Possible tax changes in 2010 and beyond

KS_Prius

Confused about dryer sheets
Joined
May 14, 2008
Messages
7
Hello,

I am new to the forum and had been considering ER (hope I am using the correct acronym for early retirement) per the numbers generated by FIRECalc. Since then, I have heard increased rumblings about the income tax rates increasing 10% per nominal income range. This, in combination with increased inflation, undermines the possibility that resources will last through retirement and I am gravitating to the 'just 1-2 more years' scenario.

I note that the potential fed tax increases do not seem to be a lively subject of debate. Those who offer guidance to those who want to retire do not mention this. A potential 10% cut in annual budget can really wreak havoc with the best of plans.

As an easy example (ignoring tax efficient vehicles), if your taxable portfolio throws off $65K gross earnings and current fed tax is 25% and state is 5%, then you are down $19,500. If the fed tax rate jumps to 35% in 2010, then the total tax liability is $26,000. The net loss to the spending budget is $6,500.

Am I missing something? Other than serious tax sheltering through muni bonds which limits the ability for the portfolio to sustain growth, how are those who are FIRE'd preparing for this possibility? Meanwhile, I will ponder the great FIRECalc to see how to model this.

Thanks!
 
I note that the potential fed tax increases do not seem to be a lively subject of debate. Those who offer guidance to those who want to retire do not mention this. A potential 10% cut in annual budget can really wreak havoc with the best of plans.
I think a lot of people don't want to touch this one because it tends to devolve into politics 99 44/100% of the time.

What do I do, knowing that I don't know what tax policy will be in 10-20 years? I diversify my investments: 401K and traditional IRAs, Roth IRAs and taxable investments. Having all three buckets to draw from in retirement helps you "engineer" your tax burden. Using today's tax brackets as an example, one might pull out as much taxable income as they could up to the limit of the 15% bracket, and if you still needed more income, pull from Roths or from other assets already taxed. That way you can draw as much as possible from low brackets and none from higher brackets.
 
1) if your income is $65K, you won't be paying $19.5K in taxes. If you are single it would be more like $11K for federal or if you are married it would be about $6.5K assuming you don't itemize (add about $3K to each for state income tax). That's if all your income comes from a 401K or an IRA and therefore is considered taxable income. If it comes from a taxable account, it could be even less since a lot of the money in a taxable account has already been taxed (it depends of course on your particular situation).

2) Where did you hear that the 25% tax bracket will increase to 35%? I find it extremely unlikely. What politician in his right mind would ever propose a 40% increase in income tax for the middle class?
 
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As an easy example (ignoring tax efficient vehicles), if your taxable portfolio throws off $65K gross earnings and current fed tax is 25% and state is 5%, then you are down $19,500. If the fed tax rate jumps to 35% in 2010, then the total tax liability is $26,000. The net loss to the spending budget is $6,500.

Am I missing something?

You're missing several things, actually:

1. The federal income tax structure is composed of graduated rates, so the first X dollars are taxed at Y%, the next Z dollars are taxed at W%, etc. This is also true of my state income tax structure, although it is far easier to be in the top bracket in my state than to be in the top federal tax bracket.

2. There are also exemptions for a certain amount of income per person on your return -- I think it was $3,500 per person in 2007. This amount is deducted from your income before the tax is figured.

3. As a result of items 1 and 2 above, along with any itemized deductions or the standard deduction, it is quite possible to earn $65,000 in income and have a federal and state tax liability of only a few thousand, not the nearly $20,000 you describe.

4. I personally expect to be able to live comfortably on less than a third of that $65,000 when I ER, so I wouldn't be surprised if my income tax liability will be zero or very close to zero.

5. If the federal government raises the 25% marginal rate by 10%, that would only apply to the dollars that were in that tax bracket.

6. You wrote "Ignoring tax efficient vehicles". Ignoring tax efficient vehicles is probably one of the bigger mistakes people make. I would hope that at least some of that $65,000 in income is either return of capital and or capital gains.

7. As a single individual, the best I can do to mitigate this issue is vote appropriately and communicate my desire for low taxes to my elected officials, as well as do the tax planning that others have mentioned. Beyond that I've discovered in the last few years that getting worried about stuff I can't control just leads to high blood pressure and no actual change.

2Cor521

ETA: crossposted with FIREdreamer so some of the points were duplicated.
 
Yes, my simplified model was really poor. I currently live in the land where I get creamed by AMT and I pay a CPA to do my taxes and I should probably try to consult an online tax calculator to model my scenario.

Although, it is not certain tax rates will go up, it appears that a number of things we are accustomed to begin expiring in 2010.

Thanks for the guidance. I will ponder this some more. Perhaps, things can work out to FIRE afterall.
 
"A potential 10% cut in annual budget can really wreak havoc with the best of plans."

Those "best plans" aren't very good if a 10% cut in your budget would really wreak havoc on them. If a 10% cut is that significant, you might want to stick it out an extra year or two.

What would a 10% cut equate to? Driving a moderately priced honda instead of a lexus? Staying at 3 star hotels, hostels, and B&B's instead of 5 star hotels on your travels? Unless you are retiring on a shoestring budget it seems like you would be able to absorb a small budget cut without a failure of your ER plans.

That being said, I am certainly planning on a big tax increase over what I pay now come 2010. If you are married and have kids and earn a middle income salary, get ready to get screwed. The marriage penalty is coming back. Child tax credits are getting cut in half. And I think the 10% bracket is going back to 15% (correct me if I'm wrong on that). And other brackets are increasing. This is just what happens if the current tax cuts are not extended. I would imagine if certain presidential candidates were ultimately elected, we could be seeing more/different taxes than these. Bottom line is that I am planning on giving away my raises for the next few years to pay the taxman.
 
Am I the only one who hasn't heard rumblings specifically about a 10% rise in taxes?

I certainly expect at some point taxes will go back up, and many people here have said that as well. And I've seen plenty of discussions about coping with it--things like rolling over IRAs to Roths now and taking capital gains now to name a couple.

I agree you shouldn't be on the edge to where this will break your plan. But I've read other posts that say you are either FI or not, and if you are FI, you can RE. This uncertainty about taxes is one reason I don't agree with that, at least for many of us.

But personally I'm more worried about medical expenses, a prolonged economic downturn, and feeling at least somewhat of an obligation to help other family members than I am a higher tax rate.
 
Based on the expiration of the current tax code, the tax year 2011 could bring these new tax brackets:

for taxable income
$0 to $71,600 - 15%
$71,601 - $146,800 - 27.5%
$146,801 - $223,800 - 30.5%
$223,801 - $399,600 - 35.5%
$399,601 and over - 39.1%
 
Based on the expiration of the current tax code, the tax year 2011 could bring these new tax brackets:

for taxable income
$0 to $71,600 - 15%
$71,601 - $146,800 - 27.5%
$146,801 - $223,800 - 30.5%
$223,801 - $399,600 - 35.5%
$399,601 and over - 39.1%

I have never seen this before but I have to say I like it as it will put me in the 15% bracket for ever. Is that for married or single. If it's for married couples, what's the 15% cutoff for singles.
 
While I think it's reasonable to assume our historically low tax rates will rise eventually, I wouldn't make too much effort trying to guess exactly how much or when. No matter what the tax code says about what will expire when, the practical reality is that it's decided by the politicians based on their whims. Just making sure you're not on too tight a budget is about all you can do.
 
Interesting site for a historical perspective on income tax rates: www.[B]tax[/B]foundation.org/taxdata/show/151.html (note the PDF/HTML/SWF files on the bottom of the first page).
 
Interesting site for a historical perspective on income tax rates: www.taxfoundation.org/taxdata/show/151.html (note the PDF/HTML/SWF files on the bottom of the first page).
That was educational. I started going back through the tables and saw a 50% rate (which I remember) then I went back a few more years and saw 70% and I felt queasy. Then I went back to the 50's and beyond and got to 91 and 92%. I was afraid to go any farther.

That was just ugly.
 
A doctor friend who came over from the UK tells me there was a time when the top rate there was over 100%. I think it was in the 50s or early 60s. He had to have his wife stop working because it was costing them money.
 
That was educational. I started going back through the tables and saw a 50% rate (which I remember) then I went back a few more years and saw 70% and I felt queasy. Then I went back to the 50's and beyond and got to 91 and 92%. I was afraid to go any farther.

That was just ugly.
Yes it was, but back then you had a tax deduction for darned near everything. For the most part, the Reagan-era deal which "flattened" the tax brackets was achieved in exchange for elimination of most of these arcane writeoffs and tax shelters.

So yes, there were 50%, 70% and sometimes even 90% brackets, but it was so easy to avoid these brackets because of the copious deductions that almost no one, even the wealthiest or those with the highest incomes, tripped on them.
 
So yes, there were 50%, 70% and sometimes even 90% brackets, but it was so easy to avoid these brackets because of the copious deductions that almost no one, even the wealthiest or those with the highest incomes, tripped on them.

That's the part that worries me.... The return of zillions of special interest deductions and loopholes. Despite the fact it's better today than a decade ago, there is still too much empahsis in the tax code on controlling our lives by dangling the "loophole carrot" in front of us. I cringe at the thought of raising tax rates and then increasing special interest loopholes.... a real step in the wrong direction for the tax code!
 
Wow, you know what tax rates will be in the future? Can I borrow your crystal ball for an afternoon?

Seriously, I think there are a lot more important variables to deal with (health insurance costs, cost of living inflation, etc.). If you stay diversified on taxes (taxable account, Roth, and traditional IRA/401K) you should be able to mitigate whatever comes down the pike.
 
That's the part that worries me.... The return of zillions of special interest deductions and loopholes.

I remember doing taxes back in the days of loopholes. Instead of finishing in an hour or two, it was more like a week or two of intensive work going over every possible loophole to see if I could worm my way into it. As a result my taxes were not excessively high, but what a waste of manpower (or womanpower, in my case).
 
I remember doing taxes back in the days of loopholes. Instead of finishing in an hour or two, it was more like a week or two of intensive work going over every possible loophole to see if I could worm my way into it. As a result my taxes were not excessively high, but what a waste of manpower (or womanpower, in my case).

Yeah. Back in the late '70s, I remember seeing my dad spending hours and hours with receipts and credit card statements, looking for everything that could possibly be a writeoff.

Frankly, I much prefer the tax code simpler: lower marginal rates, fewer special-interest writeoffs.
 
I remember doing taxes back in the days of loopholes. Instead of finishing in an hour or two, it was more like a week or two of intensive work going over every possible loophole to see if I could worm my way into it. As a result my taxes were not excessively high, but what a waste of manpower (or womanpower, in my case).

Well, it depends on other factors too. My taxes take me a looooong time to figure out.

Two kids in college. There are several interacting, confusing programs for tax deductions/credits. After you enter your data, the tax program grunts for about a minute, and runs the scenarios to figure out which combination is best for you. But, some of these can only be used X times, so w/o a crystal ball, it's still a guess. Which combination is a benefit is a function of your income, their payments (one plan credits you a higher %, but has a lower max), what year of school they are in, some are one per family, etc, etc ,etc.

Couple that in with my desire to convert as much Trad-IRA to a Roth IRA as I can, and stay in the 15% bracket, and it's a mess.

In 2007, I messed up. I meant to buy back a covered call that I sold on some highly appreciated stock. The stock rose so fast, then fell, and I forgot to check on the closing day, and I got called and took a big cap gain. I was shocked how that one event affected my tax situation. Yes, I appeared to be 'richer' that year, but not only did my tax bracket go up, but I lost some deductions, could not convert any of my IRA, lost ALL the college credit/deductions, and - no stimulus check for YOU! Another deduction I was going to look into, required me to recalculate a bunch of stuff based on the AMT. I could not even follow the directions, the tax program seemed to leave me hanging, so I just gave up on that one.

So while my income went up by 1.8X, my tax bill went up by 7.2X!

I'm actually a supporter of progressive tax rates, yes, even when I am the one hit by them. But those tax tables do NOT tell the whole story. All these funky little loophole rules made my taxes go up a very steep wall.

-ERD50
 
Yep! But in comparison with the few remaining loopholes today, back then there were so very many more and many were pretty strange! :) I really do appreciate tax code simplification.
 
Yep! But in comparison with the few remaining loopholes today, back then there were so many more and many were pretty strange! :)

I can't really say. I guess my taxes were fairly straightforward in those days. Or maybe the pain has faded with time? What years are you talking about?

I don't doubt that the were more complex then for many people, I'm just saying there is plenty of complexity today, if you happen to get trapped by it. Plenty of people have kids in college, and BTW, almost EVERY article I read describing the HOPE versus Lifetime Learning Credit got it wrong. They all said ' go for the HOPE if you qualify'. Geez, I had to dig into it to learn that what they were telling me was wrong. Sure, a 100% credit sounds better than a 20% credit, but they didn't peel the next layer of that onion to see that that the 100% credit is limited to $1,500, and the LLC is limited to $2,000.

Here's my notes from 2006:

Hope maxes out at $1500 on $2000 expenses
LLC maxes out at $2000 on $10,000 expenses (better for us)

Since we had over $10,000 of eligible expenses, well, it seemed to me that $2,000 is better than $1,500. That eluded most financial writers. Then there are a few more twists/turns for all of that, based on years in school, number of kids applying in a family, etc.

If politicians want to provide incentives for people getting an education - why not do it some straightforward method instead of a bunch of conflicting/overlapping regulations. Oh, I did say 'politicians' - guess I answered my own question :(

-ERD50
 
Yep! But in comparison with the few remaining loopholes today, back then there were so very many more and many were pretty strange! :) I really do appreciate tax code simplification.

Wasn't a filer in the bad old days, but I can attest to the strangeness. I was looking closely at a company that owns and rents barges on the Mississippi. Management indicated that there are a lot of elderly barges from the late 1970s and early 1980s that would have to come out of service soon and that this would likely be a boost to the industry. I asked why there were so many barges from that era. Reply: there was a depreciation-related tax loophole of some sort whereby doctors, lawyers and other high income folks came out ahead by buying a new barge, taking the tax write-off, and operating it at a marginal profit or even a loss for a while. Totally driven by the funkiness of the tax code back then.
 
I remember the CEO of one of the little startups I was at in the 80's buying billboards in swamps in florida (or something like that) for the writeoffs.
 
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