The implications of going over the fiscal cliff
American Funds continues to monitor events in Washington closely now that the December 31 deadline has passed with no deal in place. This means that technically the Bush era tax cuts have expired and automatic spending cuts are set to begin, but negotiations will undoubtedly continue in 2013. Any deal made this year could set the new tax rates retroactively to January 1 as well as answer a host of questions such as the status of charitable deductions, the treatment of tax-exempt interest on municipal bonds and the limits on contributions to 401(k) accounts.
But, many investors are asking what the immediate impact is on their American Funds investments if we go over the fiscal cliff. With no agreement in place, the most immediate impact will be on investors who own Coverdell education savings accounts. As of January 1, investors can no longer use Coverdell accounts to meet expenses for K-12 schooling. In addition, the annual maximum contribution has fallen to $500 from $2,000.
For others, the impact on their investments will be felt with a delay.
- Tax rates will increase on long-term capital gain distributions paid by the American Funds, and on capital gains realized on the sale or exchange of fund shares. The current maximum rate of 15% has risen to 20%.*
- Qualified dividends have been eliminated, including those paid by the American Funds beginning in 2013. Qualified dividends previously taxed at a maximum rate of 15% will be taxed at an investor's marginal tax rate.*
- Marginal tax rates will increase, with the current maximum 35% rate increasing to 39.6%.
We understand that knowing tax rates and how dividends and capital gains will be treated are important elements of any financial plans. We will continue to monitor the negotiations in Washington and will provide as much insight as we can on the impact to investors of any changes to the tax code.
*These rates do not include the 3.8% Medicare surtax applicable to net investment income for higher income taxpayers that take effect next year. Thus, if there is no deal, the maximum rate on long-term capital gains for example would rise to 23.8% from 15%. Most equity funds begin paying capital gains at the end of March. By then a deal may have been reached. We will evaluate any final agreement to determine what impact any change in rates might have on dividends or capital gains.