The Big Winners From the Obama Tax Deal

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Throughout the year, all the uncertainty about what would happen to tax laws next year has made it next to impossible to plan a reasonable investing strategy for the future. But if early reports actually result in anything more than just trial balloons, then there will be some definite winners from a proposed compromise between congressional Republicans and the Obama administration.

Where we've been
For years, everyone knew that the day would come when the 2001 and 2003 tax cuts would end. Although sunset provisions aren't terribly uncommon, it would be hard to find a more substantial and abrupt reversal of policy than what would happen if old tax laws were reinstated. Here are some examples:

  • A host of tax brackets would go up, including everything from 10% rates on low-income taxpayers returning to 15%, to the 35% maximum rate reverting to 39.6%.
  • Preferential tax treatment on dividends would disappear completely, while similar provisions for long-term capital gains would lose part of their value, as rates went from 15% to 20%.
  • Estate taxes, which applied to estates above $3.5 million in 2009 and then disappeared entirely this year, would come back to apply at far lower levels near $1 million.

Proposals on what to do in 2011 and beyond have been front and center within political debates since before the 2008 elections. The administration originally sought to let tax cuts lapse on high-income taxpayers while retaining the new low rates and other tax breaks for those in the low- and middle-income brackets.

But according to The Associated Press, President Obama and Republican leaders in Congress have now come to a compromise on what to do about the looming expiration of the Bush tax cuts. Under the proposal, the tax cuts would be extended for two years. Estate taxes would be reinstated, but at the lower rate of 35%, and would apply only for estates of $5 million or more. In addition, a new payroll tax reduction would cut two percentage points off Social Security taxes. Finally, popular breaks like the Earned Income Tax Credit and child tax credits would be extended along with the current tax brackets.

So who would benefit the most from the proposed law changes? Let's do a quick rundown:

The same old same-old for taxpayers
Taxpayers again get big benefits, with any resulting pain from higher debt to come down the road. Lots of people of all economic levels get some pretty serious breaks under this plan.

Low-income taxpayers see the status quo continue, letting them keep collecting credits that often give them refunds without paying much if any tax. Middle-income taxpayers benefit, since the break on payroll taxes can be worth more than $2,000 per individual, depending on your wage level. And high-income taxpayers reap the windfall of somewhat unexpected continuation of lower brackets.

No backlash for stocks
For stock investors, the news is equally good. Some believed that dividend stocks would suddenly lose favor if the taxes on their dividends increased substantially, with top-yielding S&P stocks Frontier Communications (NYSE: FTR  ) , Windstream (Nasdaq: WIN  ) , and CenturyLink (NYSE: CTL  ) at the epicenter of any collapse in dividend-investor sentiment.

But with dividend tax rates staying at 15% at least through 2012, investors should stay attracted to the certainty of getting money back from their stocks. So you don't need to worry about a collapse in dividend stocks just yet, and SPDR S&P Dividend (NYSE: SDY  ) and other dividend ETFs should continue to stay popular.

Small-business wins
In addition to big tax breaks from lower overall tax rates, small businesses will get some extra provisions. One will extend provisions letting them deduct certain capital expenses immediately. That's a victory for them, but it will also benefit Staples (Nasdaq: SPLS  ) , Office Depot (NYSE: ODP  ) , and OfficeMax (NYSE: OMX  ) , which cater to small-business capital spending on office equipment and furniture.

At least in the immediate term, you'll find a big group of winners from the proposed tax law changes, which is one reason why it's likely to pass. Instead of the upheaval many feared, keeping things largely as they are could help stocks keep moving up as they have for the past couple of years. Of course, we might be back in the same boat when 2013 rolls around, but for now, keep your fingers crossed that the proposed deal won't fall apart.

Handling your taxes correctly is a key element of retiring successfully. Click here to read the Fool's new special report, The 7 Secrets to Salvage Your Retirement Today.

Fool contributor Dan Caplinger is a deficit hawk but cashes his tax refund checks like anyone else. He doesn't own shares of the companies mentioned in this article. Staples is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy makes you a big winner.

Read/Post Comments (5) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 07, 2010, at 2:34 PM, DrRonPaul4Prez wrote:

    The extension of the Bush tax cuts are all good and great, but image what would happen in the stock market if the income tax was eliminated all together!

  • Report this Comment On December 07, 2010, at 5:28 PM, CPACAPitalist wrote:

    Just imagine what the stock market would do if we got rid of the government all together!? Right? Huh? Oh yeah... it would fall apart... Duhdoy.

  • Report this Comment On December 07, 2010, at 5:58 PM, lewellen180 wrote:

    Okay, I'll benefit from taxes not being raised, and from the payroll tax being cut by about a third (as far as what comes out of my paycheck is concerned). That will make life a little easier this year, yes.

    But, somehow, I don't feel like a winner.

    I guess it's because I know this debt is going to come due at some point; and the longer we put off dealing with it, the more painful it's going to become.

  • Report this Comment On December 07, 2010, at 10:31 PM, Acorn17 wrote:

    And we will pay for this when? Reducing Social Security taxes is outrageous -- it's already underfunded and headed for a massive reduction in benefits soon -- why deliberately steer it off the cliff faster? Unbelievable -- the other stuff seems more reasonable, but we still have to pay for it one day. . . Sounds like we're in for a large shock down the road instead of taking the pain in small doses all along.

  • Report this Comment On December 07, 2010, at 11:04 PM, Acorn17 wrote:

    After reading a little more from the proposal this appears to be playing politics at it's finest. The Social Security tax cut is ostensibly for 1 year. That's convenient because it becomes an issue for voters in the 2012 presidential elections, and because it will be an unknown, the president will not bear the consequences of any permanent decision. It also makes a convenient campaign point (that echoes the last election campaign in an eerie way). Something like, "I was elected on the promise to keep taxes low for the poor and middle class and make up for shortfalls by increasing taxes on the wealthy and most able to afford it, but those darned Repulicans made it impossible when the time came and I had to keep the status quo especially since letting the cuts expire unamended without a compromise would have hurt all low-mid income Americans right along with the wealthy in a recession. Vote for me again and we can do what I set out for in the first place."

    That's really weak and in my view hurts our nation long term (purely for self preservation). Personally I'm in favor of the original tax plan laid out by the president as promised 2 years ago. It's sustainable. Even though I didn't vote for him, I am very supportive of this type of thing as well as working to mitigate some of the ever-widening wealth / income gap in our nation in order to allow the poor/mid group more opportunities to join the wealthy. However, while my opinions of him have changed somewhat for the positive the last couple of years, this bold faced politiking is disgraceful. Will anyone have the guts to really deal with taxes and Social Security / Medicade to be fair to young workers, our children and grandchildren and keep our nation competitive as the rest of the world gains on us (and passes us in some areas) so quickly?

    I don't think we are a foolish (small "f") people and most people can see the wisdom in laying preparations to make us competitive as a nation for the long term. A broke government, swelling ranks of poor and underemployed, a declining middle class, and an increasingly wealthy and powerful elite few is not the dream most of us have for our nation. To avert this we must make some very difficult decisions. . .yesterday.

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