BOSTON (AP) — A frightful scenario could play out in a couple months unless a lame-duck Congress and the White House are able to resolve their differences on taxes and spending.
If they don't, Bush-era tax cuts will expire Jan. 1, and automatic federal spending cuts will be phased in. Such a combination could doom the fragile economic recovery and send the stock market into a tailspin.
What's more, tax rates on investment income would rise, a particularly scary prospect for investors in the upper tax brackets.
Investors may be inclined to sell some investments to take advantage of today's historically low rates. While acknowledging that could be sensible, John Sweeney of Fidelity Investments urges investors to heed the adage, "Don't let the tax tail wag the investment dog." In other words, consider whether you're becoming preoccupied with tax issues at the expense of long-term investing objectives.
"Building a well-constructed portfolio will give you the confidence to weather any number of geopolitical or economic crises," says Sweeney, an executive vice president with Boston-based Fidelity.
In an interview this week, Sweeney discussed how to take a big-picture approach to the short-term risks from any fall over the fiscal cliff.
But first, here's a look at the tax consequences if that happens. The maximum rate of 15 percent on long-term capital gains — the profits from selling such investments as stocks or mutual funds held for at least a year — would increase to 20 percent.
The tax on dividend income that now tops out at a 15 percent rate could rise more sharply. For those in the top income bracket, the rate would rise to more than 43 percent, with smaller increases for those making less.
Those rates may not take effect if Congress delays or otherwise averts tax increases. But it could be just a matter of time before rates rise, given the extent of the nation's debt problem.
There are relatively simple steps investors can take to minimize tax bills. For example, they can keep investments that are likely to generate a tax bill in tax-sheltered accounts like IRAs or 401(k)s, where only withdrawals are taxed.
Here are excerpts from the interview with Sweeney:
Q: What are you advising clients to do with the fiscal cliff looming?
A: It's the same advice we would offer in any given situation. Remember, presidential elections occur every four years. There are always economic cycles, debt crises, and various crises in other parts of the globe. We try to help folks come back to a place of confidence and comfort, where they understand the importance of constructing their portfolio to meet their specific objectives. We emphasize finding the right balance between stocks, bonds and short-term cash investments.
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