Here comes the taxman … BOOM!

Great analysis published this week by the non-partisan Tax Policy Center that details the potential impacts if the Bush (and Obama) tax cuts are allowed to expire at the end of the year.

The entire report is worth reading if you’re in the 53% who do pay Federal income taxes … or if you’re at the top earning end of the 47% – since you’ll get banged, too.

According to the TPC, there will be different effects on households at different income levels:

For most households, the two biggest increases would be the expiration of the temporary cut in Social Security taxes and the expiration of the 2001/2003 tax cuts.

  • Households with low incomes would be particularly affected by the expiration of the credits expanded or created by the 2009 stimulus.
  • Households at the highest income levels would be particularly affected by expiration of the 2001/2003 tax cuts that apply to upper income levels and by the new health reform taxes.
  • Upper middle-income households would be particularly affected by the expiration of the AMT patch.
  • In addition to raising average tax rates, the fiscal cliff would substantially raise marginal tax rates.  The average marginal tax rate would increase by about 5 percentage points on wages and salaries, by about 5 percentage points on interest income, by about 7 percentage points on long-term capital gains, and by more than 20 percentage points on qualified dividends.

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Potential Stock Sell-off

One implication of increasing marginal tax rates is that some investors would have an incentive to sell appreciated stocks, bonds, and other assets before the end of the year, if they believe the capital gains rate will go up as scheduled and then remain in place for tax year 2013.

That is exactly what happened following the enactment of the Tax Reform Act of 1986, which increased the top capital gains tax rate from 20 percent to 28 percent.

Capital gains realizations almost doubled in 1986 and then fell back in 1987 as investors rushed to take advantage of the soon-to-expire 20 percent rate.

Similar behavior is likely this year unless investors believe that the scheduled tax increases will be averted.

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In summary: Ouch.

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