Get ready for higher taxes! The Obama administration is pushing for changes to tax law, along with more regulatory oversight of the financial sector by the end of this year. Here’s a quick intro regarding what policy and tax law changes we might expect, and how these new rulings could impact investors.

Prepare for Tax Increases

With President Bush’s tax cuts expiring at the end of 2010,the timing for tax reform is even more critical. As the deadline approaches,and with President Obama calling for tax hikes on the top two tax brackets, lawmakers are expected to take action before the cuts expire. Indeed, many experts see those top two tax brackets moving from 33% and 35%, to potentially 36% and 39.6% for those earning about $250,000 or more a year.

Without a doubt, the economic stimulus package, the bailouts, plus the cost of proposed new social programs such as health care, will contribute to a significantly higher deficit. So, the current administration wants to try and offset some of these new federal expenses with the revenues collected from higher taxes for “the rich”.

Look for Estate Tax Reform

With estate taxes set to temporarily disappear in 2010, we should expect changes to estate tax law before changes to income tax law. The disappearance of estate taxes would eliminate revenue that Capitol Hill clearly needs as it looks to decrease its deficit. It is highly unlikely that Congress will let the estate tax drop to zero in 2010, particularly at a time when our fiscal policy is in the red.

Another reason Capitol Hill is likely to address estate tax law quickly, is that rules set to take effect at the start of 2010 will make it exceedingly complicated for heirs to figure out exactly what they owe to the government when they get their inheritance.

Heirs lose the stepped-up basis in determining the beneficiary capital gains tax starting in 2010, which means they would pay taxes based on the original cost of assets held in the estate, not their worth at a parent’s death. So the savings in estate tax is tempered by increased income taxes imposed on the heirs. Of course, that means tracking down cost basis will be more nightmarish then ever before. This change, if it passes, will be interesting from an administrative perspective.

It is widely expected that Capitol Hill will approve new legislation that would grant a $3.5 million exemption per person, with a 45% rate on anything above that.

Watch for Changes to Dividend Taxes

Another area to keep an eye on is dividend taxes. Taxes on qualified dividends have been at a maximum 15% since 2003—previously the average dividend tax rates were at roughly 28%. But the current rate is scheduled to sunset at the end of 2010 if lawmakers do not authorize changes.

President Obama’s administration has supported increasing these rates for individuals in the top two tax brackets to 20%, beginning in 2011.

According to the current proposal, taxpayers in the lower tax brackets would see their rate stay at 15%, and the lowest tax bracket would see the rate remain at zero. Of course, the outcome may be entirely different in the end.

But unlike the rush to address estate taxes, modifying dividend taxes is not likely to happen until 2010 and is not expected to be effective until 2011. Still, investors and their advisers should be aware of possible changes as they build and adjust their clients’ portfolios.

Consider Municipal Bonds

With income tax rates expected to rise for those in higher-income brackets, certain investors would do well to look to municipal bonds. Municipal bonds, now thought to be undervalued, is expected to increase in value as the public starts to feel more confidence about the financial stability of states.

Some investors have been worried that states will not be able to pay their bonds, devaluing the bonds’ worth. However, the stimulus package is now trickling much needed cash flow down to the states which need it most, alleviating that concern to some extent, which should help the bonds to increase in value.

Expect More Regulation

Investors may also find the increased oversight projected for the financial sector attractive, as regulation is expected to make the way investments are run clearer. In the wake of the meltdown that has affected financial markets, especially the derivatives area, hedge funds and big banks, investors now want more lucidity in their investments. It’s about time!

This trend is already apparent in recent legal changes imposed on the credit card industry with the government cracking down on credit card terms that have grown increasingly confusing to consumers.

We’ll see how all of this unfolds. Stay tuned for more details as they become available.

Cathy Pareto, MBA, CFP®, AIF® is the Founder and President of Cathy Pareto & Associates, Inc. For over twelve years, Cathy has been helping financial consumers and professionals understand the world of investments and finance with a sound, but down to earth money management approach. For over a decade Cathy was a Senior Financial Advisor for another Miami based investment advisory firm, where she managed over $200 million in assets for high net worth clients and retirement plans. She has extensive experience in retirement issues, asset allocation, investment selection, investment management, education planning, estate planning coordination, and asset protection strategies. Additionally, she was an Adjunct Professor and Faculty Coordinator for the CFP® Program at Florida International University’s College of Business.