When it comes to investing, there are two things you can control – how much you pay in fees and how much you pay in taxes. With fees, it’s pretty straightforward because fees are disclosed up front. A brokerage charges you $x per trade, a mutual fund company pulls x% in expenses, and both are required by law to make those very clear.

Taxes are slightly different. The tax code can be complicated and it doesn’t help that there are so many different “types” of investment accounts from 401(k)s to Roth IRAs to your plain vanilla brokerage account. When it comes to investing, what you buy and where can be just as important as what you buy.

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Representative Jan Schakowsky (D-Illinois) introduced new legislation, the H.R. 1124 Fairness in Taxation Act, on Wednesday, March 16th, that would introduce new tax brackets for those who earned more than $1 million dollars a year. The current top income tax rate is 35% on income starting at $373,650 and the new legislation would introduce five new brackets, starting at $1 million dollars.

The new brackets would be:

• $1 – 10 million: 45%
• $10 – 20 million: 46%
• $20 – 100 million: 47%
• $100 million – 1 billion: 45%
• $1 billion+: 45%

I don’t know what’s more stunning: the reality that there are people who make over a $1 billion a year or that there are people who make over a billion a year and pay the same tax rates as someone making a fraction of that.

In addition to adding new brackets, the bill would also tax capital gains and dividend income as ordinary income for those whose income was over $1 million. According to the Citizens for Tax Justice, these new rates and changes would raise $78 billion, though it’s unclear how that number was calculated.

As for historical precedence, the last time the top rate was over 40% was back in 1986 when the top rate was 50%. Just a few years earlier, in 1981, the top rate was 70% for incomes over $215,400 ($524,421.99 in 2011 dollars). Before you think those rates were high, the top rates have always been very high, peaking into the ninety-percents through World War 2 until the early 60′s. The Tax Foundation has a list of historical tax rates since 1913.

What do you think of these new rates? Would youl ike to see them implemented?

Remember when Warren Buffett famously declared that he paid a lower tax rate than his administrative assistant? It probably confused a lot of people who aren’t familiar with the myriad of ways our income is taxed and that confusion can lead to misplaced frustration and anger. With how charged politics can be, it’s not uncommon for people to get really passionate and fired up over things that they’ve misunderstood.

A prime example, outside of money and politics, is the issue of vaccines and autism. The link between the two was based heavily on the fraudulent work of Dr. Andrew Wakefield in what has now been declared an “elaborate fraud.” Yet autism is a very real problem, one whose cause is still unknown, and people still insist on not vaccinating their children. While I think I have a right to tell people what to do, the fact that this vehement rejection of vaccines is based mostly on a fraud is just one example of this.

So today, I hope to explain how our income is taxed and hopefully that will remove some of the existing, incorrect, ideas some people have about our tax structure.

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The Bush tax cuts were a hot topic these last few weeks between the deal making (extending cuts for all in return and estate tax relief for extended unemployment benefits) and the political dancing, but ultimately something had to be done. While much has been made of the tax brackets themselves, one of the other things that went along with it was the long term capital gains tax rate. They were set to increase from 0% and 15% to 10% and 20%, respectively.

So here’s the question at hand, what if we no longer had favorable long term capital gains rates (and dividend tax rates) and instead all investment gains were taxed as ordinary income? In other words, what if there was no such thing as long term capital gains? What if everything were taxed as short term?

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With the Bush tax cuts expiring, there have been several proposals out there suggesting what we do. We’ve looked at the three major solutions to the expiring Bush tax cuts as well as one less well known alternative, but there’s a new one on the table that seems to make a lot of common sense (just not political sense).

Representative Bill Pascrell (D-NJ) and Representative Michael Capuano (D-MA) suggest the introduction of a new tax bracket starting at $500,000, an idea (known as the Pascrell Compromise) they floated before the mid-term elections. It also includes a five year extension on current middle class tax rates (individuals < $200,000 and families < $250,000) and long term capital gains and qualified dividends. It also includes a one year extension on tax rates for filers making under $500,000 annually (effectively creating a $500,000 tax bracket).

This effective “decouples” the tax brackets at the $500,000 income level and political experts are claiming that this will not get Republican support. Once you decouple the higher tax brackets, it’d be political suicide to vote against continuing the middle class (income under $200,000 and $250,000) tax cuts. The interesting part will be to see if all the voters to voiced their opinion about the national deficit and debt will do the same about continuing huge tax cuts for everyone, including themselves.

In case you were wondering, Bargaineering readers weighed in on the subject just recently.

The key to building wealth is to build or buy an asset that can appreciate in value and/or generates passive income. The key to building or buying an asset that can do that is to convert your labor into capital (money). This is why saving for retirement, saving for a home, and saving in general is such an important piece of your personal finance plan.

This is the billionaire secret because this idea is well understood by people who are wealthy. They see that capital gains taxes are much lower than ordinary income, that’s why Warren Buffet pays lower tax rates than his secretary. Capital gains are taxed at 15% for 2010 while the 15% tax bracket is the second lowest federal tax bracket (for those earning up to $34,000). It’s a no brainer, you want to transition, as quickly as possible, from ordinary income to long term capital gains and dividend income.

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When people talk about the Bush-era tax cuts, they’re usually referring to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) signed by President Bush in June of 2001. Many of the provisions were set to phase in over 9 years but those were accelerated when the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) was signed just two years later. Many of those cuts are set to expire this year, the two big items being income tax rates and capital gains rates.

President Obama has publicly said that he will let the Bush-era capital gains tax cuts expire on schedule this year, so it’s important to know how they will affect your investments.
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In the December special issue of Kiplinger’s magazine, Mary Beth Franklin put together a list of tax moves that can save you big money. Normally, these tax moves are the same from year the year. Her list has a few old standbys that are also on Kay Bell’s list of year end tax moves like giving to charity and checking your tax withholding. However, there are also some 2009 specific ones such as the home energy tax credit and the first time homebuyer’s credit.

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