Jim’s Big Picture: Taxmageddon (Part 2)–How It Will Impact You Personally

JOHN:  All right.  Enough Already.  We've heard from our listeners.  Last week we did a series called Taxmageddon: How the Coming Tax Increases Will Impact the Economy, and a lot of listeners had emailed us and said, Yaeh, okay, that’s good, but what does that mean to me?  How is that going to impact us personally?  And that’s a really valid question, so enough of the emails.  We’re going to give you the answers to that:  How these tax increases will personally impact you, not just corporations or the creation of jobs or things like that related to the economy. 

So what we need to do, Jim, we don’t know how many people heard last week’s show.  Let’s do a quick review of the four major waves of taxes that are going to hit us starting in 2013.  And we should point this out as we start into this that, you know, as of January 1^st it’s not like your feet are going to be cast into concrete and you’re going to get kicked into the river.  Where this will really become obvious is on April 15^th of 2014 when the cumulative effect of these taxes all comes home to roost.  But let’s go through the four waves and we’ll go from there.  [1:43]

JIM:  All right.  Wave one is as we talked about last week is simply the expiration of the Bush 2001 and 2000 tax relief bills.  And very simply, the 10 percent rises to 15; the 25 percent bracket goes to 28; the 28 goes to 31; the 33 goes to 36; and the 35 percent bracket rises to 39.6.  The marriage tax penalty comes back, and the estate taxes come back.  The estate tax rates goes from 35 to 55 percent and the exemption drops from 5 million to 1 million.

And then the second wave we talked about were the Obama tax hikes and that is the capital gains rate will go from 15 percent to 23.8; taxes on dividends will go from 15 percent to 43.4; on top of that, you’re going to have the special needs tax go away.  There will be an increase in the Medicare payroll tax from 2.9 percent to 3.8 percent.  There will be an excise tax at 2.3 percent on medical devices and your itemized deductions for medical expenses are going to be limited.  Right now, you can deduct anything over 7 ½ percent of your adjusted gross income; the figure rises to 10 percent. 

And then the third wave of taxes that go into effect will be the alternative minimum tax, which will probably impact about 31 million families.

And Wave Four which we talked about -- we didn’t go through all of them -- it’s a 46 page document from the Joint Committee of Taxation and it’s expiring tax benefits to businesses.  In 2012, there’s five pages of tax deductions that will go away for businesses, and there’s about another four or five pages in 2013, and it goes all the way to 2014. 

But those are the four major waves of tax increases that are going to hit us beginning January 1^st of next year.  And like you said, John, most people won’t even notice this because the media won’t point it out until they file their tax return in April of 2014.  It reminds me of -- John, you remember this.  When Bill Clinton raised tax rates from 31 percent to 39.6, he gave us like four additional tax brackets.  He raised the tax on Social Security from 50 percent to 85 percent inclusion.  People didn’t understand this until they filed their ’93 tax returns in April of ’94 and that’s why the Democrats lost control over Congress:  people were so ticked so off.

This thing is so massive, but as you just mentioned for the most part, if it does go into effect January 1^st, most people won’t even notice it until they have to come up with a large tax bill come April 2014.  [4:48]

JOHN:  They will notice withholding issues early on, won’t they?  That will be one of the first bumps; correct?

JIM:  Yeah.  Because right now -- and I’m going to get into this, right now the Social Security tax rate has been reduced from 6.2 to 4.2, two full percentage points.  That is the first thing that they will notice January 1^st is that their Social Security taxes will go up and they will feel that immediately.  But that’s the first one.  I forgot to mention that in the tax wave.  That’s also -- the payroll reduction tax goes away.   That’s probably the only thing that they will feel, let’s say in the first part of the year.  [5:28]

JOHN:  Okay.  Now, what we've done here so we can answer listener requests here, we've put together four examples, which are really working out to eight but we do it for both the single individual and then for a married couple.  We’ve taken people with an income of 50,000 100,000  250,000, and 500,000 per year.  You gave that to your tax firm, I believe, and said, Here, work this out.  In other words, if these people have this income, we pick what would be a moderate income tax return in these brackets to show what’s going to happen.  [5:58]

JIM:  Yeah.  And when I was talking to our accounting firm, I said, based on experience, what are the kind of deductions you see, what do tax returns look like for somebody making 50,000 and 100,000? And the general response is, you know, if you’re a 100,000 or under, unless you’re retired, you’re really unlikely to have a lot of investment income.  It’s not until you get retired that you start drawing on your investments.  But it’s usually in the higher tax brackets that you start seeing things like capital gains, interest, dividends, et cetera.  So let’s take a look at this.

And here’s the thing that is going to be amazing.  Okay.  So if you are single and you make $50,000 a year, your total tax bill is 7,962.  Now that includes a regular tax of 6,093 and we’re also -- we did this in the State of California, so bear with us if you live in other parts of the country.  Obviously, the state tax here would be 1869, the federal tax was 6,093.  So the total of federal and state is 7,962.  That would be a 25 percent marginal tax bracket, meaning anything over 50,000 you would pay 25 percent on every dollar. 

For a $100,000 single individual, the taxes are 25,226.  Now, that is this year.  We’ll get to next year.  And that consists of 18,731 and 6,495. 

Now, here’s where it starts to get interesting.  And remember, John, we said the third wave of taxes is that alternative minimum tax, in which case we took a single individual making 200,000 and had maybe capital gains, interest and dividends.  In this scenario, the taxes go to 80,547 on a single individual making 250,000.  Here’s what’s interesting.  This individual gets hit with 5,189 of AMT tax.  And that’s when we explained this alternative minimum tax.  So the rate goes to 28 percent because obviously somebody making 250,000 is going to have higher itemized deductions; let’s say the deduction for state taxes in California was -- of that 80,000, 20,547 was California taxes and you get to deduct that on your federal tax return.  The problem is if you have too many deductions for state taxes, let’s say interest on your mortgage, charitable contributions, if you have too many of those, then the government comes back and hits you with the AMT tax.  And this is not talking about next year.  Wait till you see when we get to next year; you’re going to be shocked. 

Okay.  Now let’s take the next case.  It’s a single individual making half a million dollars a year.  The total tax would be 182,146, which would consist of roughly about 138,000 in federal taxes and about 44,000 in state income taxes, and the tax bracket would be 35 percent federal.  [9:27]

JOHN:  Okay, Jim.  As we go through this it’s really -- I know you’re going to write an article on this which we’ll post on our website.  So that’s good.  What we need to do is compare this, say for example, what everybody is paying now.  And it’s bad enough now that we’re an overtaxed society right now.  But it’s bad enough now, but what will it go to for every one of these categories.  And like we've said where there are really eight categories: four examples of single versus a married couple.  [9:51]

JIM:  All right.   Let’s bring this down to a bottom line number.  If you make $50,000 beginning next year, your taxes are going to go up roughly by $1600 or roughly $132 a month.  So if you make $50,000 a year, your taxes go up $132 a month or 1600 next year.  If you’re a single individual making 100,000, your taxes next year go up by $4100; roughly about $350 a month.  If you are single, making 250,000 you get walloped.  Your taxes next year are going to go up by 17,150 roughly; translated on a monthly basis your taxes go up about $1500 a month. 

And if you are fortunate enough to make 500,000, your taxes are going to go up to about $39,000.  You will be paying $3200 more a month in federal taxes.  [10:59]

JOHN:  That’s astounding.  That’s an incredible number.  Okay.  Now, those are the single people.  Now the married people.

JIM:  All right.  Let’s break this down into married couple.  Married couple making 50,000; your taxes next year are going to go from 4,359 this year to 6,529 next year.  Bottom line, your taxes are going to go up about $2200 a year or roughly 180 bucks a month.  If you are married making 100,000, your tax bill goes from 18,000 to over 21,000; an increase of over $3100 a year or roughly $260 a month.  If you are a married couple making 250, your taxes go from roughly about $72,000 to $82,540; that’s an increase of $10,500 a year or roughly $875 a month.  If you are married making 500,000, your tax bill goes from 170,000 to roughly 206,000; you have roughly a $35,000 increase in your taxes, that averages out to around $2900 a month.   So there you go, John.  From a single individual to married couples, everybody in this country is going to see, if you’re a taxpayer, you’re going to see your taxes go up.  [12:36]

JOHN:  Okay.  Well, most people aren’t going to see these numbers, as we've said, until the 2013 return is filed in April -- or by April of 2014.  The one thing they will see starting January 1 of 2013 is the change in the payroll taxes.  The one I’m really interested in is the small business because they pay double:  they pay their share and they pay the employer’s share.  So self-employed people are taxed twice compared to what the W-2 wage earner is taxed.  [13:09]

JIM:  Well, let’s talk about the payroll tax.  The regular payroll tax is 7.65 percent and it is assessed against the first $110,100 in income.  Each year they increase the base on which Social Security tax is assessed and it’s at a special inflation rate that is different than the inflation rate that we increase Social Security.  It’s a higher inflation rate.  It just increased from the year before; it was 106,000, now it’s 110,000.  So on the first 110,100, you would normally pay 7.65 percent against that.  Let’s say you’re fortunate and you make 110,000, you would pay $8,422.65.  That doesn't count your regular federal income tax, that’s just your payroll tax. 

Now, what happened in 2010 when the Republicans took control of the House, there was a compromise reached with the president.  And of that 7.65 percent payroll tax, 6.2 percent of it goes for Social Security and 1.45 goes to pay Medicare taxes.  So the combination of the two adds up to 7.65.  Now what they did in 2010 which went into effect in 2011, it was extended into this year, is they reduced the Social Security tax from 6.2 to 4.2.  So what happened is, you know, that was a 2 percent reduction. 

So for most individuals like if you’re fortunate enough to make 110,000, that saved you a couple of grand.  And when I had our accountant look at this, on a $50,000 a year single individual it’s going to cost you a $1000 more in payroll withholding; if you make 100,000, it’s going to cost you $2,000; if you make 250, it’s going to cost you roughly about almost 3900 because after 110,000 you also pay an additional Medicare tax of 1.45 or 2.9 if you’re self-employed. 

And right now if you’re self-employed, instead of paying 15.3 -- which is 7.65 on the employee side and then the employer kicks in the other 7.65 -- currently, John, it’s 10.4.  And that will go back up to 15.3 if you’re self-employed, so you’ll be paying roughly an additional 5 percent tax.  And that’s why they’re calling this Taxmageddon. 

In addition to that, next year, if you make a certain level, if you make 250 -- well, if you make over 110,000 you pay 1.45 percent tax on Medicare tax on anything over the Social Security limit; that’s in addition to your regular federal income tax.  Next year that goes to 3.8 percent, divide that by 2 if you are an employee and you’re roughly going to go from 1.45 to 1.9 percent on anything over 110,000.  So that’s probably the single biggest tax that’s going to affect most Americans in real time will be the payroll tax because the federal taxes which we just talked about most Americans won’t even realize that their taxes went up that much until they have to come up with a whopping tax bill when they file their 2013 income taxes, which will be 2014.  [17:04]

JOHN:  You can see real easily here how this is going to especially hurt self-employed business people and remember, these are the people that hire the bulk of the workers in the country -- over 90 percent small business.   And I realize some are incorporated as C-corps or personal corps or S-corps or whatever.  All of that aside, the one that we need to focus on is the alternative minimum tax called the AMT because it was originally put in place as a way of -- I don’t want to use the word “trap” -- capturing tax from people who made a lot of money, but had ways of structuring their income in such a way as to legally avoid the bulk of taxes; they wanted to make sure that these people pay.  But what’s been happening is as inflation has pushed things up and up, it’s actually taking people in the middle class and putting them right up into the AMT.  How are they going to be affected by this?  Let’s focus on that. [17:54]

JIM:  Let’s put it this way:  right now, this year, the AMT doesn't really impact most single individuals and married couples.  For single individuals it really doesn't impact you unless you make over $100,000 a year; if you’re a married couple, it probably doesn't impact you unless you make over $150,000 a year.  And the illustration that we gave for a single individual this year, you will be hit with roughly about $8,600 in AMT tax if you make $250,000 a year.  If you are a married couple making $250,000, you will probably be hit with about $5,200 of AMT tax. 

Now, I don’t know if this is good news or not, but next year because the tax rates go up so much across the brackets and we lose all the lower brackets; we lose the 10% brackets.  All the brackets go up by 3 percentage points.  The lower bracket goes up by 50 percent from 10 to 15, and then all other brackets go up by 3 percentage points.  The taxes go up so much that a lot of Americans will not be hit with the AMT until they make probably between 250 and 500.  In other words, it goes away.  Unfortunately, it’s because the regular income taxes go up to such a high level that people are actually paying more regular income tax, so there will be less instances of the AMT. 

And there will probably be more income tax paid than AMT also because remember, next year it will be harder to deduct expenses for serious medical illness because you won’t be able to deduct your medical expenses unless they exceed 10 percent of your adjusted gross income versus this year it’s 7 ½.  So I don’t know if it’s good news, John.  Let’s put it this way, everybody’s taxes are going to be going up across the board.  [20:05]

JOHN:  We need to drag it over to something we discussed a couple of weeks ago here.  If we summarize this whole thing up as to where we stand as far as individuals, every American paying tax -- remember, only, what, about 40 to 50 percent of the country pays the tax?  The rest of the country gets a ride -- 31 million people will be subjected to the AMT if you’re over 100,000 adjusted gross income single, or 150,000 as a married couple.  This is the rough part here.  The people who live off investments are going to go really get clobbered because the capital gains jumps from 15 to 25 percent and dividends from 15 to 43 percent.  It’s like taking half of what you make in dividends.  And you’re also going to begin paying 3.8 percent on annuities, interest and rentals.  Now, that’s where the individual’s going to see it.  Again, not till 2014, other than the payroll tax which kicks in right at the beginning of 2013. 

We need to put this into an economic perspective because as you said, number one, the economy is starting to roll over.  We pointed that out last week.  Unemployment is back up.  And small businesses are really going to get clobbered and they’re the ones who aren’t hiring because they’re jittery right now. 

So what is this going to do to the economy? [21:20]

JIM:  Well, let’s just take two organizations: the Congressional Budget Office and the Federal Reserve.  What they’re predicting is we're probably going to go into a recession by the end of the year or the beginning of next year.  They’re predicting -- the Fed in its FOMC meeting is predicting that unemployment is likely to go up and the economy is decelerating.  We’ll get into that in the next topic.  And GDP is about ready to take a 5 percent hit.  And John, I think that’s optimistic.  I think that’s assuming static accounting.   And the unfortunate thing is this can be prevented.  Unfortunately, we're seeing no leadership out of the White House and you know, what the president needs to do, if I was on -- we talked about this last week, if I was on his advisory team, I’d say forget the Hollywood producers making this illusion or your Chicago politicians, get some people from the private sector on your staff:  economists, people who know how the economy works because otherwise --

I mean we just got the ECRI weekly index.  Its annual growth rate is now a negative 3 ½ percent.  Remember, at the beginning of April we were in positive territory; we've gone from a positive 2 percent to a negative 3 ½;.  The weekly index dropped again.  It dropped from 121.8 to 121.3.  And remember, it was at 125 at the beginning of May.  So we’ve lost 4 percentage points and it’s very clear that the index peaked in the last week or the first week of April.  It has now been heading down; it leveled off for about three weeks and now has begun to decelerate rapidly and it was one of the things mentioned in the FOMC minutes accompanying the meeting and also in Bernanke’s press conference and we’ll get to that in the meantime.  [23:17]

JOHN:  Well, I guess speaking of “meantime”, what happens in the meantime anyway?

JIM:  What we're starting to see, John, and I think why we're seeing the LEIs begin to roll over is businesses are pulling back because there is just way too much uncertainty out there.  In fact, there was an article by Rich Miller in Bloomberg this week and also another article in the Economist.  And basically -- I’m just going to kind of summarize what they’re saying here.  Companies are starting to delay hiring -- and this is a quote from the CEO of the Eaton Corporation.  He said, The best strategy for companies to follow when confronted with such uncertainty ahead of December 31^st is to stay lean and keep your inventories taut.  And a lot of economists are saying the same thing.  And the CEO of Eaton said, he goes, Look, the time to board up the windows isn't when the hurricane is arriving.  You board up the windows in anticipation of the hurricane.  And that’s exactly what businesses are doing. 

And there are many economists saying that if we do nothing -- in other words, because of some political impasse, the president shows no leadership, they can’t compromise, then we're probably headed for a recession that will probably start in the latter part of the year.  And the unfortunate thing as a lot of people have talked about is you know, trying to pull a Hail Mary from after the election, let’s say in the final four, five weeks of the year.  You know, businesses aren’t going to sit there and say, Wait a minute, we're going to wait until the hurricane arrives and then we’re going to start boarding up the windows.  They’re boarding up the windows now.  And that’s why manufacturers are seeing this. 

In the Bloomberg story they talked about the defense industry is going to get hit particularly hard and this is an industry that employs 350,000 jobs.  In fact, the prospects of the sequestering that could go into effect in January has been chilling.  And you’re already starting to hear pronouncements coming out from defense contractors like Northrop Grumman, Lockheed Martin -- Lockheed Martin has already stopped hiring and training; same thing with Northrop Grumman.  The Bloomberg article talked about a defense contractor called RTI International Metals and they began building a plant in Virginia. In 2007 the idea was they were going to hire 200 workers and they basically brought it to a standstill; they’ve only hired 50 people and they’re only operating partially in terms of where they want to be because they don’t know know what’s going to happen. 

And the Bloomberg article goes on to say that if Congress does nothing -- and this is a direct quote from the article -- if Congress does nothing, 82.9 percent of US households would face tax increases averaging $3700 according to the Tax Policy Center, a non-partisan research group in Washington.  More than 98 percent of households earning more than $50,000 a year would pay higher taxes.  And this figure, John, lines up with the figures that we had our accounting firm prepare.  So this is not going to be good.   Like I said, businesses, they’re already starting to take evasive action. 

In addition to that there was a poll that went out to businesses and they were asking the CEOs:  are you guys not hiring?  Postponing hiring?  Cutting your inventories?  Is it because you’re worried about let’s say Europe, the European crisis?  And what they actually said -- and this is a quote -- what they said to us actually in the last couple of months is we are slowing hiring because the fiscal cliff -- and that’s really their reasoning more than the European uncertainty -- it’s more that Washington isn't doing anything about the tax increases that are scheduled to come on board at the beginning of next year.  The impasse over the budget is taking a toll on the economy; it’s going to reduce growth and it’s going to raise the unemployment rate.  Plain and simple, John.  I’ve seen this come out in stories in the Wall Street Journal, I’ve seen it in Bloomberg, I’ve seen it in the Economist.  This is what we're going to do and that’s what businesses are saying:  We can’t figure this out; we don’t know what is going on.  And that is what is going to happen.  [27:53]

JOHN:  So the bottom line is the average American is going to see both federal and Social Security taxes combined go up about $3700 per year; that runs about 300 a month.  And of course, it gets worse as your income goes up from 50,000 towards 500,000 in terms of the total amount that you pay.  So this is not going to be good for individuals or the economy as a whole.  The real question is whether or not the Congress -- either the president and his administration or the Congress -- will catch onto that before the end of this year and do some heavy revising.  Although on the course we're on right now, Jim, that doesn't seem to be the case but we have some time left to go.  The next question will be what this will do because remember, 2014 is also an election year, what that would do to the elections in November of 2014 say all of these taxes stay in place.  And that remains to be seen.  [28:45]