Filing tax returns in the future regardless of whos elected president is likely to involve a much deeper bite for the middle class.
Updated: May 3, 2013 12:14PM
As you race to the deadline for filing your income tax return, it's easy to get buried in last-minute tax tips. But don't get so preoccupied with the task in front of you that you forget to look at the big picture. And that big picture is likely to be higher tax rates in the years ahead.
It doesn't matter which political candidate you support. War is expensive. So is peace.
This is an election year, a year in which politicians are all promising they'll make things "better." And all of those promises cost money. If the government can't borrow the money, you can be sure they'll be figuring out how to raise your taxes!
In 2008, Tax Freedom Day will fall on April 23 -- meaning we will have worked, on average, 74 days to cover federal taxes and another 39 days to cover state and local taxes. (Residents of high-tax states such as Connecticut, New York, New Jersey and California will have to work even longer to be free of taxes.) Now, can you imagine working five or even six months of the year simply to support our government in the future?
Planning for higher taxes
If you accept the premise that the government is likely to be digging deeper into taxpayers' pockets, then you need to think about doing some long-term tax planning.
For example, the basic principle of tax-deferred retirement savings is the belief that when you retire, you'll earn less and thus be in a lower tax bracket. So you typically opt for the immediate tax deduction of a 401(k) plan or Individual Retirement Account, expecting that when you withdraw your contribution and the investment growth from the plan, your taxes won't be so burdensome.
Maybe that's the wrong approach. It's entirely possible that we are at the lowest level of ordinary income taxes and capital gains taxes that we're likely to see in our lifetime. Think of all the rhetoric about doing away with "tax breaks for the rich."
If Congress raises taxes only on the truly "rich," they'll certainly pay more -- but hardly enough to cover our deficits. Logic and mathematics dictate that in order to collect enough money to make good on promises, much less pay down debt, the middle class will bear the tax burden -- again.
If you believe higher tax rates are on the way, the Roth IRA -- or Roth 401(k), if your company offers that option --looks more enticing, assuming you are eligible to contribute. You won't get an immediate deduction for your contribution, but you will get tax-free withdrawals -- if the government keeps its promises.
Similarly, you'd want to take advantage of the current lower tax rates on capital gains and dividends. Retirement plan withdrawals are taxed as ordinary income -- at rates likely to rise. Investment gains outside a qualified plan get the lower capital gains tax rate and can be offset against losses. And if low capital gains rates seem ready to disappear at the hands of a new Congress, there could be a wave of selling of stocks at year end to lock in any remaining gains at low tax rates.
If tax rates do go higher, anything that promise tax-free income or withdrawals will be more attractive. That applies especially to saving for college in a state 529 college savings plan, where gains are withdrawn tax-free when used to pay for college.
Estate tax law offers similar uncertainty, along with the possibility of higher rates. The current estate tax laws increase the exemption to $3.5 million next year. Then the estate tax is scheduled to be completely repealed in 2010! Don't bet on it. Instead, you might want to buy extra life insurance, held in a trust outside your estate, to provide liquidity to pay the higher estate taxes that are likely on their way.
There's an old saying that nothing's sure but death and taxes. But there's no certainty about tax RATES!
So while you pay attention to filing this year's return, checking your math and hunting for deductions, remember to think about the longer term. Only some serious, big-picture tax planning can mitigate the onslaught of tax increases that are surely on the horizon. And that's The Savage Truth.
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate.