What Key Financial Issues Have Washington’s Attention?

Michael Townsend, Vice President of Legislative and Regulatory Affairs for Charles Schwab & Company spoke to a group of advisors about what effect the policies and politics coming out of Washington might have on investors in the months ahead. As you might guess, his access to Washington gives him an insider’s perspective.

Outside of the election, here are 7 key issues that have the attention of lawmakers in Washington:

1.  To extend or not to extend ? That is the question.

Two plans to deal with the Bush tax cuts are currently being proposed. The House plan calls for a one-year extension of the Bush tax cuts, although it doesn’t address AMT or payroll taxes. The Senate is also proposing a one-year extension of the Bush tax cuts, but only for those making less than $250,000 a year.

The Senate version also includes a hike in the capital gains and dividends rate from the current 15% to 20%. In the House vs. Senate proposals, the consensus is that the House plan should pass, but may meet resistance when it’s taken up by the Senate. If they can’t come to any agreement, then the Bush tax cuts will expire. Should this happen, Congress could reenact the tax cuts retroactively in 2013. So the only certainty is that the uncertainty continues.

2.  Introducing the new Medicare Tax

One of the biggest changes comes in the form of a Medicare tax. Up to this point, unearned or investment income has been exempt from paying Medicare tax. Starting in January, expect to pay a tax of 3.8% on this income. Assuming the current capital gains rate remains at 15%, this tax rate would increase to 18.8% for families making over $250,000.

3.  Say goodbye to the payroll tax cut

The 2% payroll tax cut, giving some temporary relief since 2010, is unlikely to be extended. Rates are expected to revert to 6.2% in January, 2013.

4.  Generosity has its limit – expect a lower Estate Tax exemption

Also expiring is the generous gift and estate tax exemption, currently at $5 million. If Congress doesn’t act, the exemption will revert back to $1 million – levels last seen in 2003. Proposed legislation puts the exemption at $3.5 million, while keeping the tax rate at 35%. They also believe that Congress will keep the portability feature. This allows a surviving spouse to have the benefit of any unused portion of their spouse’s exemption. This seems to be the least controversial of all the tax issues, but the conversation on the hill is still at a high-level, and many of the details need to be worked out.

5.  Good news about AMT?

The Alternative Minimum Tax, (AMT) originally designed to ensure that wealthier people with more deductions would pay a minimum amount of tax, now affects more tax payers each year at lower income levels because it doesn’t adjust for inflation. Each year, they have patched the law by adjusting the income limit as though it was inflation adjusted. Congress has been talking about permanently fixing AMT for some time. If they do address AMT, Mike thinks it will happen before year-end since applying any changes retroactively would be too complicated for both the IRS and individuals.

6.  Déjà-vu debt ceiling

The debt ceiling and automatic spending cuts (sequestration) are looming over us like dark clouds of an impending storm. The expectation is that Congress will avoid another debt ceiling showdown before the elections, but will need to raise the ceiling again by January or February of next year. The automatic spending cuts of $1.2 trillion are slated to go into effect on January 1, 2013 with half coming from defense and the other half from domestic spending. Clearly no one is happy about the cuts, and he thinks Congress may seek to unravel them blaming a “still too weak” economy to keep them in place.

7.  Buzz on the Hill

It’s still all about LIBOR – The LIBOR scandal is the latest in a series of banking industry transgressions. LIBOR stands for the London interbank offer rate. It is the most widely used interest rate in the world, and a benchmark for other rates such as mortgages, commercial loans, etc. If the manipulation of LIBOR resulted in rates that were set too high, then those who took out loans based on LIBOR may, in fact, be paying a higher interest rate than they should. This scandal is cementing the idea that the individual investor can’t get a break in the markets, and it’s getting traction in Congress.