Tax Planning Letter to All Clients – Part 1

Published: February 13th, 2009

Many of us are wondering what the new administration will mean for investors so we thought we would help summarize a few key issues. We are no doubt in a very complex legislative environment. The U.S. budget deficit in 2009 could surpass one trillion dollars.

As we went to the drawing board to prepare our comments, it was just announced that House Speaker Nancy Pelosi is considering a two-staged effort to boost the shaky U.S. economy. She is arguing for immediate action on a $60 billion to $100 billion stimulus package, followed early next year by a companion measure that would include a “permanent tax cut.” We have heard many rumors regarding this stimulus package and this will inevitably be one of the top priorities on the new administration’s agenda. This issue will be addressed in a session by Congress scheduled to meet sometime next week.

The incoming Obama administration is likely to act quickly to kill the Bush tax cuts for households with incomes over $250,000 a year, and they may move to make any new tax law retroactive to Jan. 1, 2009, according to Ken Kies, managing director of the Washington-based Federal Policy Group tax consulting division of Clark & Wamberg LLC of North Barrington, Ill.

There is rumor of an increase in capital gains tax. In order to avoid a disruption in the market and minimize sell off, Congress might signal this to be retroactive to the date of their announcement. The current rate is 15%, and that could rise as high as 20% to 25%.

It’s highly probable that Obama will choose to do the whole tax bill in the first year of his administration getting the most significant piece of legislation through what is typically called the honeymoon period. Part of the tax bill will address the estate tax rate that will reset to zero in 2010 and that will most likely be dealt with in 2009. According to Mr. Kies, mentioned above, they are unlikely to let that remain in effect.

Jamie Delaplane, a partner with Washington law firm Davis & Harman LLP, feels there will be less repercussion for investors than people think. “We are looking at an environment mostly for upper income taxpayers affected by higher rates for capital gains and dividends. Tax preferred vehicles such as 529 plans, Roth IRAs, and municipal bonds become more attractive as cap gains and income tax rates go up”. Furthermore, Mr. Delaplane feels that due to the necessity of responding to the 700 billion rescue plan, tax policy issues have now become a much higher priority. Health reform may not be as high a priority as it once was and an overhaul of the Financial Services regulatory will be in the forefront of issues.

Other issues to be addressed in the congressional session scheduled in November may include offering taxpayers relief from AMT rules and discussing the rules of Required Minimum Distributions forcing seniors to take distributions out of IRAs. There will be an argument for a suspension or waiver of the distributions possibly in 2008 and in 2009. This measure is heavily supported by the AARP. Taken directly from the AARP website: “In a letter sent to Treasury Secretary Henry Paulson on Wednesday, Oct. 29, AARP CEO Bill Novelli urged him to issue an immediate, temporary freeze on the required distributions”. Many investors have already taken their distributions or need the distributions to supplement current income. In these situations, there may be a proposal to exempt those distributions from taxation as well as providing relief from penalties on early withdrawal penalty taxes. Obama has proposed a new opportunity to receive up to $10,000 from IRAs and not have it subject to a 10% penalty. This should provide some relief directly to families.

The new administration appears to be saying the right things about cooperating during this transition period with the current administration. All of these new proposals will take time and require much thought. Obviously, Nancy Pelosi wants to get the stimulus plan together this year but the politics are indeed complicated. With the state of the economy, there is an overwhelming feeling of pressure to act and many feel it is wise to get stimulus measures negotiated this year.

Overall, economic advisors are hopeful to get something enacted by December. The lead time to benefit the economy is at least a couple of months. Obama is expected to encourage Congress to work out a plan with the Bush administration.

In addition to the issues summarized above, listed below are bulleted tax proposals directly from Obama’s administration:

• Permanently extend the child credit increase, 10, 15, 25 and 28-percent income tax brackets, and lower capital gains tax rate for taxpayers in those four brackets as well as changes to tax implications of marriage.
• Restore the top rates of 36 and 39.6 percent for high-income taxpayers in 2009.
• Increase maximum capital gains rate to 20 percent for those earning more than $200,000 ($250,000 for married couples).
• Eliminate income tax for senior citizens (over age 65) with earnings of less than $50,000 (an amount not indexed for inflation).
• Make Child and Dependent Care Tax Credit refundable and equal to 50 percent of child care expense less than $6,000
• Rename the Hope Credit to the “American Opportunity Tax Credit” and expand it to a refundable credit of 100% of the first $4,000 of college expenses.
• Refundable “Universal Mortgage Credit” of 10 percent of mortgage interest to nonitemizers, up to a maximum of $800, indexed for inflation.
• Alternative Minimum Tax will extend and index 2007 AMT patch.
• Make permanent estate tax with $3.5 million exemption and 45 percent rate
• Refundable “Making Work Pay Credit” of 6.2 percent of earnings up to $8,100 per worker or a maximum credit of $500. The credit begins to phase out at AGI of $75,000 and is indexed for inflation.
• Make Saver’s Credit refundable and change to a 50 percent of qualified retirement contributions up to $500 for individuals ($1,000 for couples) and would be phased out at AGI of $32,500 for individuals ($65,000 for couples).
• Mandate automatic 401(k)s and automatic IRAs
• Impose additional tax of 2-4 percent (combined employer and employee) on workers with income above $200,000 ($250,000 for married couples)
• Income-related federal tax subsidies for health insurance purchases through new health insurance exchange.
• Require employers to provide insurance or pay a percentage of payroll to support the national plan.
• Make Research and Development and renewable energy production tax credit (wind, solar) permanent
• Eliminate oil and gas loopholes
• Impose a windfall profits tax on oil and gas companies
• Close loopholes in the corporate tax deductibility of CEO pay

Finally, keep in mind that these are just proposals at this time. We hope this lends clarity to what this election may mean for you as investors and what to look for in the upcoming year. Should any of you have questions or comments, as always, we are just a phone call away.

May this find you all in good health!

Sincerely,

ARISTA WEALTH ADVISORS

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