Impossible Tax Planning

I was in my way to work this morning listening to some political radio. Maybe that was my first problem. One influential lawmaker wants tax cuts to expire. Another Senator with major influence on one of the budget committees wants to extend the Bush tax legislation for 2 years. Obama wants to extend the legislation for every bracket except the top two. Another lawmaker suggested the only answer is to extend the cuts permanently. Tax reform may be inevitable next year. Extensions are still in limbo with 1.5 months left in 2010.

How do you plan for your 2010 and 2011? Do you defer income to next year or accelerate it into this year? What about retirement contributions / distributions. Everyone has an opinion on what should happen. It seems more likely than not that by the end of the year some kind of extension will be passed keeping tax rates where they are. Here is the main problem: Lawmakers still want to bring in more revenue in an economic period with slow growth. They have to because the deficit is so high and the debt needs to be reduced. They know this. They can do this by raising taxes without raising your “tax rate”. What you pay in taxes overall is your effective tax rate. This is different from your marginal (top tax bracket). This is because your income is taxed at every rate below your marginal rate in a cumulative manner. It is kind of like your income lies on every stair of the tax staircase. Even more important are the deductions and credits that lower your effective tax rate.

Ask yourself if your spending habits would change if your paycheck was reduced by higher taxes. Unemployment remains high, many people have taken jobs with much lower pay, they may not be able to afford giving up more dollars. The government knows this, which is why many believe there will be an extension of the Bush tax cuts, and possible other provisions. That being said, it has not happened and congress could still be left with a stalemate and no extending legislation.

Right now, we have to plan to plan. Clients will have to sit back and wait. It could be one of the busier Decembers in recent memories. Unfortunately, we are left with blinders on. We have an idea of what could happen, but it has not happened. The estate tax area is a complete mess and the individual and business tax area sits in limbo. If nothing changes, everyone will be affected, in a period when most can’t afford to be.