Let me tell you how it will be
There's one for you, nineteen for me
'Cause I'm the taxman, yeah, I'm the taxman
“Taxman” - The Beatles 1966

The United States has a balance sheet problem that is desperately in need of repair. In a nutshell, the US government spends more than it receives in revenue. Due to years of failure to reign in government spending or increase revenue, what was once a treatable ailment has grown into a serious disease in need of some significant fiscal policy changes. Most of the new, yet to be determined policies, will result in just about everyone paying higher income taxes and potentially receiving less government benefits. Particularly hard hit will be those individuals in the upper income brackets and investors of all sorts. A few years ago our balance sheet problems could be solved by normal economic growth – the resulting corporate tax receipts would fill in the deficit gaps. However, over the past 5 years, the US has been plagued by slower than normal economic growth, coupled with significant government spending programs – hence our budget dilemma. Here are a few thoughts from our research partners and in house team about potential changes from the “Taxman.”

The Obama administration appears to have a number of ideas to raise revenue, mostly by raising taxes across the board. Here is what we expect to happen:

-The tax on long term capital gains will be increased from 15% to 23.8%.
-Dividend income tax will be increased from the current range of 0%-15% to the rate of each individual’s ordinary income.
-The upper level of federal tax payers who currently pay 33-35% will be adjusted to 35-39.6%.
-Estate tax exemption levels will be held at 3.5 million with a top rate of 45% after exemption.
-The Alternative Minimum Tax (AMT) will be expanded to include more tax payers.

We believe that most of these tax law changes will be decided sometime next year and will be retroactive for all of 2013. Therefore, there are a number of actions individuals and investors can take to pre-empt the full force of these changes.

-By the end of this year, reduce stock positions with low cost basis to capture the 15% long term rate.
-In taxable accounts, reconsider and re-evaluate the after tax effect of dividends in this higher rate environment
-Defer significant losses until 2013
-Accelerate any optional income (bonuses, etc) to the current year.
-Mentally prepare and consult with your tax advisor about adjusting estimated tax payments and withholdings.

We will be reviewing your portfolio in light of potentially higher capital gains and dividend income tax rates. Our view is that it would be prudent to sell positions with significant unrealized capital gain prior to year end, given that capital gain rates may be increasing by over 50%. We will also be reviewing your taxable accounts and re-evaluating the “after tax” dividend yield for your particular circumstances. This may cause us to make changes in these accounts to make your portfolio more tax efficient.

Keep in mind that these thoughts are simply a forecast of potential changes in tax code – no one knows for certain what will transpire. We would also highly recommend that you consult with your tax professional for additional opinions on this matter.

It is a shame that the United States has gotten itself into this mess, but it is curable and making it right will make this country, economy and financial market great …once again.

If you have questions on this or any other matter, or if your circumstances have changed, please let us know. All of us here wish you and your family a Happy Thanksgiving.

Sincerely,

Your Team at Main Street Research