After the votes were counted last night, the political landscape in Washington emerged largely unchanged, giving advisors a slight, albeit cloudy, glimpse of the tax scene in 2013.

“The question on everyone’s mind is what does this mean for 2013 and what does this mean for whole fiscal cliff and Bush tax cuts,” Tim Steffen, the director of financial planning at Milwaukee-based Robert W. Baird & Co., said. “That’s the primary question that people are going to start asking today.”

Given a democratic President, a democratic Senate, and a Republican House of Representatives, Steffen sees three possible scenarios:

The first is that President Barack Obama is able to convince Republicans in the House to agree to the tax scenario he laid out during the campaign, which would mean that the majority of Americans avoid tax increases scheduled to take effect in 2013. However, those making above $250,000 ($200,000 for singles) would see a tax increase on their income, capital gains and dividends as well as caps on the benefit of itemized deductions as well as other increases.

Second, at some point this year or more likely at some point in 2013, the two parties compromise in favor of a combination of the two platforms that were espoused during the campaign, Steffen said.

Finally, Congress and the executive branch cannot come to any agreement and everything goes according to law. That means that taxes go up across the board; an option Steffen views as “a real possibility,” at this point.

The potential gridlock from having a Republican-controlled House makes the first two scenarios “easier said than done,” Steffen said. “It’s not going to be any easier or more difficult to pass legislation than it has been in the past,” he said. “To the extent that we’ve had gridlock before, we’re likely going to have gridlock.”

The other issue is that time has all but run out for Congress to pass any legislation on the fiscal cliff by the end of this year, Steffen explained. There are basically four weeks for Congress to vote on bills, including a period between now and Thanksgiving and three weeks between Thanksgiving and Christmas. “That’s not a lot of time to draft and vote on a bill that you know is not going to be an easy pass no matter what they come up with,” Steffen said.

Moreover, legislators will have to address leftover 2011 tax issues first. The Alternative Minimum Tax, for example, must be extended or it will begin to affect lower income brackets this year, leaving some with “a lot of sticker shock” for 27 million investors when they get their returns back in 2013, Steffen said. “Anybody with more than a modest level of income needs to be concerned with how the AMT might affect them,” he said, noting that those in states with higher taxes, such as New York and California, would suffer the most. 

One certainty that advisors can take from the election is that the healthcare laws that were implemented earlier this year are likely here to stay, according to Steffen. That translates into a 3.8% tax on investment income for married taxpayers with income over $250,000 ($200,000 for singles) and a 0.9% increase in the Medicare tax on wages for families or singles at the same income level.

With that and the potential for estate planning taxes to take hit at the $1 million mark instead of $5 million, Steffen thinks that it would be wise to start taking advantage of the 2012 tax levels.

“The question is what do we do with portfolios with likely increase on capital gains, and should I be selling things in 2012 to avoid capital gains increases; And in a lot of cases I think the answer may be yes,” Steffen said.

Although a compromise later in 2013 could retroactively dial down some of the tax impact, Steffen believed that it is not likely taxes will be lower than they are now, so it would behoove clients to plan strategically and take an IRA distribution in December 2012 versus January of 2013, for example, or consider gifting opportunities in light of estate taxes.

“If your income is going to be consistent between 2012 and 2013, most people are going to lean toward the certainty of 2012 versus the uncertainty of 2013,” Steffen said.

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