As an income investor, 2012 is a pivotal year for your U.S. and Canadian holdings. First, as you may know, this is the year when the Bush tax cuts are slated to expire on Dec. 31.
We've enjoyed nearly a decade of reduced dividend and capital gains taxes since President George W. Bush signed them into law in 2003. Through the end of 2012, you pay a reduced 15% tax rate on qualified dividends if you're in the 25% tax bracket or higher. And you pay zilch on qualified dividends if you're in the 10% and 15% tax brackets. Whatever your tax bracket, you pay 15%, tops, on capital gains on investments held a year or more.
If these reduced tax rates are allowed to expire, then the capital gains tax rate will revert from 15% to 20% and the qualified dividend tax rate will revert to your marginal income tax rate of up to 39.6%.
Also in 2013, the 3.8% investment income surcharge from the recent health care legislation kicks tax in if you're earning $200,000 individually or $250,000 jointly. So, together, your dividend and interest income could be taxed as much as 43.4% starting next year.
That's the worst case. But it's not the most likely.
A long-standing war between Republicans and Democrats over the Bush-era tax cuts kept the so-called debt super-committee, a joint committee of the U. S. Congress, from reaching a deal last November. Taxes are expected to take center stage once again in the November 2012 presidential elections.
Most Democrats, including Obama, want to extend the Bush tax cuts to all but the wealthy. In both his 2008 campaign platform and again in his fiscal 2012 budget, Obama has proposed increasing the top tax rate on qualified dividends and long-term gains from 15% to 20% only for those earning more than $200,000 individually or $250,000 jointly.
In contrast, Republicans, on the whole, want to see the Bush tax cuts permanently extended for all. But even assuming a Republican win and majority control in the Senate and the House in 2013, it would be hard to push through the Republican agenda unless there are at least 60 Republicans in the Senate to avoid a Democratic filibuster. There are now 51 Democrats, 47 Republicans, and two independents.
So most of us in the middle-income tax brackets shouldn't be greatly affected by whatever tax changes take place. Still, the uncertainty will almost certainly lead to increased volatility.
Action to Take --> I'll be keeping a close watch on how the tax laws look to be shaping up during the year. If anything happens, then readers of High-Yield Investing will be the first to hear my take. Meanwhile, there's still at least a year and likely more to enjoy reduced dividend tax rates on stalwart dividend payers such as electric utilities and telecoms.
And as always, you can still enjoy the rich tax-deferred income from limited partnerships and protect your nest egg even in a worst-case scenario.
If you have any losses you're considering selling for tax purposes, then you may want to wait until next year, when a higher capital-gains rate may kick in. Beyond tax considerations, now is as good a time as ever to own dividend stocks. They provide safety in a volatile market, and thanks to the Federal Reserve telegraphing its desire to keep interest rates low for a couple more years, I know what to expect and how to advise readers of High-Yield Investing accordingly.