How To Prepare for Tax Increases Next Year In this Sluggish Economy

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We are more than halfway through the year and yet many major economic indicators are still showing the economy is not recovering as many would have hoped. The US economy lost 125,000 jobs in June and new home sales recently dropped about 33% (the most in 40 years), with pending home sales falling another 30% as well. Consumer confidence numbers showed that only 3% of people want to buy a car. These numbers are interesting considering previous tax credits targeted both these sectors. So what relief do we have in 2011 coming from the government? Well, arguably just more stimulus spending since tax changes are mostly going to affect the country adversely if Congress fails to do anything. Congress may still act as raising taxes in a bad economy is never a good idea. The media can spin it as “not letting Bush’s tax cuts be extended,” but in essence not extending tax cuts is synonymous with raising taxes. Recently, House Democratic Leader Steny Hoyer stated that Congress will push to extend tax cuts for the middle class with less emphasis on the upper brackets.

Assuming Congress doesn’t act, starting January 1st 2011, Bush’s tax cuts are set to expire bringing higher income tax rates, estate tax rates, dividend tax rates, and capital gains rates for many Americans. Not only are personal taxes expected to rise for the top brackets with the Bush tax cuts but we also see new taxes being drawn up by many state and local governments (like the soda tax and cigarette tax in New York).

So What Can You Do?

1) Relocate to a More Economic State In Terms of Personal Taxes and Business Taxes

It is not a shocker that the population of the nine states with no income taxes have strong growth when compared to the states with the highest income taxes. In case you’re in the mood to move to lower your personal taxes, these states have no state income tax:

  • Alaska
  • Florida
  • Nevada
  • South Dakota
  • Texas
  • Washington
  • Wyoming
  • New Hampshire and Tennessee (tax their residents on income earned through interest and dividends only)

If you want to cushion yourself from the blow of increased personal taxes moving to Alaska or Texas may be in the cards. One can argue that for Lebron James taxes played a factor in his decision to go to Miami over New York. However, tax savings are not only realized by millionaires. Some moves for the average job can be very easy as well. For example, a border state move from Georgia to Florida could save you up to 6% per year in state income taxes. Moreover, it is a good idea to consider those states that are also business friendly as over time more and more companies will see greener pastures. NY, NJ, VM, CA, MN, RI, IA, WI, OH, and MD tend to be the least business friendly according to the Tax Foundation’s State Business Tax Climate Index for 2010.

2) Relocate to a City With Low Property and City Tax Rates

Sometimes this is more realistic to move to a city that has lower property taxes then to move to another state with low income tax rates. Maybe you have a good job, maybe you like being close to your family and friends. In either case, many cities often attract new residents by the simple fact that they have low property taxes. For example, a person who owns a home in Stamford, CT can move to Greenwich, CT and save thousands in property taxes without compromising on other factors.

3) Vote for Politicians Pushing for Lower Taxes and Lower Spending

If taxes are very important to you, then consider those senators, congressman, or local politicians that want to lower your tax burden. It can be argued that increases in government revenues up to a certain point have a limited effect on government services. For example, since the mid 1980s, the Department of Education’s budget has increased 138 percent (adjusted for inflation) while reading scores and graduation rates have stayed relatively flat according to the Heritage Foundation. You be the judge.

4) Consider Not Getting Married

This sounds horrible, but from a tax standpoint it makes sense if Congress fails to act this year. One thing the Bush tax cuts sought to eliminate was the “marriage penalty.” The “marriage penalty” alluded to the fact that married couples are in a higher tax bracket than if they stayed unmarried living together. Even in Obama’s budget (if approved) married couples would pay more because of narrower tax brackets. This is because the standard deduction is not doubled for married couples and married couples would be in a higher tax bracket combined than if filing individually.

5) Convert a 401k or a Traditional IRA to Roth This Year

The tax laws this year allow taxpayers to convert a Traditional IRA or 401k to a Roth IRA without having to consider income limit conversion rules. Normally, there is a $100,000 adjusted gross income conversion restriction, but this no longer exists for 2010. Why is this important? Well, if taxes are going up in 2011, then the year to convert a Roth IRA is this year because you will end up paying less taxes than if you convert in 2011. High wage earners can take advantage of this opportunity now to convert money into a Roth IRA so that their retirement nest egg can grow tax free.

6) Consider Stocking Up On Over the Counter Medical Prescriptions If Applicable

The ability of families to purchase over the counter drugs will be greatly reduced or should we say greatly taxed. Money available through the health savings account (HAS), flexible spending account (FSA) and the health reimbursement account (HRA) will no longer be available to purchase over the counter medications (except for insulin) without a prescription. Over the counter medications such as simple Advil, Tylenol, Excedrin or even things like Pedialyte and prenatal vitamins if purchased through one of these accounts, could be subject to an additional 40% tax as these accounts will only be eligible to be used with prescribed medications. Be sure to check the shelf life of your medications if you stocking up.

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{ 4 comments… read them below or add one }

kt- lifedividend July 20, 2010 at 1:23 am

it would be terrible for people to put off marriage so that they save up on taxes. I hope when it is time for me to do so, i wont have to consider not getting married so as to save more money. The way this debt based economy is set up higher taxation and inflation is something that will always going to be with us. it was the way it was designed

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gail July 18, 2010 at 10:23 am

3 other options to avoid higher taxes;

1. Front-loading income in 2010 in anticipation of higher rates next year. This way you will have less taxable income for next year

2. Move to another country – Asian and Middle Eastern countries have taxes below 20% and you can hire all the domestic help you need.

3. Vote Republican

Reply

alex finkelstein July 18, 2010 at 8:47 pm

Poor suggestions. Not up to your usual fair prognosis of things.

Reply

andys2i July 19, 2010 at 8:35 pm

Sorry that you feel that way, Alex. I thought it had some decent suggestions – off course not all are practical for everyone.

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