Category Archives: Tax Law Changes

Financial impact of the budget plan and planning for tax reform

Posted on by

First, the on-going budget battle in Washington, or “the debt ceiling crisis,” should be kept in perspective. The battle is more a game of chicken, where one side will eventually blink and the ceiling increased. This political battle is not likely to have an impact on investments, as the markets have already accounted for the outcome, as usually happens well before the event. In fact, by way of example, this is much like 1989 when the municipal bonds of the Commonwealth of Massachusetts we downgraded to a rating just above that for Louisiana. Many investors panicked. However, the underlying economy had not changed. Therefore, the smart investment strategy at the time was to buy Massachusetts bonds. After Governor Weld came to office, the rating went back up and investors who held or bought the bonds had a nice profit. The equivalent today would be to buy treasuries.

Second, as it is shaping up, the deficit reduction package contains major tax reform provisions as well as huge spending cuts. This could ultimately be good for the economy and our markets, as it would bring corporate tax rates in line with other countries, falling in the 23 to 29% range. However, the base would be broadened, possibly including depreciation over longer periods, eliminating deductions for domestic production and trimming or dropping the R&D credit.
The tax overhaul raises substantial revenue, $1 trillion over 10 years. However, this less than half the amount that would have been raised by simply letting the Bush tax expire as scheduled.

New Tax Law: Many specifics will not be known until a new tax law is enacted, which is not likely to occur this year. What Kiplinger’s Tax Letter and others are predicting the following: Instead of six tax rates or brackets, with the highest at 35%, three are expected: one in the 8 to 12% range, the next in the 14 to 22% range, and the in the last in the 23 to 29% range. The Alternative Minimum Tax (“AMT”) would be repealed. The earned income credit and child credit would remain.

To do all this, there will be pain: itemized deductions would be significantly reformed, changing home interest and property tax deductions as well as charitable deductions. For example, deduction of interest might be limited to a mortgage of $500,000 used to purchase a home, but not any for a second home. In addition, the deduction of equity line of credit interest may be eliminated (no one knows what will be grandfathered, so better to have a line in place than to wait). Higher bracket taxpayers may see the deductions converted into a 12% credit.
Something of a surprise, given the push over the last ten years or more to increase personal savings, the deductions for retirement contributions may be cut back, lowering the ceiling and amount of the contributions that will be allowed for 401(k), IRA, Keogh, SEP-IRAs, profit-sharing plans and so on. Similarly, flex plan and health savings accounts may be curtailed or repealed.

We will continue to monitor the information on tax reform, and post updates when appropriate.

Any changes that are this sweeping will require serious tax planning, so that should be on your “to do” list for this fall!

Possible tax law changes and tax planning opportunities

Posted on by

From the predictions we see, Congress will be reviewing and in most cases renewing certain tax cuts. They will also pass some additional tax changes.

Here is a summary of what is expected to become law (let me know if you need more detail):

The following expired provisions are expected to be renewed: The tax free status of distributions made directly from IRAs to charity; the add-on to the standard deduction for state and local property taxes; tax breaks for state sales tax, college tuition and teachers’ school supplies; 15-year write-offs for restaurant renovations and leasehold improvements; and the R&D tax credit. The will also be a small business tax cut for hiring (let me know if you need details).

2010 is the year for Roth IRA conversion strategies, where the taxes can be paid over two years. Because of market volatility, you may want to have separate IRAs by asset classes so if one goes down, you can “un-convert”. (See prior posts on this) Note, however, that Roth conversion income can affect Medicaid premiums and taxation of Social Security benefits.

Also expected is an increase of tax rates for income and capital gains taxes for high income tax filers, where one possibility is raising the top tax rate to 39.6% on singles with taxable income above $196,000 and on married couples for taxable income over $231,000. With this could be a top capital gains rate of 20% for this group, up from 15% now. Itemized deductions could be affected as well – perhaps by capping at 28% the rate at which itemizations reduce a filer’s tax liability.

Future changes to tax rates will affect planning for 2010 – taking more income and possibly selling assets then later buying them back to up the basis for future sales.

The item still missing from the list is the fix for the estate tax (see prior posts on this). The expected change will be reviving the estate tax retroactive to January 1. However, Democrats support a $3.5-million exemption amount and a 45% rate while Republicans want $5 million and 35%. If no action is taken, 2010 will continue to have no estate tax and 2011 will have a $1 million exemption with a 60% top rate.

If you want to consider how this all applies to you, for income taxes or estate planning, let us know.

Let us know if you have questions or comments. Thanks,

Steven

Planning for Tax Law Changes – the Investment Piece

Posted on by

Among the anticipated changes in taxes for individuals are the increase of the long-term capital gains rate from 15% to at least 20% and the elimination of the qualified dividend rate of 15%. How do you respond? That depends on several factors.

If the investments are tax-sheltered, as in an IRA or 401(k) plan, then the change has no impact: current growth is sheltered and withdrawals are always taxed as ordinary income. If the investments are in a taxable account, then the analysis involves your long-term plans and investment style. On the long-term capital gains, if you may be selling investments soon, doing so now and buying back (subject to the wash sale rules, if applicable), would increase your basis so that less would be taxed later at a higher rate. However, if you plan to hold investments long-term, there is little reason to react now. That is, the increased tax far in the future is less, on a net present value basis, than paying a lower tax today.

The long-term capital gains tax is still likely to be less than the maximum marginal rate, so converting what would be earned income into capital gains remains attractive (e.g., the basis for exercising and holding Incentive Stock Options)

As for the dividends tax, again this depends on your investment strategy. If you believe that the proper stocks or funds include those that distribute dividends, then the tax cost is part of your analysis in selecting those investments over funds or stocks that do not pay dividends.

As with any decision regarding the tax impact on investments, it is the investment strategy that should rule the outcome.

We will report more on possible tax changes and related strategies in upcoming newsletter posts.

Let us know if you have questions or comments. Thanks,

Steven