Tax planning this year may be as difficult as any year in recent memory as policymakers in Washington debate potential changes under a Dec. 31 deadline that has been termed the “fiscal cliff.”
If Congress fails to act, taxes will rise more than $500 billion in 2013, an average of nearly $3,500 per household, according to an analysis by the Tax Policy Center. Middle-income households would see tax bills rise almost $2,000 on average, the Tax Policy Center said.
Without legislative action, most tax cuts adopted since 2001 will expire Jan. 1, raising rates, reducing deductions and credits, and forcing millions of taxpayers onto the alternative minimum tax. More than 10 times as many estates would be subject to the estate tax, and a 2 percentage point cut in payroll taxes would disappear.
The jump in taxes and sharp spending cuts could well push the nation's economy back into a recession, the Congressional Budget Office said. Such predictions make it likely that policymakers will broker some type of deal to limit tax hikes with more targeted budget cuts.
But taxpayers, with about six weeks until year's end, must make some income and investment decisions in this atmosphere of uncertainty.
George Cohlmia, managing director of investments for the Cohlmia Advisory Group in Oklahoma City, said taxpayers can make some common-sense moves.
“We're advising clients to take gains this year and try to defer losses until next year just thinking that rates (are going) to go up,” Cohlmia said. “We don't know how much. We don't even know what all rates — capital gains rates, dividend rates, income tax rates. But I think it's safe to say rates will be going up.”
But Cohlmia warns this doesn't mean it's time to take drastic measures such as liquidating many assets before the year ends for fear of higher tax rates.
“I don't think anyone should make long-term investment decisions based on taxes,” he said. “Personally, some of the biggest mistakes I've made buying and selling stocks have been because I've done that based on taxes.”
Taxpayers also should at least examine the implications of switching from a conventional IRA to a Roth IRA, which could be beneficial if taxes rise.
Cohlmia said the best strategy is to work with someone familiar with tax laws and investments, particularly in the current situation.
“In this case, we have to know what we don't know,” he said. “What we don't know is what's going to happen to those tax rates. Nobody knows that yet. You have to keep that within the proper perspective.”
Jimmy J. Williams, a CPA and financial planner in McAlester, said he also is advising clients it might be a good time to lock in investment gains. That's partly because of the likelihood of higher taxes, particularly on capital gains, but also because he believes the economy will be “pretty flat over the next three or four years.”
Those who have held stock in Oklahoma companies for at least five years can take gains with no tax penalty, Williams said.
Taxpayers also should consider putting more money into tax-deferred retirement plans, such as a 401(k), Williams said. That may require belt-tightening for some, Williams said, but careful budgeting, taking advantage of tax-advantaged flex spending on employee health care plans and even mortgage refinancing are worth looking into.
Healthy individuals might consider raising health care deductibles to free up funds, he said. The implications of the fiscal cliff are different for each individual, Williams said, and should be discussed with a tax professional.
Clearly, this year's unique situation has captured the attention of some consumers. Most years, Williams asks clients to schedule a visit to discuss their situation, but that has turned around, he said.
“Everybody's concerned,” he said. “We are booked solid for December for these year-end planning issues.”
Readers weigh in
Last week, readers were asked to share with The Oklahoman what they're doing, or considering, in response to the fiscal cliff and potential tax hikes.
Oklahoma City resident John Michalski said the fiscal cliff probably won't be as scary as it sounds.
“Where we were before the Bush tax cuts?” Michalski said in an email. “I seem to recall that day still followed night when we all paid our usual taxes. If we had to go back to paying those same old rates, why should it be such a problem now? Fat cats too used to the perks and shelters? That isn't exactly what I'd call falling off a cliff.”
Jim McGoodwin, a self-described long-term investor, said he wasn't worried about the fiscal cliff because policymakers from both parties are under tremendous political pressure to take action.
“I also look forward to paying more in taxes on my income, dividends and capital gains. I say ‘look forward to' because I take great pride in my country and feel blessed that I'm in a position to contribute more to it. In the long run people like me in the upper income brackets can afford to pay more to help reduce our long-term debt.”
Leo Kingston, owner of 18002sellhomes, said he would pass along any tax increases to his customers.
“I want to continue employing people and providing benefits including insurance,” he said. “The sky is not falling. However, I will have to make adjustments to continue to be a profitable company.”
Al Slattery, owner of an Oklahoma City masonry firm, said Washington policymakers are hurting his family and the families of those he employs.
“Instead of planning growth, we're planning strategies to deal with regulations, taxes and not the least how to make a profit in this complicated economy,” Slattery said.
A new standard?
Cohlmia said some of the angst about the fiscal cliff and potential tax changes likely is overblown. His clients, many of whom are wealthy, haven't been complaining too much.
“Guys who make a million dollars a year of income, I don't hear them bellyaching,” Cohlmia said. “It's not going to change their standard of living.”
Williams, who said many of his clients are “blue-collar, working-class kind of people,” said he is advising those taxpayers to avoid making drastic changes based on fiscal cliff fears.
“Don't jump in the pond with both feet; let's stick our toe in here,” Williams said.