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Several AAII members have been asking me lately about taxes. Specifically, what is going to happen to the tax code next year? The Bush tax cuts are expiring this year, creating the possibility that capital gains, dividend and estate taxes will revert back to circa-2002 levels. This means tax rates could be as high as 39.6% in 2011.

In response, I sent e-mails and made calls to both strategists and reporters who follow Washington politics closely. Every response confirmed what I’ve been seeing on the news wires: no progress is being made on the expiring tax breaks.

This is mostly because Congress has been preoccupied with other matters. Health care reform, financial reform, the economy, Supreme Court nominee Elena Kagan and British Petroleum’s (BP) oil spill have all taken precedence. Plus, there has not been a public outcry. Brian Mattes, principal and director of government relations at Vanguard, says members of Congress are getting plenty of letters expressing concern about the size of the federal deficit, but no requests to take action on capital gains or dividend taxes.

None of this means Congress won’t act. Logic dictates that incumbents won’t want to defend a potential hike to a 39.6% tax rate during a hotly contested midterm election. On the other hand, President Obama’s deficit commission is scheduled to release its findings in December, setting the stage for a potentially lengthy and heated debate about taxes next year.

If this seems like a lot of verbiage to say I don’t know what taxes will be next year, well, that’s because it is. The simple fact is that nobody knows what is going to happen. Mattes pointed out that the House has a limited time to act if it wants to hand off a bill to the Senate by the September session. So, it is possible that we could get some visibility on this issue later this summer. Then again, this is Washington we’re talking about.

Obviously, if you own AT&T (T), Verizon (VZ) or some other high-dividend yielding stock and are in a high tax bracket, this is no small matter. The uncertainty is also problematic for those with unrealized capital gains or estate issues. Unfortunately, we are just going to have wait and see what does and does not occur. In the meantime, you can lower your tax exposure by using a tax-deferred account to hold dividend-paying stocks, avoiding unnecessary trades and offseting realized capital gains with realized losses.

THE WEEK AHEAD

The Fed will hold a two-day meeting starting on Tuesday. No change in interest rates is expected. The meeting statement, released on Wednesday afternoon, will be analyzed for any changes regarding observations about the economic recovery or new language concerning the European sovereign debt crisis.

There will be about 15 S&P 500 member companies reporting next week. Included in this group are Adobe Systems ((ADBE) - Tuesday), Walgreen Company ((WAG) - Tuesday), Bed, Bath & Beyond ((BBBY) - Wednesday), Nike ((NKE) - Wednesday), Lennar Corp ((LEN) - Thursday) and Oracle ((ORCL) - Thursday).

May existing home sales data will be published on Tuesday and news home sales data will be published on Wednesday. Other notable economic reports will include May durable goods orders (Thursday), the final revision to first-quarter GDP (Friday) and the revised June University of Michigan consumer confidence survey (Friday).

The Treasury Department will auction $40 billion of two-year notes on Tuesday, $38 billion of five-year notes on Wednesday, and $30 billion of seven-year notes on Thursday.

Charles Rotblut, CFA is a Vice President with AAII and editor of the AAII Journal.

Source: Capital Gains and Dividend Taxes Still Uncertain