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Posts Tagged ‘AMT’

Lately, the media has been dominated by the compromise on US federal tax policy that has been brokered by President Obama that will lead to an extension of current income tax rates, lower estate and payroll tax rates and an extension of unemployment benefits.  It is very likely to pass almost intact and free up the logjam that has hampered this lame duck session of Congress.

Uneven Recovery

From the point of view of a resident of Main Street, the economy is still ailing.  Consumer demand is still off.  A stubbornly high unemployment rate persists.  Real estate values continue to drop in most markets and at best have settled in at levels not seen in nearly a decade. In general, it’s not a pretty picture.

On the other hand, business profits, productivity and cash (now sitting at about $2 Trillion) are up. And this has been reflected on Wall Street by a healthy rise in most major indices.

So the prescription for getting out of this funk is a familiar one: Low taxes leads to growth.  Sometimes, though, conventional thinking can be dangerous.

Economic Theory

From a purely economic theory point of view, there are really only three participants in the economy who can spur demand and ultimately growth: consumers, businesses or government (at all levels).

With consumer spending hampered by unemployment and nervousness about what assets, income and jobs that they may have, you can’t really expect consumers to be leading us to growth.

While businesses have the cash and the profits, they seem to be in wait-and-see mode “keeping their powder dry.”

So that leaves governments at the local, state and federal level. Unfortunately, most local and state governments don’t have the resources or the legal authority to continue deficit spending so that leaves us dependent on the federal purse to help spur the economy.

Tax Package as Stimulus

The tax package compromise as proposed is not perfect.  Like any piece of legislation, it is a mash-up (though the versions seen on Glee are usually much more fun to watch).  It certainly provides the potential for much-needed economic stimulus.

By putting cash in the pockets of the persistent unemployed, it will help keep households running and bolster their local economies when cash is circulated.  By reducing payroll taxes on those who are working, it will also lead to direct spending in much the same way that the under-reported stealth “middle class tax cut” of 2010 did.

By patching the Alternative Minimum Tax (AMT) for another year, more than 21 million households were protected from an unexpected hike in their personal tax burden (estimated at around $3,000 to $5,000 for each family) which might have choked off funds available to circulate in the rest of the economy for goods and services.

The big question will be whether the upper income brackets will use their tax breaks on income and estate taxes to pump up the economy.  Certainly, it could help with high-end consumer goods, vacation homes, and furnishings.  But as much as these purchases will help jewelers, real estate agents, car salesmen and clothing retailers, there’s only so many shoes, watches, cars and homes that someone can consume.

Good Politics May Make for A Bad Economy Long-Term

But will this create jobs?  How quickly can an expected $100,000 cut in income taxes for the richest 1% of Americans translate to business investment that creates jobs?  And at the end of the day, does this potential added economic activity keep us on track for growth?

These are the kinds of questions that probably prompted credit analysts at Moody’s Investor Service, a credit rating company, to put out a cautionary note about the possible negative impact on federal finances with its ultimate impact on consumers.

From a purely political point of view, this may be a good deal.  From a short-term economic stimulus point of view, it provides some benefits.  In the long-term, though, there is a real risk that the nation’s strained finances will take a hit to its credit rating leading to higher borrowing costs for the government directly and for all consumers seeking credit as well.

The Rich (And The Government) Are Different

Why?  Well, ask any mortgage borrower.  When you have pristine credit, it’s easier to borrow money at the most favorable rates.  Over the long-term, borrowing $200,000 at 6% will cost you more than borrowing the same amount at 4.5%.

On the other hand, when a borrower’s credit score is lower – even by a little – then the options available can dry up or cost more.

This is what may happen as we move forward and digest the impact of this tax plan.  It ultimately is kicking the can down the road for others to deal with.  The estimated price tag on the plan is between $700-billion and $900-billion to be added on top of a trillion-dollar plus federal deficit. And the proposals for cutting the deficit prompted much gnashing of teeth and proclamations of lines in the sand indicating that there is no likely easy compromise on their recommendations especially in a grid-locked Congress next term.

US Credit Score on Watch List

Is there an immediate problem?  No.  As long as we still have investors who are confident that they will get paid back on the money that they lend us through their purchase of our government’s debt.  Unlike the mortgage borrower in my example, the government can vote to increase its credit limit and authorize the printing of cash. Not something that your typical consumer or state government can do.

And investor’s in the marketplace seem to be OK with that as seen by the cost of insuring against default through derivatives. An insurance contract to protect $13.-million worth of U.S. government debt currently costs €41,000 a year, according to data from credit-information firm Markit Group. That is down from €59,000 in February of this year, and far less than in early 2009, when it cost €100,000.

But this can turn on a dime.  Ask those folks in Greece.  They are painfully aware what can happen when investors and banks lose patience and pull the plug and the credit line.

Yes, Greece is not the US, which has the benefit of being the world’s reserve currency.  But that should not lead us to complacency and hubris.  We need more than conventional thinking and political party maneuvering.  We need the kind of shared sacrifice that the Greatest Generation exhibited which won the peace in a global conflict and pulled us out of the other greatest global economic calamity of the last century.

Either we need to make the tough choices now while we can or we will be forced to pretty much at gunpoint down the road.  That’s not a pretty picture nor a way to grow in the long-term.

Maybe we can get the folks from Glee to work on a musical mash-up of sorts that will make this happen.

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The clock is running out on this session of Congress.  While far from a sure thing, at least there is movement on the tax front.  Whether that movement is progress or a step back will depend on your point of view.

It’s been said many times:  Two things you don’t want to see being made are sausage and legislation.

This go-around with the recently negotiated tax bill is just such an example.  In the spirit of the holidays, there is just about something for everyone in this proposed compromise: tax cut extension, cut in payroll taxes, a fix to the AMT exemption, extension of unemployment benefits.

While the full impact is yet to be digested, it is certain that the debate is far from over.  And it is almost equally certain that in its present form it will likely add considerably to the federal budget deficit.

Since we are still in fragile economic territory, demand stimulus is still needed.  And at least this proposal, while far from perfect, will provide that in the form of funding for unemployment benefits, lower payroll taxes and

Now that there will be “tax certainty” let’s see if the job creation will follow.

I’m happy to see that there is a patch for the AMT so that millions of families won’t be unexpectedly hit by a stealth tax increase.  Unfortunately, a permanent fix of the AMT is not on the radar and we’ll be doing this again next year as well.

And from an estate planning point of view, there will finally be some certainty on this front – at least for now.

While ‘stimulus’ is a bad word, at least there will be some economically beneficial parts to the proposal.  The most direct positive impact on the economy and aggregate demand is having more cash in the hands of average consumers.  On this point, the extension of unemployment benefits, in addition to being just morally right, will put cash in the pockets of millions who will immediately circulate it for payment of needed goods and services – not to mention paying the mortgage to help avert more foreclosures.

I’m no fan of trickle down economics and don’t think that we can afford tax breaks that for the most part will not lead to job creation in the near term.

Now we’ll see how the proposal will fare in Congress.  In any event, let’s hope that the sound you hear in the background is only the clock ticking down to the end of the session and not the timer of a not-t00-distant debt time bomb counting down to a nasty explosion.

 

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The Wall Street Journal reports that efforts to pass an extension of the Bush-era tax cuts have failed in the Senate.

If these politicians are serious about getting rid of “tax uncertainty” and reducing tax liabilities on the vast majority of Americans, then they should be dealing with a relatively simple and uncontroversial thing – patching the AMT tax exemption. Otherwise, more than 21 million families will see their tax bills go up next year. But like the estate tax, these are for the most part great stealth taxes. No one has to go on the record about voting for higher taxes because it just will happen.

As a nation we cannot even afford to extend the Bush-era cuts temporarily much less permanently if we are serious about tackling the deficit. And the tax cuts are far from being stimulative in this economic environment.

More stimulative options would include payroll tax holidays and extensions to unemployment benefits.

Instead we will be left with the “tax uncertainty” of the AMT and the estate tax. And every other thing that is the serious province of government will be held hostage.

On second thought, there really is no tax uncertainty. The Congress has had nearly nine years to come up with solutions for the estate and Bush tax cuts. We know that the rates on both will be going up on January 1. And we know that AMT will, too.

So now that we have certainty, can we please move forward and do some other stuff that really needs doing?

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On Wednesday night as I drove Spencer to visit his grandparents, I was listening to an NPR program. The segment included an interview with members of the President’s commission on the budget deficit and the debate over tax policy.

I think that we all can agree that saving money, not spending foolishly and living within our means are good starting points for long-term financial success whether for governments, businesses and individuals. These are values that I hope to instill in my toddler and teach my clients.

I applaud the effort to put on the table controversial ideas to at least begin an adult conversation.  As I noted in a different post on the topic, if we do nothing to get our financial house in order, we risk economic growth, prosperity and national security for ourselves and our posterity.

Reality is a whole lot different than made-for-radio or -TV soundbites.   During the interview, Senator Judd Gregg (R-NH) noted that it’s not a good time to raise taxes.  In the context of the debate over the extension of the Bush-era tax cuts, Gregg was pretty clear about his stand: raising taxes during this fragile recovery while lots of folks are out of work will not help the economy.

OK.  I’ll buy that even though I still believe that only through shared sacrifice making tough and sometimes unpopular policy or tax changes will we as a nation get our financial house in order on our time frame as opposed to being forced during some crisis like the folks in Greece to make drastic cuts in a short time frame.

But if that is what the Senator believes than why is that he and members of his party have no regard for the “tax uncertainty” of their inaction on the estate tax?  After December 1, the exemption level drops from the $3.5 million level in 2009 (right now there is no estate tax for 2010) to $1 million.  And the tax rate will go up from 0% in 2010 to 55%.  This was what existed before these cuts were put into place in 2001.

And what about the Alternative Minimum Tax?  The average American will likely see his tax bill go up between $3,000 to $5,000 next year by Congress doing nothing. This parallel and stealth tax system will ensnare more than 21 million households of average income Americans if the AMT exemption amount drops as is scheduled after December 31 if there is no action by Congress.  This means that households filing jointly with income as low as $45,000 will lose out on many deductions and exemptions and end up paying a higher flat rate tax instead of the graduated income tax rates that everyone is now fighting over.

I guess that such moves regarding the estate tax will help gain someone political points.  And by ignoring the AMT, no one and everyone can take the blame without singling out anyone for a particular vote.

Maybe it’s OK when living and working inside the Beltway of Washington to do this.  Saying one thing and doing another or simply ignoring reality are probably good skills for politicians of every stripe and party.  But for the rest of us, this kind of rhetoric on the one hand coupled with hypocritical actions (or inactions as the case may be) on the other just makes no sense in the real world.

During WWII there was a saying:  Loose lips sink ships.  In Washington these days, loose lips cause more than hot air. The rest of us simply catch a cold and end up paying more.

Now how is that going to help consumers stimulate the economy?

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AMT.  At first glance you might think that some letters have been transposed. But unlike the machine that spits out money to you, the AMT is the stealth tax system that threatens the financial health of millions of Americans each year.

The Alternative Minimum Tax, created decades ago to make sure the super-rich paid their fair share of taxes, has become a sure-fire way for the federal government to scoop up more tax revenues out of the pockets of average taxpayers without really raising taxes while playing  lip service to reducing taxes.

The AMT applies a flat tax rate to income above a certain exemption amount.

Each year more and more working class Americans are caught in the net of the AMT unless Congress approves patches to minimize the impact.  If patches aren’t made to the AMT, it means that more than 21 million additional households will face an average tax increase between $3,000 to $5,000.

No one in Congress really wants to fix the problem because the AMT provides so much revenue to the Treasury’s coffers. Sure, each year patches are usually passed.  But it takes longer and longer for them to do it.  And any real effort to reform the tax code and scrap the AMT system is unlikely.

The AMT is a parallel tax system requiring taxpayers to essentially complete two tax returns each year and pay the higher of the two if certain conditions prevail.  And when you fall under the grip of the AMT, you lose out on lots of your typical deductions and exemptions.  Accordingly, your tax liability goes up (or refund goes down) leaving more in the hands of the government.

Tea Party or not, Congress is fiddling and you may be left with less in your pocket or your ATM because of the AMT.

Going into this past election season, there was much made about the Tea Party activists and Republicans opposing tax increases especially during the fragile economic times we are in now.  There has also been lots of talks about the need for “certainty” in the tax code so that business owners could plan better, invest more and eventually create more jobs.

All are laudable.  But the reality that confronts us now is we have tax uncertainty going into another year.

Like a teenager completing a term paper at the last-minute even though it had been assigned weeks before, Congress has had several years to address lots of issues like the Estate Tax and the Bush-era tax cuts set to expire on December 31.

But because of political posturing, nothing has been done to address these issues.  In fact, if you want to talk about tax uncertainty ask an estate planning attorney since the Congress has left everyone hanging about what rates will apply going forward.

So despite the fact that AMT patches are generally non-controversial, no effort has been made to deal with them as Congress postures and blusters about extending tax cuts that will primarily help multi-millionaires who on average earn more than $1 million each year.

And even though the party about to control power in the House seeks to provide “tax certainty” and not create a drag on the economy, there is a real chance that inaction on the part of Congress will dampen economic activity in 2011.

Why? Think of it this way.  The IRS needs to know what the law is to prepare the forms needed by your tax preparer and the company that makes the software used by your preparer.

Right now the AMT exemptions for 2009 are:

  • $46,700 for single and head of household filers,
  • $70,950 for married people filing jointly and for qualifying widows or widowers, and
  • $35,475 for married people filing separately.

Unless Congress takes action, the AMT exemption amounts for 2010 are scheduled to be lower than the 2009 figures:

  • $33,750 for single and head of household filers,
  • $45,000 for married people filing jointly and for qualifying widows or widowers, and
  • $22,500 for married people filing separately.

Proposals in Congress would set the 2010 exemptions for those who are married filing jointly at $72,450 and $47,450 for singles.

And even if the Congress gets its act together, it may not be enough time for the IRS and tax preparers to set up their systems properly.  This will delay the processing of returns and in turn delay the receipt of billions of dollars in tax refunds.

What do you think that $300 billion more in the hands of taxpayers sooner rather than later will do for an economy needing stimulus?

So while Congress fights over extending cuts to folks who may not even qualify for them in the first place since they may already be subjected to the AMT, it may possibly force millions of others to at best wait for refunds or at worst pay more in taxes despite lip service to the folks who elected them.

Regardless of how this plays out, you really need to keep an eye on how tax policy risks can impact your own personal bottom line.

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