tax exemption, you may not need an ILIT. But if the Bush tax cuts expire–and exclusion amount reverts to $1 million–then you may well need an ILIT. So the lack of certainty does present a problem for financial professionals.  

That said, some planning exists, such as a IRA-to-Roth IRA conversion, which is a logical way to save on income tax. We’ve also been doing asset repositioning, such as moving dividend-paying stocks or mutual funds into IRAs and Roth IRAs. We’re also recommending tax-free municipal bonds.

Hersch: Are your clients shying away from fixed annuities because of continuing low interest rates?

LaBrecque: Yes, but if we start to move into a more inflationary environment, which I think we’re destined eventually to be in, then clients might consider shifting assets from short-term equity products to long-term fixed income products. The fiscal cliff presents a short-term equity problem; inflation is a long-term fixed income problem.

Hersch: What other opportunities do you foresee for life insurance and financial service professionals in the year ahead?

LaBrecque: In our practice, we’re doing a lot of work involving planned giving to charities. Some clients, for example, have opted for charitable gifts of life insurance. We’ve also seen a recent resurgence of SLATs–spousal lifetime annuity trusts–that entail establishing, for example, an ILIT for a surviving spouse.  

There is a strong market now for planning opportunities to use up the $5.12 million individual lifetime gift exemption that expires at year-end.