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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.
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.