How to not let the tax tail wag the dog with the Taxpayer Relief Act Featured

8:11pm EDT January 31, 2013
How to not let the tax tail wag the dog with the Taxpayer Relief Act

When Congress passed the American Taxpayer Relief Act, it came with just enough time to give a clearer picture of expectations for the year ahead.

“There was a lot of anxiety and uncertainty in the last quarter of the past year as the deadline got closer and people had no idea what to do about their tax planning,” says Rick Applegate, president and CEO of First Commonwealth Financial Advisors.

Smart Business spoke with Applegate about the changes and how they impact your tax and financial planning.

What are some of the tax law changes? 

The act avoided higher ordinary income tax rates for most Americans, but higher-income earners — $400,000 per year for single filers or $450,000 per year if married and filing jointly — will have their tax rate revert back to 39.6 percent, the highest ordinary income tax rate in this country before the tax reductions instituted by President George W. Bush. This impacts approximately 1 to 1.5 percent of Americans.

The biggest overall impact is the 2 percent increase in the payroll tax back to 6.2 percent, which might slow the economy’s growth rate in the first six months of 2013. In the year ahead, the Social Security tax tops out at incomes of $113,700 — therefore, an individual could pay up to an additional $2,274 and a working couple even more. It’s estimated that the 2 percent increased payroll tax will generate about $125 billion for the Social Security system, but that’s money that reduces discretionary consumer spending, which has otherwise helped to drive a U.S. economic recovery.

Another notable change is the 5 percent increase in capital gains and dividend rates for higher-income earners to 20 percent. This increase was not as bad as it could have been — capital gains rates on dividends were scheduled to go to ordinary income tax rates, which could have been as high as that top income tax bracket of 39.6 percent.

Investment income also gets the new Medicare surtax of 3.8 percent tacked on for anyone making more than $200,000, or $250,000 if married and filing jointly. It’s not a killer, but people at these income levels who rely on investment income will pay.

Some other changes are:

  • Estate tax exemptions and rates. Congress extended the $5 million exemption and adjusted it for future inflation, and upped the top estate tax rate to 40 percent.

  • Permanently indexing the Alternative Minimum Tax to inflation. This fixed the problem where more and more middle-class Americans were paying a tax originally meant to catch high-income earners who used deductions and loopholes to avoid paying any taxes.

  • Reinstituting phase-outs of certain deductions for those with higher incomes.

If anyone was a winner in the tax bill, at large, it was people with educational loans and families trying to pay for college. The act extended certain credits and deductions for qualified taxpayers.

How do investment advice and tax considerations go hand-in-hand?

You don’t want your investments to be ruled by tax decisions — you want investments to be made based on the projected economics of the deal and its potential returns.

That’s why it’s an adviser’s job to get people past their fears and emotions, and focus on making money. If investors can’t get past it themselves, they should sit down with a trained adviser who has a perspective on why there are always opportunities out there.

What are some strategies that can add value in the year ahead?

The average investor shouldn’t be too intimidated by these adjustments because, by and large, they mostly impact those in very high-income brackets. High-income earners may benefit from tax-exempt income from municipal bonds, tax deferrals like low-cost annuities, and/or decreasing their ordinary income by deferring more taxable income today into a retirement plan.

Until Congress permanently deals with the debt ceiling, headline volatility will likely be a fact of life. However, we still think that 2013 will be a fairly good year for the stock market. We would advise taking advantage of market declines that are likely to occur and to buy into opportunities such as the emerging markets. Investors shouldn’t let headlines make decisions; smart investors take advantage of market dips because, long-term, the stock market offers good value.

Rick Applegate is the President and CEO of First Commonwealth Financial Advisors. Reach him at (724) 933-4529 or

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