My Friend, 'Fiscal' Cliff

NEW YORK (TheStreet) -- My lifelong best friend's name happens to be Cliff, and I can't tell you the number of times recently that I've thought of bestowing on him the nickname "fiscal," or suggesting he get a vanity license plate for his car using that same term.

It has nothing to do with him, just his name. He's an incredible guy, and I've been blessed to have know him for 43 of our 46 years.

Unfortunately, " "fiscal clif" is one of those new terms you can't seem to go more than a few hours without seeing or hearing. It's seeping into our minds the same way "tech bubble" did a dozen years ago, or "bailout" did just a few years ago.

But the notion that so many changes are converging at one point in time is startling. Especially at a point in time when our national debt has not only exploded above $16 trillion, but is accelerating. This is crunch time.

Yet, Mr. Market, in its ultimate wisdom, seems to be unconcerned, at this point, anyway. That's because there's some kind of compromise, at least on the tax front, that is already priced in. Whether the current tax rates will be extended for everyone, for those with income below $250,000, $1 million or what have you, remains to be seen. But the markets are expecting an extension of some sort.

If you have not yet familiarized yourself with the changes, now is a good time to do so.

There are some nice surprises in there for everyone, among them:
  • The 10% tax bracket disappears, and is replaced by 15%
  • 25% bracket goes to 28%
  • 28% to 31%
  • 33% to 36%
  • 35% to 39.6%
  • Lapse of the AMT exemption patch
  • Return of itemized deduction and personal exemption phase-outs
  • New Medicare tax, an additional 0.9% on wages above $200,000 for singles, $250,000 for marrieds
  • Unearned Income Medicare Contribution Tax, part of "Obamacare", 3.8% tax that applies to the lesser of "net investment income" or the excess of adjusted gross income (AGI) over $200,000 single, $250,000 married
  • Expiration of child tax credit (goes back to $500 per child under age 16, from $1,000
  • Lapse of qualified dividend tax treatment -- tax on qualified dividends goes from long-term capital gains rate, to taxpayers ordinary income tax rate.Increase in long-term capital gains tax rate, from 0% for those in the current 10% or 15% brackets to 10%; to 20% in the 25% bracket or higher
  • Expiration of the payroll tax cut. Employees' share of FICA will increase from 4.2% to 6.2%

Those are just the highlights. The changes are fairly drastic, especially for an economy that may again be on the brink of a recession.

My own expectation is that the current tax structure will be extended for incomes below $250,000, no matter what happens in the elections. Broadening above $250,000 will depend on the elections.

I do not expect the payroll tax cuts to be extended. I have my doubts as to how stimulative that cut actually was, and it came at the expense of the non-existent Social Security trust fund. Talk about "kicking the can down the road" -- another expression I'd gladly go without hearing for the next 50 years.

If, in fact, no extensions are made, or they are for above 250,000 only, dividend-paying stocks will more than likely suffer the consequences at some point, not necessarily by year's end.

An increase in rates from 15% to 43.4% (including the Medicare surtax), will make these stocks less attractive, and non-dividend payers, or high-quality growth names more attractive. Munis might be also be looked upon favorably, except for the fact that yields are so low.

Mr. Market is not yet worried about any of this. Heck, there's still three months left in the year. What worries me most, beyond the deficit and fact that tax increases are but a drop in the bucket in solving it and will likely hurt economic "growth," is a scenario in which the tax rates and laws are again temporarily fixed.

Uncertainty does not help matters. Uncertainty is why companies have so much cash on the books and are not hiring.

This is only the tip of the iceberg in the "fiscal" cliff issue. More for another day.

"Fiscal" Cliff, if you are reading this, you may want to trademark that name.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.

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