The election is over, and I have to say I am thrilled. No, I’m not talking about the outcome (I’ll withhold my opinions there, since this is not a political blog, though I will say I think election night set a record in terms of the number of banter-by-text messages I exchanged with many friends and family.) I’m referring to the fact that I don’t have to hear a campaign ad every 30 seconds, everywhere I go, for a long, long time. Regardless of your political affiliation, I’m guessing you may agree. So now what? As I moved into the first day post Obama re-election, I found myself wondering about what was next. What’s going to happen to all those tax holidays? How about the impending fiscal cliff? Some of these things affect stock compensation directly, others peripherally. In today’s blog, I explore the impact of the election on some of these key issues, as relates to our world of stock compensation. I apologize in advance because it’s a long one this week, but sometimes it just ends up that way.

What’s What?

First, I leveraged an expert for today’s blog, Bill Dunn of PricewaterhouseCoopers. He’s spent a good part of the past several months doing presentations, including one at our recent NASPP Annual Conference, on the impact the election would likely have on a number of issues, like taxes (if you attended the conference, you have the slides from Session 6.2: “Election 2012! The Campaign Trail and Equity Compensation,” and if you didn’t attend or did and would like to hear the presentation, you can obtain the materials/audio on our web site.) Bill is the perfect source to add flavor to today’s blog, and I’ll refer to several of his insights and comments.

Let’s start by examining the makeup of Washington. The outcome of election 2012 was basically that the American people ratified the status quo. President Obama has won another four years in the White House, the Republicans still control the House, and the Senate remains in Democratic hands. In terms of the balance of power, we are in essentially the same place as we were before the election.

With the status quo in place, I asked Bill about what significant events would occur in the coming months, relative to taxes and equity compensation. Here’s what I learned:

• Bush era tax cuts are set to expire December 31,
  2012. Also set to expire are the current tax holidays, like that on FICA (which was temporarily reduced to 4.2%, down from 6.2%).

• Automatic government spending cuts go into
  effect in 2013, cutting the defense budget amongst other things.

• The combination of the two points above result in a
  worst-case scenario known as the “fiscal cliff”: reduced government spending
  and increased taxes. Predictions include possibility of recession if
  changes are not made.

·        
The retained balance of power in Washington presents
challenges in dealing with the fiscal cliff and future tax policy because:

o  
The President could sustain a veto

o  
The House will control tax legislation, and

o  
Either party could filibuster
(non-reconciliation) bills in the Senate

With huge tax and spending changes on the horizon, one primary concern is the abruptness of the change. You have a “perfect storm” of huge spending cuts coming together with huge tax increases all at once. So what’s on the table for each party in terms of a path to resolve this potential crisis? Most agree that some action is needed. Bill shared some
perspective on both parties’ stated views on the topic:

Democrat View:

• Propose selectively eliminating the “Bush Tax
  Cuts”

o  
Increase Ordinary income tax rate (top rate from
35% to 39.6%)

o  
Long-term capital gains increase from 15% to 20%

o  
Qualified dividends increase from 15% to 39.6%

o  
Associated supplemental income rates would
increase (28% up to $1M (from 25%), 39.6% for $1M+ (up from 35%))

Republican View:

• No tax increases

Scenarios, Scenarios

With divided view points on how to
handle tax policy in Washington, what
are possible outcomes and when? Here are a few plausible scenarios:

• Postpone action by extending all the tax cuts
  and suspend spending cuts until Congress comes up with a solution in 2013

• Temporary compromise on rate action before
  December 31, 2012

o  
In this scenario, results would likely be skewed
towards Democrats’ terms and result in tax increases for upper income taxpayers

o  
Qualified dividends might stay aligned with
long-term capital gains rates, perhaps at a rate of 20% for certain taxpayers

o  
Tax rates could also rise for upper-income
taxpayers, but with redefinition to increase threshold ($1M?)

• Republicans could hold fast to their anti-tax
  increase pledge, presenting the “fiscal cliff”

o  
But maybe only until enough pain is felt by both
parties, enough blame is given to one party, or the government suffers a
promised downgrade in its debt rating by Moody’s.

Why Do I Care?

As a stock plan professional, the obvious question is “Why
do I care about all this government policy stuff?” While I’d like to just turn
my head for several months until something changes, I realize that the issues
on the horizon are significant and problematic for our economy and
taxpayers.  As stock plan professionals,
we are directly involved in withholding ordinary income taxes and informing plan
participants about our withholding obligations. I’m not going to get into the
debate on “what” tax topics should be presented to employees (that’s for you
and your counsel to dissect). What I will suggest is that there is a vastly
different tax landscape slated for 2013 and beyond. If Congress does not take
action to make changes or extend tax cuts/holidays by December 31, 2012, these changes
will come to fruition, at least until further action is taken.  I don’t recommend advising employees on the
timing of making a transaction (leave that to their advisers), but if the tax cuts expire, it’s likely that
some (if not all) participants will experience a material difference between
executing a stock transaction in 2012 vs. 2013 in terms of the tax impact. As a
result:

• If
  no action is taken to change rates or extend tax cuts, be ready for the
  possibility of increased transactions towards year-end.

• If
  action is taken to change tax rates or extend tax cuts, then
  stock plan professionals will need to be prepared to implement new or extend existing withholding
  rates.

With a lot of uncertainty around what the future will hold
in terms of tax policy, one thing is certain: be prepared for changes, lots of
them. Not only will plan administrators likely have to adjust withholding rates, but the education
message to participants will need to be tweaked. For these reasons, I do care
about the impending fiscal cliff and how Congress intends to move forward.

-Jennifer

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