However, Congress did allow the payroll tax holiday that was enacted in 2010 to expire, which adds 2% to the amount that workers pay into Social Security.

Higher income taxpayers are facing a larger tax bill with top rates on income and capital gains increasing.  Additional surtaxes for Medicare plus reductions in allowable deductions will be felt by affluent taxpayers.

Here are a few tips for the 2013 tax year:

Adjust your withholding

With the increase in Social Security withholding, a taxpayer who earns $50k per year will see $1k less in take home pay.

One way to lessen the pinch is to have your withholding adjusted so that you keep more of your money throughout the year.  This is particularly helpful if you typically get a big refund with your tax return.

Take a look at a tool that the IRS offers to estimate the number of exemptions to claim for the remainder of the year.

Fund your 401k and other employer sponsored benefits

This may seem obvious, but there are a lot of tax triggers that are tied to adjusted gross income.  Contributions to employer sponsored plans such as 401ks and cafeteria plans are one of the easiest ways to reduce the amount of income that gets counted toward AGI.

Some key AGI thresholds determine if you are eligible to take the child tax credit, fund a Roth IRA, deduct student loan interest or take an education credit.  Also this year the itemized deduction and personal exemption phase-outs are back for high income taxpayers.

Watch out for the Medicare surcharge

As part of the healthcare legislation commonly known as “Obamacare” a 3.8% Medicare surcharge on investment income for wealthier taxpayers was added.  Beginning in 2013 single taxpayers with incomes in excess of $200k and joint filers in excess of $250k will be hit with this tax based on their investment earnings.

This includes dividends, interest capital gains, annuities, royalties and rental income.  Portfolio construction needs to be considered in order to mitigate income from taxable accounts.  Also this is another area where funding 401ks and other employee benefit plans can have a big impact.

Gift appreciated stock

This isn’t a new strategy for 2013, although it has become even more attractive for those in the top income tax bracket as their long term capital gains rates have increased to 20%.  The annual exclusion for 2013 allows up to $14k to be given away to an unlimited number of people free of gift tax.  For a relative in the lower tax brackets the most they will pay in capital gains tax is 15%, and there is a potential for 0% if they are below the 25% income tax bracket.

Watch out for the “kiddie tax” as this strategy will not work for kids under the age of 19 or full time students under the age of 24.  Also, gifting appreciated stock to qualified charities allows for a full deduction of the value of the stock, and the charity, of course, does not recognize any gain based on their tax exempt status.

Plan ahead!

As financial planners, we believe that tax planning is one area that can pay off immediately and it is often the easiest place to start.

Photo credit: 401(K) 2013

Photo credit: Alan Cleaver

Tax planning is an essential part of financial planning.

With all of the talk about the fiscal cliff dominating the headlines, it’s important to remember that there’s still some time left before this year’s tax laws expire.

Here are a few tips that may help to make filing your 2012 tax return a little less painful:

* Note: Consultation with your tax advisor before implementing any tax strategy is always recommended.

Photo credit: Alan Cleaver

Facing the Cliff

With the election coming up next month, we thought it might be a good time to discuss our thoughts on the looming fiscal cliff.

What’s the Fiscal Cliff?

The term “fiscal cliff” was first used by Ben Benanke to describe the imposition of large tax increases and spending cuts that are legislated to occur on January 1, 2013.  If Congress fails to act, a total of $600 billion, or about 4% of GDP, will be taken out of the economy next year, almost guaranteeing a recession.

With the memory of the 2011 debt-ceiling debacle still fresh, no politician on either side of the aisle wants to have to answer to their constituents if Washington can’t get together on this somehow.

What will happen?

There are several possibilities for what could happen, including pushing the issue for another year by extending most or all of the current tax laws.

An intriguing path to resolution being discussed is to actually go over the fiscal cliff, and fix it as soon as possible by working retroactively.  When the Bush-era tax cuts expire in January, tax rates return to Clinton-era levels, and Republicans would then be negotiating to reduce taxes rather than being pressured to raise them.  The Democrats would certainly welcome this but they will also stick to their call for raising taxes on the wealthy.

Both sides would have some common ground in that they want to avoid the dramatic cuts to military and non-military spending. Either way the calls for action will get louder and louder as soon as the election is over.  We believe that it is likely a compromise will happen.

What does this mean for me?

While this uncertainty makes it difficult to do tax planning, it doesn’t change our investment strategy.  We consider fiscal policy as part of our research process, but we don’t believe in making dramatic shifts in our allocation strategy based on something that may not happen.

Investors that move into cash and bonds (as a bet that there will be no compromise) will have a tough decision as to when to get back into stocks if Congress and the White House do indeed find some common ground and markets move higher as a result.

Our disciplined process includes gradually reducing stocks as prices move higher, which puts us in a position to capitalize on a market sell-off.  Our investment philosophy/strategy is focused on the long-term with an understanding of both macro economic conditions and client specific needs.  No matter what happens with the fiscal cliff, we are prepared.

Photo credit: Aaron D. Feen

Demand will continue to skyrocket as currently one-third of India’s households do not have access to the electrical grid.  Political dysfunction and cultural attitudes compound the problems when politicians promise cheap electricity to a population already taking it without paying for it.  Not only does India have to somehow find a way to supply energy to the incredible growth in demand, but it has to do so by trying to overcome one of the world’s most inefficient systems.  India is facing some very serious challenges as it seeks to convince the rest of the world that it is ready to be taken seriously as a viable economic partner.

While the United States has some big issues to address we have always been a nation that understands the importance of a modern, reliable energy infrastructure.  The government’s role is to provide investment for improvements to our existing system and fund research to advance technology.  Our public investment should be looked at in terms of opportunity as the information-based economy has driven consumer demand over three-fold in the last 50 years.

Public sector investment leads to opportunities in the private sector as new technologies continue to drive innovations in efficiency.  Historically there has been resistance against moving to renewable energy sources because they weren’t cost competitive.  However, wind and solar are starting to grow as a part of our overall energy production because advancements in technology are starting to close the gap.

Fossil fuels are still overwhelmingly important to our energy needs making up 70% of our energy production.  However, natural gas has continued to grow as an important component of our energy production as the amount of energy we generate from oil and gas has diminished over the last two decades.  The U.S. has large natural gas reserves and gas is seen as a cleaner option than coal and safer than nuclear.

There are opportunities in the distribution system as well.  We are investing in smart grid technology that will fundamentally change the way we receive and use electricity.  We have always received electricity into our homes and businesses as a one way street from the power company.  Digital technology will allow the consumer to be a part of the grid by supplying usage information back to the utility that will make distribution much more efficient.  Renewable sources such as wind and solar also provide an opportunity to decentralize power generation so that it would even be possible for a consumer to sell their excess power back into the grid.

India’s problems provide a stark example of how difficult it is for an economy to function without a reliable energy system.  The world is watching and taking notes.

Photo credit: Sistak

So here we are again.   Our political leaders are already starting to position themselves so they can claim they are being reasonable and everything would be okay if the other side would just come around to seeing things their way.  But how far are they willing to take this tough talk?  This same situation last year turned out pretty badly all around.  Our debt was downgraded from its previously unblemished AAA rating for the first time in our nation’s history, the stock market sold off almost 20% and confidence was shaken throughout our country.

However, let’s take a look at what is different this time.  For starters this is a Presidential election year and both sides remember what happened last year.  There is certain to be some finger pointing, but there is also likely to be some caution as neither party wants to bring too much attention to its role in what went wrong last year.  Secondly, at least on paper, it seems there is some room for compromise as the disparity between federal receipts and outlays remains historically wide.

Narrowing Gap

However, we feel that a gradual narrowing of the revenue and spending gap, similar to the pattern beginning in the early ‘80s through the mid ‘90s, is the best case for the country as unemployment is still too high.  Moving too quickly to reduce the deficit either by being overly aggressive in spending cuts or raising taxes too much or both could disrupt the economy and hurt job growth.  So actually, maybe the best situation is for grudging compromise on both sides which may mean the gap will be closed a bit at a time.

There is a possibility that our country will again be held hostage by political grandstanding and we’ll see a repeat of last year.  However, there also may be enough incentive for both sides to find some common ground.

Families also face an emotional decision as best intentions often run head first into the realities of paying for four years of college.  We all want what’s best for our kids and paying for their college education is certainly best for them, right?…  Maybe not.

According to a new study, Affording Emerging Adulthood: Parental Financial Assistance of their College-Aged Children, having your children help pay for their own college education can reap benefits beyond those of being debt free upon graduation.

The structure of having a job, for instance, can help to limit distractions that too much free time so often brings.  The kids who were fully funded by their parents, including discretionary spending, were more likely to be heavier drinkers and drug users.

There is, however, an implication that a balance should be sought, as too much of the burden transferred to the child can often lead to extending the amount of time it takes to complete a degree or even dropping out of school altogether.

A suggestion that comes to mind is to remain flexible.  There are a variety of paths to a four year degree, including starting in a community college.  Also, options for funding through loans are available that can help families spread resources over longer periods of time.

Sending your kids to college can be intimidating for everyone in the family, and preparing financially is only one aspect to consider.  Allowing them some ownership in the process can help them add some critical tools for when they are on campus by themselves.

Here are some more of our thoughts on college education:

• Bang for your College Buck
• College Planning in an Uncertain World

Photo credit: James Almond

* We hope these tips are helpful as you’re preparing your tax return.  If you have questions, contact your personal tax preparer.

Make your IRA contribution.

You have until April 17th (this year’s filing deadline) to make contributions to your IRA accounts (Roth or traditional) for 2011.

There are rules to follow in order to be eligible to contribute: http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee

Reduce your Adjusted Gross Income.

Some available tax opportunities, education credits for example, are dependent upon staying below a certain AGI.

One of the best ways to keep your AGI as low as possible is to take advantage of employer benefits.  Max out your 401k, and look into the cafeteria options (health, dependent care, etc.).

Taking full advantage of these opportunities can give you a chance at other tax opportunities.

Watch out for the Social Security tax bubble.

There is a fairly complicated formula that is used to determine if any of your Social Security benefits will be taxed.  Understanding where that threshold is can save you a big tax bill.

Here’s a pretty handy calculator: http://www.calcxml.com/do/inc08

Don’t forget about HSA contributions.

Speaking of benefits provided by your employer: If you have an HSA account that is sponsored through your employer you may be eligible to make additional contributions if you haven’t reached the maximum.

Make sure that you have enough qualified medical expenses before you contribute.

Watch out for new reporting rules for sales of stock investments.

Form 8949 Sales and Other Dispositions of Capital Assets has been created by the IRS in response to new regulations that require financial institutions that custody investment assets to begin reporting cost basis on form 1099B.

Consider accelerating income into 2012.

No one knows for certain what the lawmakers in Washington DC will come up with after current tax laws expire at the end of this year.  If Congress does nothing then tax rates will automatically go up as they will sunset back to higher rates that were in place before President Bush came into office.

Strategies include: deferring itemized deductions to 2013, harvesting capital gains, deferring capital losses, taking additional IRA distributions, Roth conversions.

Don’t forget mileage deductions.

For 2011, the deduction for business miles is 51 cents per mile, for charity 14 cents and for medical miles 19 cents.

Looking ahead to 2012 the IRS has issued new rates: http://www.irs.gov/newsroom/article/0,,id=250882,00.html

Photo credit: 401K

Relenting to the calls from his opponents for transparency, he recently released his tax returns.  Not only does the information shine a light on Mr. Romney, it puts the issue of fairness in our tax system back onto the front page.

The Washington Post: Mitt Romney’s tax returns shed some light on his investment wealth

Some of the highlights from the returns:

• 550 – Total pages filed for 2010
• $42.6 million – Amount of reported income for 2009 and 2010
• 13.9% – His effective tax rate
• Zero – Amount of wages earned

Mr. Romney’s tax return is being criticized as an example of how our tax system is rigged to favor those who control capital (wealth).  Much of the income that was reported on his return was in the form of something called carried interest.

This income was from profits Mr. Romney received through his participation in Bain Capital, a private equity firm that he helped co-found in the 1990s.  There is plenty of criticism pointed at how private equity generates profits – most notably from his Republican opponents – but also at how this profit is taxed.

There is a special provision in the tax code that allows for capital gains treatment for carried interest.  This means that Mr. Romney’s tax rate is capped at 15% on this income instead of 35%, if it were treated as ordinary income (as many critics say it should be).

It’s getting harder for those in the private equity industry and their Congressional allies to argue not only that this is good tax policy, but that it is fair.  Most Americans hold their investments in tax deferred accounts which they funded through payroll contributions. When withdrawals are taken from these assets they are taxed at ordinary rates.  No loophole for the middle class here.

Income disparity is at an all time high and the anger directed at the wealthy is being stoked yet again. Higher tax rates for the Mitt Romney’s in this country are being pushed by the President and even by some of the wealthy themselves.

Warren Buffett points to the fact that his secretary pays taxes at higher rates than he does because most of her income is derived from wage compensation while his comes overwhelmingly from investments.

The decade of the 2000s saw overall tax rates decline while GDP growth rates fell.  We do believe that tax rates are going to rise, especially for those whose incomes are derived from investment sources.

Our long-term issues of entitlement funding, in particular healthcare, will likely require higher tax revenues even though some of our current political leaders lack the ability (or the nerve) to face this reality.

Photo credit: Gage Skidmore

A recent study by the Congressional Budget Office shows that the wealthiest U.S. income households have garnered a disproportionately large portion of total income growth over the last thirty years.  In the last three decades, the top 1% of U.S. earners have seen their slice of the country’s income pie double from 10.5% to over 21%.  Their real (inflation adjusted) after-tax incomes rose by 275% while the bottom 20% of income households have experienced quite a different reality as their real after-tax incomes grew by only 18 percent.  As a result, the income gap between the wealthiest and poorest Americans has grown to a level not seen since the 1920’s.

How did the Gap Become so Wide?

Much of this widening income gap is believed to have been caused to a large extent by technological advancement and to a lesser extent globalization. As this study points out, it’s imperative for policy makers to increase access to education and training in order that worker skills meet the demand from today’s rapidly changing world.

Lower skilled U.S. workers are at a disadvantage because they have faced a dual threat to their livelihoods.  Yes cheap foreign labor has contributed to U.S. job losses, but automation has been a bigger factor.

Currently much of the financial benefits from technology gains are showing up in corporate bottom lines.  At some point the benefits from technology gains, however, have to be spread further down to workers.  Henry Ford had a goal to build a car that the average American worker could afford while paying his own workers a wage that would allow them to buy the cars that they were producing.  Through his determination and ingenuity, the Model T rolled off of the first modern industrial assembly line in 1908.  The American economy and the life of the average worker were forever changed.

Corporate and political leaders need to work together to leverage advancement in technologies so that the lower and middle of the income spectrum have more of an opportunity to participate.

We will continue this discussion of factors that we think have played a role in creating the large income gap as well as some possible solutions for restoring a healthier balance in our next post on this topic.

Karl Smith writes about this post at Modeled Behavior.

In discussing the significance of this chart

He says “The center of the distribution is moving rightward. This means not only is our vehicle fleet rapidly aging but that if vehicle production actually fell the scrappage rate would skyrocket in the coming years.”

In other words, either we are headed to a highly unlikely new reality of far fewer cars per capita, or demand is building for replacing cars much the same as with housing.

In a recent LA times article, Jerry Hirsch writes, “Consumers are heading to dealerships to replace aging cars. The industry estimates that the average age of vehicles on the road is approaching 11 years as people have delayed purchases because of the recession and more recently an uncertain economy.”

At some point the pent up demand for new cars (or homes) builds up enough so that consumers will begin to buy.  And home builders and car manufacturers will then ramp up production and create jobs to meet that demand.