Tax Changes To Be Aware Of

With all the economic turmoil and distress out there, taxpayers have a few bright spots to look forward to in 2009. However, like much of the tax policy enacted by our elected officials over the past forty years, these changes are small, and in some cases temporary; staying current on what affects you in this ever amassing web of rules is likely to leave you crossing your eyes and dotting your Ts. Cutting through the blur, presented here are a few highlights to be aware of.

For wage earners, the maximum contribution to a 401-K retirement plan rose by $1,000 to $16,500. For those baby boomers fifty years and older, an additional $5,500 can be contributed for a total of $22,000. (We can only guess that congress was discretely told that inflation will erode the value of retirement dollars so the contributed amount should go up.) Remember, each dollar going into a plan is tax deductible, denying the tax collector thirty or forty cents.

Former President Bush signed legislation that allows millions of people who are at least seventy-and-a-half to skip the mandatory IRA distribution, but only for 2009. This is another revenue reduction for the government because these distributions from seniors are taxable. Although the amount a person must take is determined by the retirement fund balance at the end of the previous year, the actual dollars are usually taken out later. So, the government is not requiring older Americans to sell deeply depressed assets to fund these distributions. Of course, retirees this age are not constrained and can take as much in distributions as they desire, but it’s subject to their normal tax rate for that year.

A long running and pivotal controversy is the Federal Estate Tax. This tax was originally levied on the estates of deceased persons as a temporary measure to fund the Spanish-American War. Some quick research shows that that five-month conflict over Cuba has long past, it’s been over for one hundred ten years.

This so-called “death tax” was repealed for a few brief periods in our history but stands in place today. For many years, there was a standard exemption of $600,000 for each person. That meant that only those whose assets were greater than that paid the tax. Thirty years ago when cars cost $3,000 and houses cost $40,000, the designated $600,000 would have excluded most people. Inflation changed all that, but the estate tax exemption stayed the same, subjecting millions of people to the war levy. During the past eight years, the exemption increased first to $1 million, then $2 million, and for 2009 it is $3.5 million. This increase will result in a major decline in the number of estates subject to the tax.

The amount of tax payable starts around thirty percent and tops out at forty-five percent on the remaining amount. The estate tax is supposed to completely disappear in 2010 for only one year. Then it reverts back to an exemption of $1 million with a maximum rate of fifty-five percent. I guess the Congress figured that the Spanish-American war won’t be fought that year. But it makes tax and estate planning for older Americans quite challenging.

The money you make is yours after you pay taxes, right? Well, not exactly. If you want to give money to anyone, it may be subject to the Federal Gift Tax. For many years, there was a gift tax exemption of $10,000 per year. Anybody could give anyone else up to that amount without paying tax on it. Again, there was no provision for inflation until 2001. The exemption amount has grown since then and is now $13,000. You can give more than that by directly paying someone else’s tuition or medical expenses.

Employees and employers will want to take note of the increase in Social Security Tax they will pay in 2009. Each pays 6.2 percent of the wage amount to our trusted government retirement fund for a total of 12.4 percent. While this is the same as last year, the wage amount that you must pay this tax on has increased to $106,800, up $4,800 from last year. Any wages over this amount are not subject to the tax. The increase in the wage cap has averaged 4.1 percent per year versus inflation of 2.8 percent. To wit, in 1993 the wage cap was the first $57,600 of salary. Will this cap increase with the new government in office, hungry for tax revenue? (Of course, this is a rhetorical question.) Looking back at the origins of the social security system, a 1936 government pamphlet said: “And finally, beginning in 1949, twelve years from now, you and your employer will each pay three cents on each dollar you earn, up to $3,000 a year. That is the most you will ever pay.”

So far these are some highlights for the year, but with bailout fever potentially providing cover for big new taxes, the best may be yet to come.

Rick Glaze is the president of Glaze Capital Management of Los Altos, as well as a General Securities Principal offering securities through First Allied Securities, member FINRA/SIPC. His first novel, The Middle Fork, will be published in May.