Tax increases depend on definition of "wealthy"

What is wealthy these days anyway? Is it a household with an annual income of $250,000, or is it $1 million?

If we're going to avoid the dreaded "fiscal cliff," President Obama and Congress are going to have to decide, potentially in an upcoming lame duck session that political expert Andrew Friedman calls "The Mother of All Lame Duck Sessions."

During a webinar sponsored by Sammons Retirement Solutions on Nov. 8, Friedman, who is principal of The Washington Update, said the federal budget deficit will become President Obama's "legacy issue," which presidents tend to focus on during their second term. He has the rest of this year and 2013 to show he's going to be serious about deficit reduction, before mid-term elections inevitably take center stage in 2014.

But let's get back to the wealthy and that fiscal cliff. With Obama's reelection, Republicans are coming to realize that affluent Americans are going to be subject to higher taxes next year. The question is, how wealthy do you have to be before your tax rate increases?

The Bush-era tax cuts, which will expire at the start of 2013 without action from Congress, will be the subject of much debate during the lame duck session. In an effort to raise revenue to combat the deficit, Obama and the Democrats do not want to extend the Bush tax cuts for wealthy Americans, which they define as households with annual incomes of more than $250,000. White House senior adviser David Plouffe has said President Obama will veto anything that extends the Bush tax cuts for the wealthy. But the question of how wealthy is wealthy is something that could very well be negotiable, Friedman said during his webinar comments last Thursday.

Republicans, who of course want the Bush tax cuts extended for all Americans, may be forced to (shudder) compromise and accept that said Bush tax cuts will not be extended for Americans with household incomes of, say, $1 million instead of $250,000. The Obama administration would also (shudder) compromise and allow the tax cuts to be extended even to wealthy Americans who fall short of that $1 million household income figure.

See also: Avoiding the fiscal cliff

Neither side wants to see the Bush tax cuts sunset completely, as that would surely mean a big push over the fiscal cliff, which is why the wealthiest Americans will likely see their tax rate increase. Friedman did warn that a deal to extend the Bush tax cuts may not happen during the lame duck session and may in fact have to wait until the tax cuts have expired in 2013. The reason? Remember all those Republicans who signed Grover Norquist's "Taxpayer Protection Pledge" to never vote for any tax increases under any circumstances? Well, if the ones who still have their seats after Election Day want to keep to their pledge, they would want to allow the Bush tax cuts to expire as 2013 ends, meaning higher tax rates for everyone. Then, with tax rates raised, they can agree to reduce the tax rate and still adhere to their pledge.

Friedman did say he thinks the fiscal cliff will be avoided, and he said he also thinks we will see an estate tax exemption rate between $3.5 million and $5 million next year. He says neither side wants to see the estate tax exemption revert back to $1 million, as it is scheduled to do at the beginning of 2013 unless Congress acts. But Friedman warned that Democrats are more likely to let the lifetime gift tax exclusion limit revert from $5 million down to the 2001 level of $1 million. Friedman recommended advisors on the call to talk to their clients about taking advantage of the gifting opportunity that could shrink substantially once the ball drops on New Year's Eve.

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