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What You Should Be Doing for Taxes Before Year-End


     By Fulcrum Inquiry Damages, Appraisal, Accounting & Economics Expert Witnesses

PhoneCall David Nolte at (213) 787-4100


Expert Witness: Fulcrum Inquiry
Less than a month remains for planning transactions that will reduce your overall taxes. This year is considerably more complicated (yet important) because of expected changes under the Obama administration and the Democratic-controlled Congress. This article focuses on higher-income earners.
Only a month remains before 2008 tax planning will be behind us, and we will be stuck with the tax impact of our 2008 transactions. Tax planning is important in the current year to a greater extent than in any recent year.

The incoming Obama administration and a Democratic-controlled Congress will almost certainly change taxes for the “rich” (i.e., married couples with incomes over $250,000, and singles with income over $200,000, to whom this article is directed). Obama will be pressured to meet campaign promises for lower taxes for certain taxpayers, and will justify this occurring rapidly as a means of economic stimulus. Because of an enormous deficit which would otherwise be made even larger by tax cuts for certain taxpayers, the budget impact will be offset by a tax increase for the “rich”. As part of a tax decrease for some, the new administration is unlikely to be terribly concerned about the economic concerns that might otherwise discourage new taxes, particularly since income and wealth redistribution was an explicit provision of Obama’s tax strategy.

We anticipate that a tax rate increase in 2009 is a near certainty AND will happen quickly – probably with a retroactive date of January 1, 2009. Those commentators claiming the current worldwide recession will prevent a major tax increase are incorrect. Three of the five major tax increases that occurred over the past thirty years occurred during a recession.

Income taxes

Taxpayers in the highest two existing tax brackets are likely to see rates returning to what existed during the Clinton administration. This means the 33 percent bracket will increase to 36 percent and the current top bracket of 35% will increase to 39.6 percent. Obama also proposed restoring or increasing phase-outs of personal exemptions and deductions based on income levels, which will magnify the rate increases described in the preceding sentence.

Obama has been vague about payroll taxes, but some increases are likely. Obama has said that payroll taxes on wages above $200,000 should be increased from two to four percent. If combined with an elimination of maximum amounts or caps of the existing taxes, the additional payroll taxes could be substantial portion of the overall tax increase.

Long-term capital gains, which are currently taxed at 15%, will face new rates of at least 20%, and perhaps higher.

Here are actions that you should consider:

1. 2008 is the exception to the rule that one should defer income and accelerate deductions. Although paying taxes later remains worthwhile, the likely tax rate increase means that one is better off being taxed on income in 2008 than in 2009.

2. For those who still have unrealized capital gains, consider whether your holding period for those underlying investments will be sufficiently short to warrant selling the securities now to be taxed on longer-term capital gains rates that currently exist. Our capital gains investment calculator will perform the math for you.

3. Based on Obama’s comments, dividends will likely continue to get the same favorable tax treatment as investment capital gains, although the tax rates for both will likely increase. For this reason, investors desiring dividend-paying stocks need not change an investment approach which focuses on dividends. (This is area more uncertain because this favorable tax treatment was part of the Bush tax decreases, which Obama has said should be eliminated for the highest income taxpayers.)

4. Because of increased income tax rates, this is the year to make your 401(k) or other retirement contribution on an after-tax, or Roth basis. Roth plans are the clear winners if tax rates are higher when the money is withdrawn than when the investment is first made.

5. Because of investor losses in 401(k) plans, proposals have been aired to rethink entirely these retirement plans. Although these dramatic changes are not likely, the need for additional tax revenues may cause 401(k) benefits for upper-income taxpayers to be curtailed more than what occurs under existing law. For this reason, assuming you are making Roth contributions and assuming that you have the financial flexibility to do so, consider maxing out on the 2008 limits, even if this represents more than what you might otherwise do for a single year retirement contribution.

Estate Taxes

The current estate tax is eliminated in 2010 (for only a single year). It is a near certainty that the lack of an estate tax in 2010 will be eliminated. Based on Obama’s statements, most believe that the estate tax exclusion will be made permanent (probably at $3.5 million, which is the 2009 exemption level), and the maximum tax rate will be 45%. However, it would not surprise us if large budget deficits tempt the Democrats to increase estate taxes above these levels.

More important from a planning perspective, some of the current planning tools used for estate shifting could become legislatively prohibited or reduced. Limitations would likely affect minority or factional-interests discounts, and lack-of-marketability discounts. Both of these are currently respected (although often litigated at higher discount amounts) under current tax case law.

If estate shifting tools will be limited starting next year, those plans should be implemented now. Although many in the older “giving” generation are less inclined to gift wealth away in uncertain times such as what exists now, a (i) bear market for real estate and other investments, and (ii) a low interest rate environment is exactly the time when gifting programs will have the greatest success and impact. Planners should raise this sensitive topic with their wealthy clients, and suggest that the clients obtain financial advice that will show the older generation what wealth level is realistically required to provide future security. Current use of the existing $1 million ($2 million for a married couple) federal gift tax exemption should be considered before 2008 ends.

The annual gift tax exemption is $12,000 per recipient for 2008 and $13,000 for 2009. Married couples can double these individual amounts. Successive gifts below the annual gift tax exclusion can accumulate to be a substantial amount, particularly when multiple recipients are involved. Those engaging in estate minimization techniques should be sure to use their 2008 exemption, as it otherwise is permanently lost.

Business Taxes

Business taxes were not the focus of the campaign debate, except in a few areas. Because the U.S. already has high corporate taxes relative to many developed countries, overall large corporate tax increases are not as likely to occur. Consequently, business year-end planning ideas are not as clear or necessary as it is for individuals.

Tax changes will occur in certain focused areas. Here is our best guess:

1. There will likely be a windfall profits tax on oil companies.

2. Based on the notion that multinational corporations should be discouraged from shifting jobs overseas, the current tax deferral involving not taxing foreign earnings until they are repatriated could be eliminated or reduced. Never mind that this change will do nothing to stop jobs from going to lower-priced foreign labor. This additional tax sounds good in publicity sound bites, will affect larger corporations that are not popular with voters, and will help pay for the tax cuts that lower-income voters will receive.


Of course, this article’s predictions are not certain. Interpreting what the Obama administration might accomplish is subject to (i) contradictory comments from the President-elect while he was campaigning, and statements made by his various advisors, (ii) the ever-changing economic picture, and (iii) the negotiations that are part of any political process. Nevertheless, doing nothing and making no predictions will almost certainly mean that you will pay higher taxes than what would otherwise have been possible.


Fulcrum Inquiry performs business appraisals, economic analysis, and forensic accounting.

ABOUT THE AUTHOR: David Nolte
Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials, CPA, MBA, CMA and ASA.

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While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.
For specific technical or legal advice on the information provided and related topics, please contact the author.

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