How to Prepare for Higher Taxes

No one knows which taxes are going up and by how much. But there are ways to cushion yourself

By Ben Steverman

Financial advisers for wealthy Americans assume that their clients' tax bills are going up. But that's about all they know for sure.

President Barack Obama campaigned on proposals to raise taxes—on income, capital gains, and dividends—on Americans who earn more than $250,000 per year. And in the year since he formulated that platform, the federal government's fiscal situation has gotten more dire, as a result of the recession, stimulus spending, and preexisting debt. On Aug. 25, the Congressional Budget Office raised its estimate of the total deficit from 2010-19 by $2.7 trillion, bringing it to $7.137 trillion. The White House's estimate for the deficit over the next 10 years is $9 trillion.

Eventually, tax experts say, the government will need to fill those deficits with extra revenue. "Don't expect any good news on the tax front," says Marilyn Cohen, president of Envision Capital Management. "We've got a multitrillion-dollar bill to pay, and it's not going to pay itself."
Five Rules to Follow

But so far the details of those tax increases—which taxes, when, and how much—are highly uncertain. President Obama has proposals, while Democrats and Republicans in Congress have a myriad of other proposals. Even if Congress does nothing, many provisions of President Bush's tax cuts are set to expire in 2011.

"Until they get through Congress, there's no way of knowing what will really happen," says Tim Steffen, a financial planner and tax expert at Robert W. Baird.

At a time of such uncertainty, BusinessWeek asked tax experts and financial planners what individuals can do if they're worried about a higher tax burden. Here are five common themes:
1. Stay Flexible

"You plan with the tax laws as they are, recognizing that they can change at any time," says Matt Havens, a planner at Global Vision Advisors. Congress may come up with creative ways to boost revenue, he says—not just by raising rates but by limiting deductions or closing tax shelters.

For this reason, individuals trying to limit their tax bill should remain flexible. "Don't get yourself into a situation where you've locked yourself into something," Steffen says. "You need to be able to react to any changes that come."
2. Pay More in 2010?

Federal tax rates haven't increased in 2009, and many expect most tax rules to stay the same in 2010. However, says tax attorney Scott Estill, "In 2011, all bets are off."

The potential for tax increases in 2011 makes 2010 a "key year," says Estill, author of the book Tax This! An Insider's Guide to Standing Up to the IRS.

With taxes on income, capital gains, and dividends now at historical lows, the next 15 months may be the best time to be paying taxes—before rates are raised.

Of course, few employers are going to pay you in 2010 for work you've promised to do in 2011. But Holly Isdale, managing director at Bessemer Trust, says that if you are already planning on selling a business, it might make sense to get it sold before the end of 2010. You would probably pay a smaller capital-gains rate on that sale, she says.

The same is true for capital gains on stocks or real estate—assuming you have any gains after the brutal housing and equity markets of the past couple of years.

For workers who are expecting a lump sum at retirement, a 2010 retirement might make sense for the same reason, Steffen says. Stock options might also best be exercised before taxes go up.

Also, Estill says, next year might be the perfect time to convert traditional individual retirement accounts, or IRAs, into Roth IRAs. In 2010, income caps will be dropped on Roth conversions, which require tax payments.

Related Posts by Categories :