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How to Prepare for Higher Taxes

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Regardless of which side of the isle you fall politically, there is no denying the fact that taxes are going to go up. We don’t know when but it probably won’t be far in to the future. There is certainly room for a lot of political debate on this topic but I want to talk about your money and what you can do to prepare.

Why are they going up? They don’t have any room to go down. A lot of effort has been made to keep more money in the American consumer’s pocket over the past decade. Add to that wars, recessions, and a drop in wages resulting in less tax revenue and that is why our national debt continues to rise nearly out of control. If we are to learn from countries like Greece, Italy, and Portugal, high national debt loads will eventually come back to nearly bankrupt a county. Although it would be nice to see lower taxes, the numbers don’t add up to make that a reality. And compare our current tax brackets with historical averages, we’re paying very low rates.

How will they go up? Rollbacks. The Bush era tax cuts which lowered the income tax bracket as well as dropped the rates on capital gains taxes will expire in 2013. There’s also the one year payroll tax cut and other tax advantages that are set to expire. Congress may extend some of them but many believe that we will see an end to those tax cuts. Also in 2013, higher income earners will pay an extra .9% to fund the new Obama healthcare law.

In light of what has happened in the Eurozone, there is growing sentiment to come up with a “go big or go home” solution and that will almost surely result in higher taxes.

What should you do? The obvious thing to do is to prepare for the worst and hope for the best. The worst would be no job but depending on your circumstance the more realistic worst case for you may be your same income level with a higher tax rate. This is the time to get serious about paying down debt and cutting expenses. For some people that’s extremely difficult right now but look for the small expenses that you could cut. (Starbucks?)

Here are a few other ideas:

Refinance

You can use one of the many financial calculators to see how much money you would save if you refinanced but along with higher taxes will come higher interest rates so the days of 4% mortgages are probably not long for this world.

Get a Roth

If you have a traditional IRA, consider converting it to a Roth IRA. With a traditional IRA you pay taxes on your gains when you reach retirement age and start withdrawing the money. With a Roth IRA, you pay the taxes now and withdraw tax fee at retirement. If you convert now, you’ll pay less taxes on the gains you have already made and if you’re young, you’re probably in a lower tax bracket than you will be when you retire. Of course you should talk to a financial adviser to see if that’s a good move for you.

Company Perks

If you have stock options through your company, consider cashing some of them out while the taxes on those gains are still low. Not all options are taxed in the same way but it’s worth exploring. Also remember that company stock options are part of your overall investing portfolio. If you have more money tied up in company stock options than you do your other investments, there’s probably something wrong with your asset allocation. Tax benefits aside, it may be appropriate to cash out a portion anyway. (By cash out I mean put the proceeds in an IRA or other saving vehicle)

Pardon my bias but being an American is a privilege and although most of us believe that our politicians could do a better job managing the nation’s money, I never want to lose sight of the fact that I have opportunities that others don’t simply because I’m an American. I’ll be annoyed if more of my money has to go to the government but I’ll quickly get over it. I don’t know about you but I don’t want my children living in a bankrupt America and I’m willing to pay a little more  to make sure that happens.

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8 Responses to “How to Prepare for Higher Taxes”

  1. Steve says:

    What does refinancing have to do with taxes?

    • DonC says:

      Refinancing could actually increase your taxes by reducing your mortgage interest deduction. I’m thinking Jim is suggesting ways to save money to offset the pending tax hikes..

    • Brendan says:

      As the US national debt goes up, the perception of investors around the world is that it becomes less and less likely that the US will be able to repay its debt. This, in turn, raises bond rates. All interest rates on borrowed money (mortgages, car loans, etc.) are tied to bond rates.

      If the US has to sell bonds at a higher interest rate, taxes have to be raised to either:

      A) pay the higher bond yields; or,

      B) raise enough money to start paying down the debt and borrow less money.

      The US debt is high enough that at some point it will no longer be a prudent investment.

  2. Roland says:

    Higher tax rates will not reduce the deficit. The congress always spends some multiple of revenues so increased revenue equals higher deficits. In addition, people constantly confuse tax rates with tax revenues. Incerased rates do not equate to increasing revenue. People react to tax rates and shelter their income above about 18% tax rate. Under FDR the tax rate was 90% which resulted in most of the nations capital fleeing to tax free municipal bonds which helped extend the great depression by years. The only way to get out from under this crushing debt is to grow the economy which will produce a flood of revenue. Reducing capital gains tax to zero would be a good start. It’s not going to happen so we are doomed.

  3. Strebkr says:

    In the eyes of the average person, even if there is a temporary tax break (a la the payroll tax reduction going on now) they will yell and scream when its time for things to go back to normal.

  4. Headed_Out says:

    I just hope the Euro keeps falling so the dollars I have saved up are worth more when I immigrate to Northern Europe in the summer of 2012. I have no interest in paying BO’s debts.

  5. Joe says:

    What a misleading Headline! Get into Tax Free Municiple Bonds for now. Keep some dividend paying stocks but only about 25% of your portfolio.


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