The Alternative Minimum Tax (AMT)

In the past ten years there have been eight temporary legislative AMT-related "patches," designed to forestall a sudden dramatic increase in the number of individuals who are affected by the AMT. The latest two-year patch, included as part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, is effective through December 31, 2011. That means you can expect additional AMT legislation later this year or in early 2012.

What is the AMT?

The AMT is essentially a separate federal income tax system with its own tax rates, and its own set of rules governing the recognition and timing of income and expenses. If you're subject to the AMT, you have to calculate your taxes twice--once under the regular tax system and again under the AMT system. If your income tax liability under the AMT is greater than your liability under the regular tax system, the difference is reported as an additional tax on your federal income tax return. If you're subject to the AMT in one year, you may be entitled to a credit that can be applied against regular tax liability in future years.

How do you know if you're subject to the AMT?

Part of the problem with the AMT is that, without doing some calculations, there's no easy way to determine whether or not you're subject to the tax. Key AMT "triggers" include the number of personal exemptions you claim, your miscellaneous itemized deductions, and your state and local tax deductions. So, for example, if you have a large family and live in a high-tax state, there's a good possibility you might have to contend with the AMT. IRS Form 1040 instructions include a worksheet that may help you determine whether you're subject to the AMT (an electronic version of this worksheet is also available on the IRS website), but you might need to complete IRS Form 6251 to know for sure.

Common AMT adjustments

It's no easy task to calculate the AMT, in part because of the number and seemingly disparate nature of the adjustments that need to be made. Here are some of the more common AMT adjustments:

• Standard deduction and personal exemptions: The federal standard deduction, generally available under the regular tax system if you don't itemize deductions, is not allowed for purposes of calculating the AMT. Nor can you take a deduction for personal exemptions.
• Itemized deductions: Under the AMT calculation, no deduction is allowed for state and local taxes paid, or for certain miscellaneous itemized deductions. Your deduction for medical expenses may also be reduced, and you can only deduct qualifying residence interest (e.g., mortgage or home equity loan interest) to the extent the loan proceeds are used to purchase, construct, or improve a principal residence.
• Exercise of incentive stock options (ISOs): Under the regular tax system, tax is generally deferred until you sell the acquired stock. But for AMT purposes, when you exercise an ISO, income is generally recognized to the extent that the fair market value of the acquired shares exceeds the option price. This means that a significant ISO exercise in a year can trigger AMT liability. If ISOs are exercised and sold in the same year, however, no AMT adjustment is needed, since any income would be recognized for regular tax purposes as well.
• Depreciation: If you're depreciating assets (for example, if you're a sole proprietor and own an asset for business use), you'll have to calculate depreciation twice--once under regular income tax rules and once under AMT rules.

AMT exemption amounts

While the AMT takes away personal exemptions and a number of deductions, it provides specific AMT exemptions. The amount of AMT exemption that you're entitled to depends on your filing status.

 

AMT Exemption Amounts by Filing Status	2011	2012
Married filing jointly	$74,450	$45,000
Single or head of household	$48,450	$33,750
Married filing separately	$37,225	$22,500

Note: The 2012 figures assume no additional Congressional action.

Your exemption amount, however, begins to phase out once your taxable income exceeds a certain threshold ($150,000 for married individuals filing jointly, $112,500 for single individuals, and $75,000 for married individuals filing separately).

What happens in 2012?

AMT exemption amounts and phaseout thresholds are not adjusted for inflation--they only change through legislation. This is one of the principal reasons that more people tend to be subject to the AMT each year. The increased AMT exemption amounts included in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 are for the 2010 and 2011 tax years only. Unless Congress passes new legislation, 2012 AMT exemption amounts will return to pre-2001 levels. In addition, without new legislation, the AMT rules could limit your ability to claim certain nonrefundable personal tax credits in 2012, including the American Opportunity (Hope) and Lifetime Learning tax credits, the dependent care credit, and the credit for the elderly and disabled.

AMT rates

Under the AMT, the first $175,000 of your taxable income is taxed at a rate of 26%. (If your filing status is married filing separately, the 26% rate applies to your first $87,500 in taxable income.) Taxable income above this amount is taxed at a flat rate of 28%.

The lower maximum tax rates that apply to long-term capital gain and qualifying dividends apply to the AMT calculation as well. So, even under AMT rules, a maximum rate of 15% (0% for individuals in the lower two tax brackets) applies. However, long-term capital gain and qualifying dividends are included when you determine your taxable income under the AMT system. That means large capital gains and qualifying dividends can push you into the phaseout range for AMT exemptions, and can indirectly increase AMT exposure.

Technical Note: In the context of AMT exemption amounts and tax rates, taxable income really refers to your alternative minimum taxable income (AMTI). Your AMTI is your regular taxable income increased or decreased by AMT preferences and adjustments.

Summing up

Owing AMT isn't the end of the world, but it can be a very unpleasant surprise. It also turns a number of traditional tax planning strategies (e.g., accelerating deductions) on their heads, so it's a good idea to factor in the AMT before the end of the year, while there's still time to plan.

If you think you might be subject to the AMT, it may be worth sitting down to discuss your situation with a tax professional.

 

IMPORTANT DISCLOSURES

The information presented here is not specific to any individual's personal circumstances.

To the extent that this material and/or website concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials and/or website are provided for general information and educational purposes only based upon publicly available information. Information throughout these materials and/or website, whether stock quotes, charts, articles, or any other statement or statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable - we cannot assure the accuracy or completeness of these materials and/or website.

These materials and/or website do not constitute a complete description of our investment services or performance, and nothing in this information should be interpreted to state or imply that past results are an indication of future performance. There are not warranties, expressed or implied, as to the accuracy, completeness, or results obtained from information contained within these materials and/or posted on this website or any "linked" website.

The information in these materials and/or website may change at any time and without notice.

This communication is strictly intended for individuals residing in the state(s) of CA. No offers may be made or accepted from any resident outside the specific states referenced.

 

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012.

Women: What You Should Know When Starting a Business

According to the Small Business Administration (SBA), the number of women-owned businesses grew 44% from 1997 to 2007--twice as fast as male-owned firms. Many of these businesses started small, begun by women seeking the exciting and potentially rewarding experience of "being their own boss" while doing something they enjoy. If you're thinking about starting your own business, you'll need a sound plan, a little creativity, personal dedication, and probably some form of financial investment.

But before you make the commitment to starting your own business, the first question to consider is whether owning your own business is right for you. Here are a few of the important factors to consider when starting your business.

Personal investment

Why do you want to start a business? For the most part, you should believe you have a great idea that you are passionate about. Giving your business a chance to be successful will require a personal commitment and probably some sacrifices. Are you prepared to invest the time, money, and personal resources to get your business started?

As you might imagine, there's a lot that goes into starting a business. You'll have to do some market research to determine the potential size of your market, identify the competition, and set the price of the goods or services you'll offer. You should develop a written business plan, research the best legal form to use for your business, and understand what licenses and/or permits you'll need. And you'll have to figure out how much capital you'll need to start your business, and where that capital will come from.

Type of business

What kind of business do you want? Do you have a unique idea, or do you want to get involved in a type of business that already exists, like a franchise? What products or services will your business provide? Have you identified your target market? Who is your competition, and what will separate your business from your competition? Depending on the type of business, how long will it take before your products or services are available to your target market? How big and how quickly do you want your business to grow?

The type of business you choose should not only match your talents, abilities, and interests, but it also should have a viable place in the market, based on your competition and the potential demand for the products or services your business will offer. Getting this information will take some time and effort, but many businesses fail simply because they're in the wrong market or the competition is too strong.

The business plan

It's one thing to have a great idea for a business, but it becomes much more real when you put it down on paper. A business plan is essentially the story of your business: the name of your business, what your business does, how you came up with the idea for your business, what markets you serve, what differentiates your business from the competition, where your business is now, and where you see it in the future. Not only should your business plan serve as a road map to a successful business venture, but if you're going to seek financing for your business, you'll almost certainly be asked for a business plan. There's generally no set form for use in developing a business plan, but most plans cover these essential elements:

• An executive summary, which briefly describes your business as a whole and touches on your business's profile and goals
• An in-depth explanation of the history and development of your business
• A summary of the products and/or services you offer
• A customer description, market analysis, and competitor analysis
• A description of your business's legal structure (e.g., corporation, partnership, sole proprietorship) and management organization
• An explanation of your marketing plan and sales strategy
• A capitalization plan including projected revenues, cash flow projections, pro forma financials, and an explanation of how you'll use funds

Selecting a business form

One of the first decisions you'll need to make is what form of legal entity your business will take. If you're starting a business from scratch (as opposed to buying an established business), your options are many. The type of entity you select is important because it can determine the types of permits you'll need, where and how your business should be registered, the extent of protection from personal liability each type of entity affords, and the amount and form of taxes that may have to be paid. While it's a good idea to consult a financial or legal professional before selecting the type of entity for your business, here's a brief description of the more common forms of business structures.

Sole proprietorship: A sole proprietorship is the most straightforward way to structure your business entity. As a sole proprietor, your business is simply an extension of you. Sole proprietors are liable for all business debts and other obligations the business might incur. This means your personal assets can be subject to the claims of your business's creditors.

Partnership: A partnership is a business entity where two or more people enter into a business relationship for mutual profit. Partnerships are organized in accordance with state law. In a general partnership, all partners can act on behalf of one another in furtherance of partnership business, which means each partner is personally liable for the acts of the other partners, and all partners are personally liable for the debts and liabilities of the partnership. Limited partnerships and limited liability partnerships may provide some liability protection for partners according to the state law where the partnership is formed.

Corporations: There are several different types of corporations. Generally, two advantages of corporations are that they provide a shield from individual liability and are the easiest type of entity to use to raise capital. Some common types of corporations are S corporations and limited liability corporations or companies. A C corporation is taxed as a separate entity, whereas S corporations and most limited liability corporations pass income, gains, deductions, and losses of the business through to the shareholders.

Financing your business

Your business plan is in place. Now you have to figure out how and where you'll get the funds to set your dream in motion--and sustain it. Figuring out how much money you'll need is not always an easy question to answer. The first step in determining your financing needs is to develop a line-item budget, projected over a period of months and/or years.

Next, you'll need to figure out how to finance your business. The two general categories of financing available for businesses are debt and equity. Debt requires repayment of a loan. Equity involves raising capital by selling parts of the business to investors.

One place to look for capital might be your own assets. You may be able to raise money for the business from your savings or borrow against a retirement plan, life insurance policy, credit card, or the equity in your home.

Another common source of funds for new businesses is what's called "friends and family." However, such funding is most likely to be successful if it's structured in a businesslike way, with clear terms of repayment or ownership participation.

You can apply to banks or credit unions for loans. The Small Business Administration has a website devoted to women-owned businesses at www.sba.gov. There you can find resources to help you start and finance your business. Also, your local chamber of commerce may be able to refer you to state and local agencies that provide financial assistance to new businesses located within your geographic area.

Anything else?

There are plenty of other things to consider, such as taxes, licenses, fees, and permits. You'll need to think about where to locate your business and how you'll market it. Will you have employees? Will you add a retirement plan? If so, you'll have regulatory requirements and tax responsibilities, as well as possible workers' compensation to consider. But you don't have to go it alone. There are experts available to serve as mentors or counselors. Check the Women's Business Resources section of the Small Business Administration website at www.sba.gov for information on locating a mentor.

IMPORTANT DISCLOSURES The information presented here is not specific to any individual's personal circumstances. To the extent that this material and/or website concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials and/or website are provided for general information and educational purposes only based upon publicly available information. Information throughout these materials and/or website, whether stock quotes, charts, articles, or any other statement or statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable - we cannot assure the accuracy or completeness of these materials and/or website. These materials and/or website do not constitute a complete description of our investment services or performance, and nothing in this information should be interpreted to state or imply that past results are an indication of future performance. There are not warranties, expressed or implied, as to the accuracy, completeness, or results obtained from information contained within these materials and/or posted on this website or any "linked" website.   The information in these materials and/or website may change at any time and without notice. This communication is strictly intended for individuals residing in the state(s) of CA. No offers may be made or accepted from any resident outside the specific states referenced.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012.

Is Your 529 Plan Making the Grade?

As of June 2011, there were 8.8 million open 529 college savings plan accounts (Source: College Board, Trends in Student Aid, 2011). If you're one of the millions of parents or grandparents who've invested money in a 529 college savings plan, the arrival of a new academic year may be a good time to see how your plan stacks up against the competition. Mediocre investment returns, higher-than-average fees, limited investment options and flexibility--these are some of the things that might have you thinking you could do better with another plan. If you discover that your 529 plan's performance has been subpar, what options do you have?

Roll over funds to a new 529 plan

One option is to do a "same beneficiary rollover" to a different 529 plan. Under federal law, you can roll over the funds in your existing 529 plan to a different 529 plan (college savings plan or prepaid tuition plan) once every 12 months without having to change the beneficiary and without triggering a federal penalty.

Of course, you'll need to research other plans and then choose one, which may take some time. Once you decide on a plan, the rollover process is fairly straightforward. Call your existing 529 plan manager to see what steps are required (some plans may impose a fee for a rollover, so make sure to ask); your new plan should have a system in place to accept rollover funds. You must complete the rollover within 60 days of receiving a distribution to avoid paying a penalty.

If you want to roll over the funds in your 529 college savings plan account more than once in a 12-month period, you'll need to change the beneficiary to another qualifying family member to avoid paying a federal penalty. As a workaround, you can change the beneficiary back to the original person later.

Change your investment strategy in your current 529 plan

Just because you can switch to a different 529 plan doesn't necessarily mean you should. If the new plan has roughly the same mix of investment choices and similar fees as your current plan, you might ask yourself if you'd be better off staying put and simply changing your current investment allocations. This is especially true if you have invested in your own state's 529 plan and the availability of related state tax breaks depends on you remaining in a state plan.

Section 529 college savings plans generally allow you to change the way your future contributions are invested at any time. So, for example, if you originally picked a more aggressive investment option, you can choose a different one (or more than one) for your future contributions.

However, the rules are stricter when it comes to your existing contributions. If you're unhappy with the performance of your current investment portfolio but don't want to switch plans completely (using the rollover option described earlier), you may have another option. Specifically, 529 college savings plans are federally authorized (but not required) to let you change the investment option for your existing contributions once per calendar year without having to change the beneficiary. (This is different from a plan allowing you to pick a new investment option for your future contributions.) Before joining a 529 plan, check to see if it offers this flexibility for existing contributions.

Other options to consider

Some 529 college savings plan investors may wonder whether they should continue putting money into their accounts if their investment returns have been lackluster, or even in negative territory. Although more 529 plans nowadays are likely to offer more conservative investment options, such as certificates of deposit or money market funds, you still might decide that you'd like to have more control over your college investments. In that case, you might consider a Coverdell education savings account or an UTMA/UGMA custodial account, both of which let you choose your underlying investments.

Finally, keep in mind that any college investment strategy should be reexamined periodically in light of new tax laws and changes in individual circumstances. A financial professional can help you understand your options, compare 529 plans, and select the right investment strategy for your situation.

Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in each issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

IMPORTANT DISCLOSURES The information presented here is not specific to any individual's personal circumstances. To the extent that this material and/or website concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials and/or website are provided for general information and educational purposes only based upon publicly available information. Information throughout these materials and/or website, whether stock quotes, charts, articles, or any other statement or statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable - we cannot assure the accuracy or completeness of these materials and/or website. These materials and/or website do not constitute a complete description of our investment services or performance, and nothing in this information should be interpreted to state or imply that past results are an indication of future performance. There are not warranties, expressed or implied, as to the accuracy, completeness, or results obtained from information contained within these materials and/or posted on this website or any "linked" website.   The information in these materials and/or website may change at any time and without notice. This communication is strictly intended for individuals residing in the state(s) of CA. No offers may be made or accepted from any resident outside the specific states referenced.

Concentrated Stock Positions: Considerations and Strategies

Whether you inherited a large holding, exercised options to buy your company's stock, sold a private business, hold restricted stock, or have benefitted from repeated stock splits over the years, having a large position in a single stock carries unique challenges. Even if the stock has done well, you may want more diversification, or have new financial goals that require a shift in strategy.

When a single stock dominates your portfolio, however, selling the stock may be complicated by more than just the associated tax consequences. There also may be legal constraints on your ability to sell, contractual obligations such as lock-up agreements, or practical considerations, such as the possibility that a large sale could overwhelm the market for a thinly traded stock. The choices appropriate for you are complex and will depend on your own situation and tax considerations, but here is a brief overview of some of your options.

Sell your shares

Selling obviously frees up funds that can be used to diversify a portfolio. However, if you have a low cost basis, you may be concerned about capital gains taxes. Or you may want to avoid any perception of market manipulation or insider trading. You might consider selling shares over time, which can help you manage the tax bite in any one year, yet allow you to participate in any future growth. However, remember that long-term capital gain tax rates are currently at historically low levels (current rates carry through tax year 2012). If you plan to sell and will face taxes anyway, now might not be the worst time to have to pay them.

If you hold restricted shares, you might set up a 10b5-1 plan, which spells out a predetermined schedule for selling shares over time. Such written plans specify in advance the dates, prices and amounts of each sale, and comply with SEC Rule 144, which governs the sale of restricted stock and was designed to prevent insider trading. A 10b5-1 plan demonstrates that your selling decisions were made prior to your having any insider knowledge that could influence specific transactions. (However, terminating the plan early or selling too much too quickly could raise questions about the plan's legitimacy.)

You might also be able to avoid some of the restrictions on how much and when you can sell by selling shares privately rather than on the public market. However, you would likely have to sell at less than the market value, and would still face capital gains taxes.

Hedge your position

You may want to try to protect yourself in the short term against the risk of a substantial drop in price. There are multiple ways to try to manage that risk by using options, which can be especially useful if you're legally restricted from selling your shares. However, bear in mind that the use of options is not appropriate for all investors.

Buying a protective put essentially puts a floor under the value of your shares by giving you the right to sell your shares at a predetermined price. Buying put options that can be exercised at a price below your stock's current market value can help limit potential losses on the underlying equity while allowing you to continue to participate in any potential appreciation. However, you also would lose money on the option itself if the stock's price remains above the put's strike price.

Selling covered calls with a strike price above the market price can provide additional income from your holdings that could help offset potential losses if the stock's price drops. However, the call limits the extent to which you can benefit from any price appreciation. And if the share price reaches the call's strike price, you would have to be prepared to meet that call.

A collar involves buying not only protective puts but also selling call options whose premiums offset the cost of buying the puts. However, as with a covered call, the upside appreciation for your holding is then limited to the call's strike price. If that price is reached before the collar's expiration date, you would not only lose the premium you paid for the put, but would also face capital gains on any shares you sold.

Monetize the position

If you want immediate liquidity, you might be able to use a prepaid variable forward (PVF) agreement. With a PVF, you contract to sell your shares later at a minimum specified price. You receive most of the payment for those shares--typically 80% to 90% of their value--when the agreement is signed. However, you are not obligated to turn over the shares or pay taxes on the sale until the PVF's maturity date, which might be years in the future. When that date is reached, you must either settle the agreement by making a cash payment, or turn over the appropriate number of shares, which will vary depending on the stock's price at the time of delivery. In the meantime, your stock is held as collateral, and you can use the upfront payment to purchase other securities that can help diversify your portfolio. In addition, a PVF still allows you to benefit to some extent from any price appreciation during that time, though there may be a cap on that amount.

Caution: PVF agreements are complicated, and the IRS warns that care must be taken when using them. Consult a tax professional before using this strategy.

Borrow to diversify

If you want to keep your stock but need money to build a more diversified portfolio, you could use your stock as collateral to buy other securities on margin. However, trading securities in a margin account involves risks which you should discuss with a financial professional before considering this strategy.

Exchange your shares

Another possibility is to trade some of your stock for shares in an exchange fund (a private placement limited partnership that pools your shares with those contributed by other investors who also may have concentrated stock positions). After a set period, generally seven years, each of the exchange fund's shareholders is entitled to a prorated portion of its portfolio. Taxes are postponed until you sell those shares; you pay taxes on the difference between the value of the stock you contributed and the price received for your exchange fund shares. Though it provides no liquidity, an exchange fund may help minimize taxes while providing greater diversification (though diversification alone does not guarantee a profit or ensure against a loss). Be sure to check on the costs involved with an exchange fund as well as what other securities it holds. At least 20% must be in nonpublicly traded assets or real estate, and the more overlap between your shares and those already in the fund, the less diversification you achieve.

Donate shares to a trust

If you want income rather than growth from your stock, you might transfer shares to some form of trust. If you have highly appreciated stock, consider donating it to a charitable remainder trust (CRT). You receive a tax deduction when you make the contribution. Typically, the trust can sell the stock without paying capital gains taxes, and reinvest the proceeds to provide an income stream for you as the donor. When the trust is terminated, the charity retains the remaining assets. You can set a payout rate that meets both your financial objectives and your philanthropic goals; however, the donation is irrevocable.

Another option is a charitable lead trust (CLT), which in many ways is a mirror image of a CRT. With a typical CLT, the charity receives the income stream for a specified time; the rest goes to your beneficiaries. You receive no tax deduction for transferring assets unless you name yourself the trust's owner, in which case you will pay taxes on the annual income. Other philanthropic options include donating directly to a charity or private foundation and taking a tax deduction.

Managing a concentrated stock position is a complex task that may involve investment, tax, and legal issues. Consult professionals who can help you navigate the maze.

IMPORTANT DISCLOSURES The information presented here is not specific to any individual's personal circumstances. To the extent that this material and/or website concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials and/or website are provided for general information and educational purposes only based upon publicly available information. Information throughout these materials and/or website, whether stock quotes, charts, articles, or any other statement or statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable - we cannot assure the accuracy or completeness of these materials and/or website. These materials and/or website do not constitute a complete description of our investment services or performance, and nothing in this information should be interpreted to state or imply that past results are an indication of future performance. There are not warranties, expressed or implied, as to the accuracy, completeness, or results obtained from information contained within these materials and/or posted on this website or any "linked" website. The information in these materials and/or website may change at any time and without notice.    This communication is strictly intended for individuals residing in the state(s) of CA. No offers may be made or accepted from any resident outside the specific states referenced.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012.

The "Fiscal Cliff"

What is the "fiscal cliff"? It's the term being used by many to describe the unique combination of tax increases and spending cuts scheduled to go into effect on January 1, 2013. The ominous term reflects the belief by some that, taken together, higher taxes and decreased spending at the levels prescribed have the potential to derail the economy. Whether we do indeed step off the cliff at the end of the year, and what exactly that will mean for the economy, depends on several factors. Will expiring tax breaks be extended? With the "Bush tax cuts" (extended for an additional two years by legislation passed in 2010) set to sunset at the end of 2012, federal income tax rates will jump up in 2013. We'll go from six federal tax brackets (10%, 15%, 25%, 28%, 33%, and 35%) to five (15%, 28%, 31%, 36%, and 39.6%). The maximum rate that applies to long-term capital gains will generally increase from 15% to 20%. And while the current lower long-term capital gain tax rates now apply to qualifying dividends, starting in 2013, dividends will once again be taxed as ordinary income. Additionally, the temporary 2% reduction in the Social Security portion of the Federal Insurance Contributions Act (FICA) payroll tax, in place for the last two years, also expires at the end of 2012. And, lower alternative minimum tax (AMT) exemption amounts (the AMT-related provisions actually expired at the end of 2011) mean that there will be a dramatic increase in the number of individuals subject to AMT when they file their 2012 federal income tax returns in 2013. Other breaks go away in 2013 as well. Estate and gift tax provisions will change significantly (reverting to 2001 rules). For example, the amount that can generally be excluded from estate and gift tax drops from $5.12 million in 2012 to $1 million in 2013, and the top tax rate increases from 35% to 55%. Itemized deductions and dependency exemptions will once again be phased out for individuals with high adjusted gross incomes (AGIs). The earned income tax credit, the child tax credit, and the American Opportunity (Hope) tax credit all revert to old, lower limits and less generous rules. Individuals will no longer be able to deduct student loan interest after the first 60 months of repayment. There continues to be discussion about extending expiring provisions. The impasse, however, centers on whether tax breaks get extended for all, or only for individuals earning $200,000 or less (households earning $250,000 or less). Many expect there to be little chance of resolution until after the November election. Will new taxes take effect in 2013? Beginning in 2013, the hospital insurance (HI) portion of the payroll tax--commonly referred to as the Medicare portion--increases by 0.9% for individuals with wages exceeding $200,000 ($250,000 for married couples filing a joint federal income tax return, and $125,000 for married individuals filing separately). Also beginning in 2013, a new 3.8% Medicare contribution tax is imposed on the unearned income of high-income individuals. This tax applies to some or all of the net investment income of individuals with modified adjusted gross income that exceeds $200,000 ($250,000 for married couples filing a joint federal income tax return, and $125,000 for married individuals filing separately). Both of these new taxes were created by the health-care reform legislation passed in 2010--recently upheld as constitutional by the U.S. Supreme Court--and it would seem unlikely that anything will prevent them from taking effect. Will mandatory spending cuts be implemented? The failure of the deficit reduction supercommittee to reach agreement back in November 2011 automatically triggered $1.2 trillion in broad-based spending cuts over a multiyear period beginning in 2013 (the formal term for this is "automatic sequestration"). The cuts are to be split evenly between defense spending and nondefense spending. Although Social Security, Medicaid, and Medicare benefits are exempt, and cuts to Medicare provider payments cannot be more than 2%, most discretionary programs including education, transportation, and energy programs will be subject to the automatic cuts. New legislation is required to avoid the automatic cuts. But while it's difficult to find anyone who believes the across-the-board cuts are a good idea, there's no consensus on how to prevent them. Like the expiring tax breaks, the direction the dialogue takes will likely depend on the results of the November election. What's the worst-case scenario? Many fear that the combination of tax increases and spending cuts will have severe negative economic consequences. According to a report issued by the nonpartisan Congressional Budget Office (Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013, May 2012), taken as a whole, the tax increases and spending reductions will reduce the federal budget deficit by 5.1% of gross domestic product (GDP) between calendar years 2012 and 2013. The Congressional Budget Office projects that under these fiscal conditions, the economy would contract during the first half of 2013 (i.e., we would likely experience a recession). It's impossible to predict exactly how all of this will play out. One thing is for sure, though: the "fiscal cliff" figures to feature prominently in the national dialogue between now and November.

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Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012.