Over the next few months, the issue of taxes and the expiration of the Bush tax cuts will become a major headline and the topic of several dinner table discussions. Predictions range from the biggest tax hike in generations, to actual tax breaks, to some combination of the two. The market doesn’t like uncertainty, so expect to see more volatility and larger market moves from now until the tax issues are decided and mid-term elections are over.
Politics aside, how will these changes affect you? What can you do now to potentially save a few extra dollars at tax time?
Here’s What We See Happening
We don’t think there will be massive tax hikes for a variety of reasons. Historically the controlling party in Congress loses seats during the mid-term elections. The economy is recovering, but it is still fragile. And finally, there are new taxes within the recently passed healthcare legislation. There are certainly signs of recovery, but many Americans are still struggling while waiting for the economy to pick up again. Remember all politicians want to get re-elected, and raising taxes is a sure way to diminish your chances. We think taxes will return or increase in a few areas including the estate tax, dividends, and short-term capital gains, while leaving most of the middle-class tax cuts in place.
What we do know is that the changes could affect you and your family. If Congress doesn’t act, the Bush tax cuts will expire on December 31, 2010 and taxes will go up for just about everyone. Here’s a list of potential increases:
- The Estate tax could go back to 55% for estates over $1 million (there is currently no estate tax in 2010).
- Higher taxes on marriage and family, including a child tax credit being but in half to $500.
- Capital gains tax going to 20% from 15%. Dividend tax could go to 20% or even your personal income rate.
- Personal tax rates going up about 3% across the board.
What the Politicians Want
At the moment the Administration and most Democrats do not want to raise taxes for those making less than 200K (250K for families). On the other hand, taxing those making over 200K/250K could affect small business owners as many report their business income as personal income. A recent poll by the U.S. Chamber of Commerce finds that higher taxes are the biggest threat to job creation according to the business owners surveyed, making it the most frequent response.
Republicans seem to want to extend a portion of the tax cuts for all in some way, arguing that higher taxes will hinder spending and investment at a time when the economy needs it most. Opponents argue that this would increase the deficit as less money would be flowing to the government. Keeping taxes low and reducing the deficit is not easy to do, especially during an economic recovery.
Fed Chairman Bernanke recently stated to congress that “in the short term I would believe that we ought to maintain a reasonable degree of fiscal support, stimulus for the economy…” adding that “in the longer term, I think we need to be taking steps to reassure the American people and the markets that our fiscal situation is going to be well controlled.” Treasury Secretary Geithner stated something similar, saying that tax cuts should expire for “the most fortunate 2 or 3 percent of Americans. … That will help us begin the process of making a contribution to bringing down our long-term deficits.”
Democrat or Republican, here are some facts. Raising taxes will most likely hurt small businesses, the consumer and others at a time when the recovery is still fragile. There are new taxes also included in the recently approved healthcare legislation. Extending the tax cuts will probably add to the long-term deficit, a growing concern among voters. People are realizing more and more that we have a serious long-term debt issue to tackle. For these reasons, we feel that Congress will compromise and meet somewhere in the middle.
Ways to Save Money with Rising Taxes
The reality is that no one knows what will happen towards the end of the year. Taxes will have to go up eventually, but the question is when and how. In the mean time, here are a few ways you can potentially save a few dollars at tax time while also improving your estate and financial picture. With any of these methods, be sure they make sense for you and are inline with your long term objectives.
Generate Cash Now
If you are planning to make a big purchase sometime in the near future, it may make sense to generate that cash now by selling some investments at a potentially lower tax rate. You should take a look at your short-term and long-term losses and gains, along with other factors, to determine if this strategy would prove beneficial.
Roth Conversions
Converting your traditional IRA in 2010 and claiming the income on your 2010 tax return allows you to pay taxes now at the current rates. However, this could push you into a higher tax bracket so be sure to consult with your tax advisor.
The government has provided incentives to convert during 2010, making it a potentially great year to do so. For example, the taxes you would have to pay can be spread out over two years (2011 and 2012). However, tax rates could increase in 2011 and in subsequent years. Deciding to convert should only be done after careful consideration and consulting with your tax advisor and Wealth Advocate. Be sure to request the WrapManager Roth Conversion Kit by clicking here to learn more!
Accelerate Income This Year
It could be beneficial to realize more income this year at the potentially lower rates. This would include things like exercising stock options, taking distributions from retirement accounts, and realizing more short term and/or long-term gains.
Charitable Contributions and Gifting
If taxes do increase next year, a charitable contribution will provide a greater tax benefit when the taxes are higher. Waiting to make the contribution until next year could save you money. Gifting your low cost basis securities is beneficial as you are getting rid of a higher tax liability compared to securities with a higher cost basis. This benefit increases if capital gains tax rates go up.
Move Your Income Producing Strategies
Take a look at your investments in both your taxable and tax-deferred accounts. Currently, allocating investments taxed at lower capital gains and dividend rates to taxable accounts and those with higher tax rates to tax-deferred accounts may be beneficial. This could change depending on any potential changes in the tax rates.
In fact, we think dividend paying stocks are going to do well in the future as people look for investments where they are ‘paid to wait’, will benefit from a slow but growing economy, and are not as sensitive to interest rate fluctuations. One of our recommended managers, Federated Investors, specializes in dividend paying stocks, with a dividend yield of 5.5% as of May 31st, 2010. Click here to learn more!
Tax-Exempt Securities
These include securities like municipal bonds, which could become more attractive at higher tax rates.
Final Thoughts
The above ideas should always be carefully considered by you, your tax attorney, and one of our wealth advocates before implementing. While the benefits of each one may sound good, they may not be appropriate for you given your financial picture and objectives. Understanding your financial picture is critical in determining if the above strategies are good for you.
We help our clients understand their financial picture and suggest investment strategies using some of what we believe are the best money managers around. If you’re worried about rising taxes, protecting your nest egg, or simply want to get a better idea of your financial picture, give one of our wealth advocates a call at (800) 541-7774 or click here to get started!
We believe having a plan is so important that we highly recommend it to all our current and new clients. It doesn’t take that long and from the feedback we’ve received, most even enjoy going through the process and finding out where they stand financially. Call us today or have a Wealth Advocate contact you to get started!
The attached report and information have been prepared or produced by WrapManager, Inc. from sources and data believed to be reliable. Information provided in this report is for educational and illustrative purposes only and should not be construed as individualized investment advice, as an offer to sell, or the solicitation of an offer to buy any security in any states where such an offer or solicitation would be prohibited by regulations. WrapManager, Inc. is not a tax advisory firm. We recommend you contact your tax attorney or CPA prior to utilizing any of the tax-related strategies mentioned or discussed. Returns and experiences will vary for each client. Each client’s risk tolerance and investment objectives are unique to them. Past performance may not be indicative of future results. No assumption that future performance of any specific investment or product made reference to directly by WrapManager, Inc., on its Web site and in marketing materials, will be profitable or equal the corresponding indicated performance level(s). If performance numbers are generated gross of fees, a client’s return will be reduced by investment advisory fees and any other expenses. Opinions expressed are those of WrapManager, Inc. and are subject to change without notice and are not necessarily those of Prospera Financial Services, Inc., its directors, parent company or its affiliates. Securities offered through Prospera Financial Services and cleared through First Clearing, LLC. Prospera Financial Services - Member FINRA/SIPC.