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Special Report: Fiscal Cliff Agreement

January 4, 2013

While the compromise does not satisfy both sides, and does not satisfy us due to the lack of necessary changes on entitlements and need for heavy budget cuts that were almost entirely not addressed, it does forestall many of the changes that would most negatively have impacted the economy and markets.
-John M. Roberts, director of research, Hilliard Lyons

 

Tax changes and potential market impact

 

Congress and the President finally came to an agreement on a resolution, albeit temporarily and at the last minute, on the so-called Fiscal Cliff. The Fiscal Cliff was the combination of the end of the Bush-era tax cuts, an end to the temporary 2% reduction in the payroll tax rates, a group of budget cuts, and various other tax law changes set to take effect on January 1st.

While the compromise does not satisfy both sides, and does not satisfy us due to the lack of necessary changes on entitlements and need for heavy budget cuts that were almost entirely not addressed, it does forestall many of the changes that would most negatively have impacted the economy and markets. As a result, it essentially permanently codifies the lower tax rates from the Bush tax cuts for taxpayers below a specified threshold, as well as various credits, exemptions, and other deductions. High income earners would be impacted, however.

The largest individual change is on the tax rates for high income earners. For couples with income in excess of $450,000 and singles with incomes over $400,000, their income tax rates will be hiked back to the Clintonera tax rates of 39.6% on all income in excess of those thresholds.

Further, their capital gains and dividend rates will also be boosted to the capital gains rates in place during the Clinton years, or to 20% up from the previous 15% level. 

However, beyond that, we note taxpayers at these levels will also be subject to additional taxes related to Obamacare that will push their marginal tax rates to 43.4% and 23.8%, respectively. These taxpayers (and in fact those with even lower incomes -- $250,000 for singles and $300,000 for married couples) will be subject to phase-outs on their personal exemptions and limitations on their itemized deductions; this will effectively add another 1% or so to their tax rates, putting the top marginal federal tax rate at about 45% for high income earners above these thresholds.

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