Looming Tax Hikes Largest in History

Matthew Apodaca, CPA

It has been a tough past few years for the majority of the country. We have all felt the sting of the “Great Recession”. We have confronted hurdles of roller coaster volatility in the stock market, gloomy predictions of national debt, unexpected layoffs and unemployment, and suffered with friends and loved ones through a foreclosure or a short sale. These have been historically trying times for us all.

The next hurdle for us to jump over is coming in 2011: Higher Taxes.

Higher taxes are a scary prospect to think of in our fragile, recovering economy. While it seems contradictory to have higher taxes right now, there are a few reasons this is most likely going to happen. Our current national debt is rising, Congress is uncertain in an important election year, and current tax break legislation expires this year. ALL of these issues point to the most significant tax changes in a decade.

Current Tax Breaks Expire
The dreaded estate tax returns in 2011 after a one-year hiatus. While we all complain that income taxes are a pain, estate taxes can be downright brutal - and are often overlooked in tax planning. If you have over one million dollars in assets, and pass away in 2011, your estate will pay tax at a 55% tax bracket. Take a moment to calculate your estate’s value. While $1,000,000 may seem out of reach for most, you may be surprised once you factor in the value of your home, household items (cars, collectables), retirement accounts, and the value of your small business. Your estate may be closer than you think to the $1,000,000 trigger. Not preparing for estate taxes can have absolutely tragic consequences to your beneficiaries; planned inheritances are effectively halved by estate taxes.

New Taxes will be Enacted
With our large national debt growing exponentially, the current political mindset strongly leans toward increasing taxes. Even if November brings changes in the political make up of Congress, our national debt is so large that some form of increased taxes will have to be addressed in 2011. Here are some of the things we might see in the next year.

Tax rates may increase 3-5% across the board for both individuals and businesses. If you make $60,000 a year, another $1,800-$3,000 of Federal Tax will either be deducted from your paycheck or be paid in April 2012. Corporate tax rates may increase too, which creates additional tax on corporate profits. Whether you are an employee or small business owner, there will be less money left over to take home or reinvest in your business if tax rates increase as expected.

For investors, dividends will be taxed at your ordinary income rates (rather than the typical 15%) and capital gains will likely increase to 20% or higher. This can be crippling on low-cost basis assets with unrealized long-term gains. Investors may be discouraged to continue to invest since their return on investment will take a severe tax hit, reducing actual gains.

With additional effects associated with the changes to health care, this next decade is being set up to become the decade of high taxes.

Fewer Deductible Items
Many deductions and credits will be subject to phase-outs or be reduced. Businesses may be forced to depreciate assets rather than capture their asset expenses in the current year. This is very unfortunate as cash is going out, but the deduction only trickles in a little bit each year! Individuals will face more phase-outs on itemized deductions, which are already severely limited for anyone without a large mortgage interest deduction. Reducing deductions is effectively another tax hike to the predicted 3-5% increase in tax rates… leaving even less money left over after taxes.

Some Relief?
To avoid sounding completely doom and gloom, there may some potential relief in sight. However, it is politically based, so we cannot be sure, but there may be some limited relief in the offing. President Obama would like the tax rate increase to be applied only to those individual filers making over $200,000 a year (or $250,000 married). Therefore, if you or your household earns under these amounts, you may have a reprieve on tax hikes – at least for 2011. However, is it not guaranteed this will happen.

Whenever we face a large obstacle in life, there are always choices in how to handle it.

• We can bury our heads in sand and hope for the best.
• We can complain about why the problem is here in the first place.
• Or, we can take action and start planning how we will best adjust.

The best thing you can do in 2011 is to work closely with your Certified Public Accountant (CPA) for Tax Planning. Tax planning will help you understand your taxes, predict a more accurate cash flow, and properly implement tax savings strategies. Your CPA knows there are many ways to legally reduce your tax bill, but they generally need to be implemented before the year is over, not after. The last thing you want to hear when you have your tax return prepared is, “Well, if we had reviewed this six months ago we could have saved you xxx amount of dollars on your tax bill.”

2011 will be an important year for Tax Planning at every level. We recommend that you take action now! Business Owners should have quarterly or even monthly conversations with their CPAs. Individuals should not wait for their tax appointment to chat with their CPAs whenever there is a big change: new job or unemployment, buy or sell of a house, marriage or divorce, family changes, increases (or decreases) to pay, etc. Planning with your CPA WHEN life changes occur can help you mitigate tax liabilities and give you ample time to be ready for tax bills, rather than be surprised in April.

We know the economic road ahead is going to be difficult and full of obstacles. You can prepare today for the road ahead, or ignore the warning signs and hope for the best when you hit that rough patch! Take the smart road: use regular tax planning to your advantage.