What the New Tax Law May Mean to You
Anytime we are looking at income tax strategy, particularly in the face of new or modified tax code out of Washington, I strongly advise everyone to check specific elements of the law with their attorney or tax advisor. There are a number of changes and modifications which were enacted in the final weeks of 2010 which warrant a closer look by everyone in the interest of sound financial planning. These changes will be in effect for the 2011 and 2012 tax years. If you have questions as to how any of these features may specifically affect your personal financial planning, please follow up with your tax professional.Immediate Effects
The new law temporarily extends the 2001 and 2003 federal income tax rate cuts, extends unemployment insurance for 13 months, provides new payroll tax breaks, reinstates the estate tax, and more. According to a Fidelity Investments recent note to account holders each of us is impacted in some way. The good news: The new law will give taxpayers a bit of clarityand an opportunity to plan with relative confidence knowing that the playing field wont change dramatically, at least for two years. But beyond that, an increase in the Medicare tax for upper-income Americans is slated for 2013. And more changes are likely in the future, given the pressure to raise revenues to reduce the deficit, and talk of sweeping tax reform.
Passage of this tax law ensures that individuals at all income levels wont face an automatic tax increase in January, (2011) says Shahira Knight, Fidelitys vice president of government relations. This is the most important feature near term, yet there is ample reason to look further into the future given what we know today.
The automatic reduction in social security tax will mean an immediate increase in the average wage earners take home pay. The Congress enacted this provision, in my opinion, in the hope that Americans will do what we have done for many years: increase consumer spending to assist in the recovery. There is a much better use of these funds in an effort to improve your financial future: increase your monthly contribution to any employer sponsored retirement savings plan (401-k, e.g.). If you already have provided that the maximum contribution be deducted from your check under your employers plan, then move any increase in take home pay into an insured savings account or into managed investment accounts such as those offered by BCU Investment Advisors. In short, dont follow the crowd and view this tax reduction as a windfall, and instead use it to your advantage to build up longer term reserves. For those earning an annual gross income of $80,000, this reduction amounts to $1,600 per year!Capital Gains and Dividend Tax Rates
I have always been amazed at how much investment income is lost back to the market by people refusing to sell very profitable holdings because they dont want to pay the expected income tax bill on those profits. I can name many stocks, for example, which have repeatedly increased in value by 100% or more, only to fall back substantially while the average investor stands by and does nothing. As discussed in earlier columns, stick to sound investment strategies as to when to buy or sell, dont fear paying the tax bill as part of the strategy. The Congress has left the tax rate on long term capital gains and dividend income at 15%. Since we continue to face mounting deficits and a total debt which now will certainly exceed $14,000,000,000,000 (thats trillion!) in a matter of days, I encourage you to hit this link and ask yourselves how long tax rates will remain this low. http://www.usdebtclock.org/
If you check the history of IRS Tax Rate Tables, you will find that we had a maximum tax rate which exceeded 90% for high income earners in the 1970s. I am not predicting such tax rates to be imminent; I am predicting that income tax rates on capital gains and dividends will not be any lower in my lifetime. There are many reasons to consider selling profitable holdings, including the opportunity to reinvest the funds in potentially more rewarding investments going forward. Again, a consultation with BCU Investment Advisors will allow you to gain necessary insight on this aspect of the current tax laws. It should also be noted that for taxable income levels of less than $68,000, the tax rate for dividends and capital gains is currently 0%!Roth IRA Conversions
Another consideration under the current laws may be to convert your Traditional IRA into a Roth IRA. Briefly, the Roth IRA accumulates free of federal income taxes over the life of the account. Since Traditional IRAs were set up and grown with pre tax dollars, withdrawals from Traditional IRAs are taxed at ordinary income tax rates as the withdrawals are made. Under the assumption that tax rates are likely to increase in the future, if you are considering a conversion to a Roth IRA you may want to take action under the current income tax rates. Once you convert to a Roth and pay the taxes due on the Traditional IRA withdrawals, the Roth will begin to accumulate tax free for its duration.Changes at a Glance
The table below, provided through IRS data and Fidelity provides a quick view of the major changes. There are many more important aspects of the new law which greatly impact estate planning and gifts; please seek professional tax advice for longer term financial and estate planning.
The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances.
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