End of the road: Tax breaks for affluent likely to be snipped

As Congress attempts to trim the nation's deficit, advisers and their clients should brace for a less generous tax code in 2013. While legislators in Washington are making budget trimming a priority this session, the real action will take place in 2013, James Delaplane, a partner at Davis and Harman LLP, said at the InvestmentNews Retirement Income Summit last week. “We may have some preliminary steps, but the real action is likely to come in 2013, and you'll see a macro effort to deal with the reform of the tax code,” he said. “At some point, action is going to be forced onto the policymakers. I think it's just a matter of time before the grand deficit reduction legislation happens.” The tax deal that President Barack Obama struck with Congress last fall bought investors some time on the treatment of capital gains and dividends. However, the extensions of those cuts are set to expire at the end of 2012. Unless Republicans are able to gain control of the House, Senate and the presidency in 2012, the tax cuts probably won't be extended, Mr. Delaplane predicted. “If Obama weren't looking forward to 2012, he wouldn't have struck that tax deal,” he said. “Presuming the economy is more solid and the deficit pressures are starker, then that's a recipe for tax cuts' not being extended.” As a result, income tax rates on higher earners likely will rise in 2013, and the capital gains rate is unlikely to remain at its current level. Meanwhile, tax incentives for retirement savings are no longer safe from cuts. The Bowles-Simpson deficit reduction commission proposed capping tax-deferred savings in defined-contribution plans to the lesser of $20,000 or 20% of income in an attempt to shore up the nation's budget. The commission didn't specifically comment on the treatment of tax-free inside buildup for life insurance and annuities, but it may be limited in some way, Mr. Delaplane said. “The political push-back won't be small, but every sacred cow is taking its nicks,” he said. Mr. Delaplane warned advisers that the Federal Reserve is expected to reach the federal debt ceiling this month, which means that Congress will have to vote on raising the cap. That could delay hitting the limit until August. Congressional freshmen are likely to push back against that move unless they get some substantial agreements to slash government spending, he said. “We are entering a high-stakes effort here, and even the president knows that some reforms have to accompany the debt ceiling vote or it won't go through,” Mr. Delaplane said. He recommended that advisers tell their clients that this discussion is going to be tough and that the markets may not react favorably. “It's going to get down to the last minute, and it won't be what the Treasury will prefer or what the markets want,” Mr. Delaplane said. “Put on your seatbelts.” E-mail Darla Mercado at dmercado@investmentnews.com.