The votes are in; the Democrats will control the White House and both Houses of Congress. Federal taxes will increase. In my opinion, federal taxes would have increased no matter which party won the presidential election; the issues are now; “How much?” and “Whose ox will be gored?” If the new Administration and Congress are going to demonstrate any degree of fiscal responsibility, they must address the massive deficit in which this nation finds itself and the ability to pay for the new programs we have been promised.
From a tax perspective, I believe everything is on the table; income, transfer, employment, and excise taxes. Notwithstanding the campaign rhetoric, I believe that every income tax bracket is at risk with the highest rate probably being 39.6 percent, the long-term capital gain rate at least 20 percent and possibly twenty-five, the highest estate, gift, and generation-skipping transfer tax rates will not be below 45 percent, and the estate tax exemption will not exceed $3.5 million per person. Corporate tax rates will not go down. Count on a tax bill passing by mid-2009 with an effective date retroactive to January 1. There is little we can do to avoid the employment and excise tax increases, some of which are already on the books, so what can we do in the remaining two months to mitigate the coming income tax increase?
While all year-end tax planning must have at least a two-year focus, it is reasonable to assume that for most of us, tax rates in 2009 will be higher than those we enjoy now. Therefore, I believe it will be prudent to accelerate income into 2008 to the extent possible and postpone deductions until 2009. The higher your income tax bracket, the more important this becomes. I believe that the rate change is particularly important for capital gains.
Keep in mind that a change in the capital gains tax rate from 15% to 20% is not a five-percent increase, but an increase of 33-1/3 percent. Likewise, an increase from 15% to 25% would be an increase of 66-2/3 percent. An increase in the highest ordinary income tax rate from 35% to 39.6% is an increase of more than 13%, not the nominal 4.9%.
The rule of thumb would be to defer taxes until a later year because of the time value of money. Assume you could trigger a $10,000 capital gain in either 2008 or 2009 and the capital gins tax rate was not increasing from 15%. It would be better to defer the $1,500 tax until next year, invest that amount at a 5% return, cash in the investment a year from now, pay $1,500 tax at that time, and keep the $76 interest income. If you assume a long-term capital gains tax increase from 15% to 20%, however, the economics change. You would have to invest about $1,900 today to pay a $2,000 tax a year from now on the same $10,000 gain. Alternatively, you could recognize the gain this year, pay the $1,500 tax now and be better off by $400. If you assume a tax increase from 15% to 25%, the numbers change even more dramatically. You would have to invest about $2,380 today to pay a $2,500 tax a year from now. Alternatively, you recognize the gain this year, pay the $1,500 now and be better off by $880.
It seems to me that appropriate year-end tax planning would involve accelerating all income and gains this year and deferring losses and tax deductions until next year, unless you know you’re going to be in a much lower tax bracket in 2009. So how do you do that?
- Recognize capital gains and qualified dividends this year, and defer losses until next year. I don’t believe there’s a significant chance the losses will go away between now and January.
- If you already have net capital losses this year, no harm no foul; they will carry over to future years and offset higher taxed gains in future years. (If you choose to trigger capital losses during the remainder of the year, wait at least 31 days before re-investing in the same securities).
- Cash-basis businesses should bill customers and clients early and push for collections in 2008. Keep in mind, however, that your cash-basis customers and clients will likely want to wait and pay you in 2009.
- To the extent possible, take commissions and bonuses in 2008.
- Defer tax-deductible items (property taxes, mortgage interest) until next year.
- Charitable contributions are a special consideration. If you are gifting cash, do so January 2, 2009 rather than December 31 of this year (don’t harm your charitable beneficiaries by waiting longer; they need the gifts more now than ever before). If you are giving appreciated property, do so in January. If you are going to sell securities that have declined in value, wait until January, sell the stock, recognize the loss, and gift the cash.
- If you are age 70-1/2 or older, own IRAs, and want to make a charitable contribution from your IRA, have the IRA trustee make the gift this year and have the distribution made payable directly to the charity, not to you.
- If you plan to make energy saving improvements to your home, postpone them until 2009. A $500 tax credit may be available.
- Business deductions for equipment purchases may be more beneficial if taken in 2008, not 2009. In 2008, you may elect to expense up to $250,000 in new equipment purchases. This amount is currently scheduled to drop to $133,000 in 2009. Don’t hold me to that, however; another tax stimulus package could extend the $250,000 deduction beyond 2008.
This is the best advice I can give at this time. My “recreational reading” in 2009 will be the proposed tax law changes. I have done so since 1976, beginning with proposed legislation when it is first introduced and following it through to final legislation. I will keep you appropriately informed.
If you need help with your year-end tax planning, contact me.
Ronnie
Copyright 2008 Ronnie C. McClure, PhD, CPA
