Sunday, December 12, 2010

How the Tax Deal Could Affect Your Finances

President Obama called the bipartisan tax agreement announced last week a "framework." There's still no comprehensive outline of the proposals. And its passage by Congress isn't assured.

But the deal does address a range of tax issues that have been in question for months or years. Here's how the various provisions could affect taxpayers.

Individual tax rates: The Bush-era tax rates would be extended for two years for all taxpayers. Current rates would remain in place, with a top rate of 35%.

Capital gains:
Current rates would be extended, and the top rate on long-term capital gains would remain at its historic low of 15% for two years.

Dividends: Current rates would be extended, and the top rate for qualified dividends -- those on most stocks held longer than two months -- would remain 15% for two years.

Payroll tax: The agreement calls for a two-percentage-point cut in an employee's portion of payroll (FICA) taxes, just for 2011. The change would make the tax 4.2%, instead of 6.2%, on the first $106,800 of wages per worker, according to the nonpartisan Tax Policy Center.

Alternative minimum tax:
A two-year "patch," for 2010 and 2011, would keep the AMT exemption at or near current levels.

Extenders: The framework doesn't address several popular "extenders" that will expire this year or have already done so, but White House officials said they were included in the agreement for 2010 and 2011. Among them: transfers of IRA assets to charities by those over age 70 1/2; a state and local sales-tax deduction for itemizers; an additional standard deduction for real-estate taxes; and a deduction for teachers' expenses.

Unemployment insurance:
Federal benefits would be extended at their current level for 13 months, through 2011.

Selected tax credits:
The framework proposes to extend the $1,000 child credit and maintains its expanded refundabilty for working families for two years. It also would expand the Earned Income Tax Credit for larger families and married couples, and maintain both the higher-education tax credit and its partial refundabilty for the same period.

-- Laura Saunders
The Wall Street Journal

Spending Payroll Windfall

Working taxpayers will get a little, temporary raise, if the payroll-tax reduction in the tax agreement goes into effect. It isn't life-changing money -- the benefit tops out at $2,100 per year for anyone making $106,800 or more -- but it's enough to have a ripple effect if used wisely.

Legislators, of course, are hoping you'll do what Americans usually do with extra cash: buy things, patriotically heating up the economy. In fact, studies show that structuring a tax cut in precisely this way -- a little bit over a longer period of time, as opposed to a lump sum -- stimulates spending, not saving.

Will many people actually stash the cash? Probably not, says Ross Eisenbrey, vice president at the Economic Policy Institute, a think tank: "Most people are probably going to spend it."

But perhaps you'd do better to set your own agenda. Experts say there are ways to use the cash that will turn that 2% raise into a much bigger windfall. Here are three of them:

Juice retirement savings.
Contribute that extra 2% to a 401(k) or individual retirement account. In this instance, you also would save on taxes since the added contribution to those plans would be pretax. Contributing the money to a Roth IRA would also be a small tax lottery because experts largely expect taxes to rise after 2012 -- making today's after-tax dollars (Roth contributions are made with after-tax dollars) "cheaper" than they will be in the future.

Create a health-care kitty.
The cost of health care is expected to go up next year -- an expense most families haven't yet felt, or budgeted for, but one the payroll-tax cut could well cover.

Employees are projected to pay about 15% more next year for health-insurance deductibles and co-payments, with the average deductible about $675 for a single person and about $1,500 for a family with a preferred-provider insurance plan, according to the Kaiser Family Foundation.

Upgrade your appliances.
As appliances get older, they get more expensive, says Scott Brown, owner of New Hampshire-based appliance-repair company Samurai Repair Man. They break and need repairs, and they get less efficient, which means higher energy bills.

-- AnnaMaria Andriotis

Financial Literacy

Ever wonder how good the fellow residents of your state are at managing household finances? Find out on the website

A small spoiler: New York, New Jersey and New Hampshire were among the top five states in at least three of five measures of financial capability, according to a survey of more than 28,000 people released last week.

Financial capability was measured based on these components: how many households spend more than their income; whether individuals had a "rainy day" fund to cover three months' worth of expenses in case of an emergency; how many individuals used nonbank borrowing methods in the past five years; how high individuals scored on five financial literacy questions; and how well individuals comparison-shopped, obtained credit reports and checked credit scores, and understood financial contracts.

The survey was funded by the FINRA Investor Education Program Foundation in consultation with the Treasury Department and the President's Advisory Council on Financial Literacy.

-- Maya Jackson Randall
Dow Jones Newswires

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