Don’t Tax Yourself
Tax season is here again. Whether you have filed already or not for this year is immaterial at this point. Why? Because around 250 years ago, Ben Franklin was quoted as saying- “…nothing is certain but death and taxes.” It would be a cliché if it wasn’t a mere statement of fact. In hindsight, one could argue that it was a peculiar thing for him to say because taxes were not a part of American life the way they are today. In the earlier times, only the wealthy paid taxes. But after the 16th Amendment passed in 1913, income taxes became more commonplace- though most people were still in the lowest tax bracket of 1%. After World War 2, the everyday working people along with the wealthy started paying an increasing share which has evolved to the actual rates we pay today. Every few years, changes are made, as taxes have become a major political football. However, no matter your politics or station in life, whether you pay directly through your income, or more indirectly through the items you purchase, two things in life are certain: “death and taxes.”
The statement is particularly true today with our current deficit. So, if we are all resigned to this bitter fate, the least we can all do is have a basic knowledge of the changes and updates to the tax laws as they happen each year, and how they might affect us. For example, in 1945 at the end of WW2, the top tax bracket was 94 percent! But since 1990, the top rate has fluctuated between 31 and 39 percent. Perhaps it is too late to strategize for 2021, but it is not too late for this year. What are the changes for 2022? They’re not too dramatic, but let us look at the bracket comparisons below:
Updates have been made to account for inflation, so the changes are not great. In addition, the standard deductions have slightly increased to $25,100 for Married, Filing Jointly and to $12,550 for those who file Single, or Married Filing Separately. Another change is an increase in some of the retirement savings accounts. While IRA contributions remain at $6,000 plus an additional $1,000 if older than age 50, contributions to 401Ks and Roth 401Ks are higher. The contribution limits have been increased to $20,500 with an additional $6,500 “catch-up” amount for those over age 50, (a total contribution limit of $27,000). For SEP IRAs and Solo 401Ks, the new limit is $61,000 (with an additional $6,500 for solo 401Ks for those over 50).
Keeping up with things like your current tax bracket and how much you can contribute to retirement savings accounts could make a difference in the amount of non-discretionary cash available each year. For example, knowing that if you and your spouse file jointly, you can lower your adjusted gross income by contributing $54,00 into your retirement accounts, it may be enough to put you into a lower tax bracket. In a lower bracket, you might be able to withhold less in taxes, freeing that money up for further investing, saving, or spending. Remember, getting a tax refund may indicate that your financial habits are inefficient because that money could have been put to use during the previous year. Instead, you have just given the government an interest free loan. But most Americans do not adhere to this kind of foresight:
Taxes themselves may be an election year toy, but Americans of every political stripe unwisely prefer to get refunds instead of using the money throughout the year. This can be very costly, particularly if you have outstanding credit card debt. For example, in a 2020 online article by SmartAsset, a person with credit card debt received a $3,000 tax refund that actually cost them more than $350 in accrued interest on their debt. This could have been prevented if taxes were not overpaid and the debt was addressed earlier.
Staying abreast of the current year’s tax rules can greatly help in your long-term planning and funding of goals. It is also worth being alert for potential changes which may be in the making. For example, capital gains rates are 20% for individual filers who have a modified AGI over $459,750 and married joint filers with an AGI over $517,200. However, there is talk of lowering income requirements, lifting the capital gains rate to 39%, or even to changing it from a flat rate to ordinary income.
At this time, much of the debated changes are for estate taxes. Currently, there is a federal gift and estate exemption of $12,060,000 per individual or $24,120,000 for married couples but there was a recent proposal in the Build Back Better Act for the amount to revert to the previous level of $5 million per person or $6.2 million as adjusted for inflation. Also included was a proposal for a change in property inheritance. Currently, when property is inherited by the deceased, the beneficiary inherits the property at the stepped-up basis value (the value of the property when the grantor died.) The proposed change would eliminate the stepped-up basis. Instead, the cost basis would go back to the value of the property on date that it was originally purchased. How does that sound?
Needless to say, these proposed modifications could leave a large tax bill for beneficiaries and would change the strategies for passing on wealth to future generations. For now, the proposal was defeated. Those changes will not become a reality for this year. But that does not mean we’ve seen the end of those ideas. If nothing else, many of the current tax rules expire in 2025 so changes, amendments, updates, etc., are a strong possibility in the near future. Remember, we spent trillions of dollars to get through the pandemic and it worked. However, resuming normality and re-assuming prosperity comes with a cost.
Planning is now more essential than ever. Be prepared for future tax law changes which will be less “friendly” and have a contingency course of action. Don’t be shocked when income taxes, estate taxes, or even sales taxes rise, no matter who is in office. Years ago, one politician said, “Read my lips…no new taxes!” and guess what…he raised taxes. The sad part is that he may not have had a choice. So, be conscious of the evolving landscape. The federal contribution might be obligatory, but you can pay less and keep more by being financially aware and fiscally efficient. Consult with a financial planner or CPA to review the strategies that are best for your situation. Contact us for further questions. And remember, pay Uncle Sam, but don’t tax yourself.
