Advanced Personal Finance

I don’t write resolutions at the beginning of the new year. In fact, I’m kind of anti-goal in general, but that’s a topic for another post. Even so, it does help me to periodically remind myself to not focus on things related to personal finance that I can’t control.

Things fall into two categories for me - things I can affect and things I cannot. Things I can affect largely end at my skin and I find putting energy into things I cannot affect is just a waste of effort. I didn’t come to this conclusion easily or early in my life and it’s something I can forget. But it helps to remind myself from time to time.

Here are just a couple of things I cannot affect I’ve kicked around in my own head recently.

1. Interest rates. Regardless of what I think about the Fed, foreign investors, or the U.S. government, I know without any doubt I don’t have any bearing on interest rates. Those other groups of people do, but I don’t. Thinking about how this or that event might affect rates or making investments based on what direction I think rates are going to move isn’t smart for me. None of this means I don’t care what interest rates are. Far from it. As a soon-to-be mortgagee, I care deeply. I just don’t get to decide what rate I get, so why worry about it.
2. Economic indicators. There are as many economic indicators as there are economists - and that’s a lot. Whether it’s inflation, job growth, GDP or whatever, I know what I think about them means nothing. Low unemployment rates mean nothing if you’re unemployed. You have no say on unemployment. You most certainly do have a say in whether or not you are unemployed. Focus on what you can do and ignore the rest.
3. Housing prices. If there is one thing on this list I should care about, it’s this one. We recently sold our house very quickly, but for arguably less money than we could have a year ago. Does that matter? Not a bit. We weren’t selling our house a year ago; we sold it last month. Focusing on or worry about the value of your home doesn’t do any good. In a market like this, it only makes you miserable. What’s the point of that?
4. Gas prices. I don’t drive much and that’s about to change to ‘almost none.’ Nevertheless, even if I did drive more, I wouldn’t complain about gas prices. What good does it do? What are you going to do - drive less to work? not pick up the kids after school? visit your in-laws less? Well, maybe that last one, but the fact is most people don’t do a lot of discretionary driving. You can drive a more fuel efficient car, properly inflate your tires, and combine trips. You most definitely can’t change gas prices by boycotting or complaining.
5. The direction of the stock market. If you think you know what direction the stock market is going in tomorrow, this week, or this year, you’re deluding yourself. I don’t care who you are - you can’t predict it and you can’t affect it. What you can do is invest in it, month after month, year after year. Over the long haul, you’ll make a great deal of money. In the short run, who cares?
6. Taxes. I don’t know whether my personal taxes will go up or down this year. I do know I’ll be paying taxes. Do I get a say in how much? For all practical purposes, no. Worrying about taxes is pointless. (Planning for taxes, however, is decidedly not.)

I don’t know about anyone else, but I try to spend my time and effort on things I can do something about. And these things don’t fall into that category. Shouting at the tide never works. You just end up wet and hoarse.

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A couple of weeks ago, I wrote about how if Congress doesn’t act soon to fix the ever-engulfing AMT, it could delay tax refunds for everyone due one. Well, the Senate passed, by a wide margin, a temporary fix to the AMT. There are still a couple of roadblocks in the way, though.

First, the House hasn’t taken up its version of the bill. Second, the two versions are not exactly alike and must be reconciled.  Third, the House version is significantly different and hasn’t even been taken up by the full House yet.  Democrats, now the party of fiscal responsibility apparently, are pushing for offsetting revenue (i.e. additional taxes somewhere else).  And we all no how much Republicans hate taxes on anyone for anything.

So it seems that there’s a very excellent chance you won’t be getting your tax refund right away.  Which would be OK, except that also means neither will I.

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The poor unloved estate tax. It gets no respect and I don’t understand why. Flexo at Consumerism Commentary posted an article about Warren Buffett’s recent testimony before Congress on the subject. Buffett urged the Senators not to repeal the estate tax. I agree wholeheartedly (and not just because doing so puts me on Warren Buffett’s team).

Estate tax explained

The estate tax has to be the most maligned, misunderstood part of the IRS code. Critics call it the ‘death tax’ in an effort to generate popular support for its repeal. But the phrase ‘death tax’ is way misleading.

‘Death tax’ is misleading because virtually no one in America has to pay the estate tax. According to the IRS’s own data, in 2005 less than 1% of estates pay any taxes at all. The more proper term for this tax is the inheritance tax.

The estate tax is applicable when an individual leaves assets in excess of $2M (going up to $3.5M in 2009). Almost no one in the U.S. leaves that kind of money when they die.

Losing the family farm or small business

‘But what about the small business or family farm owner?’ people will ask. This classic line of attack on the estate tax goes something like this. When an owner of a family farm dies, his or her heirs will have to sell the farm just to pay the taxes on it. They’ll lose the farm!

This, in a word, is crap. The American Farm Bureau, a pro-repeal, pro-farm lobbying organization has never found a single example of this happening. Not one. Maybe a reason is because few farms reach the $2.0M threshold and of those that do, most have liquid assets available to pay the tax. Or maybe it’s that if the heirs agree to actually work the farm for 10 years, they get a $4.1M pass.

The family farm big enough to be heavily taxed by the estate tax is a myth.

So what about small businesses? Here again, hardly any are big enough to be affected by the tax. Only 4% of small businesses are bigger than $3.5M.

Some more objections punctured

• It’s double taxation. It’s not double taxation. Think about it - the gains in small businesses and family farms are unrealized gains. They’ve not yet been taxed.

• The tax rates are unreasonable. It’s true that the top estate tax rate is 48%. The problem with this line of thinking, though, is that marginal rates don’t mean very much. If you’re in the 25% tax bracket, does it mean all of your income is taxed at 25%? No, it doesn’t (see this great explanation of effective tax rates from NCN). So even if an estate does pay estate tax, the true percentage paid is much, much lower than 48%. In fact, according to the latest IRS data available, of those estates having to pay any tax, the percentage paid averaged 20%.

• It punishes success. I disagree. What it does is tax those most able to pay. It’s probably the most progressive tax in the IRS code. It only punishes success in the same way capital gains tax punishes stock market success - if you make money, you have to pay a small percentage in taxes. As Flexo says, “File this under the category of ‘problems I’d like to have one day.’”

• It will discourage investment (especially in small businesses). Let’s get real. I’d be willing to bet the estate tax consequences have never entered the mind of an entrepreneur considering starting a business. It simply makes no sense that someone would forgo gaining personal wealth because at some future time, their estate will be taxed.

No repeal

It simply boggles my mind that someone other than the handful of people actually subject to this tax would be in favor of its repeal. The estate tax brings in real revenue. When it is temporarily repealed in 2010, the federal budget will lose $56B.
There are only three ways to plug a $56B hole in a budget. You can

• raise other taxes,
• cut services,
• or borrow the money

Borrowing the money just worsens the already criminally large deficit being left to future generations to clean up. Raising other taxes must, by definition, affect more people (read you and me) than the estate tax. Or we could cut government programs - who’d like to suggest one?

If you’re in favor of the estate tax, you must either be in favor of higher deficits, higher taxes, or cutting government services.

The simple fact is the estate tax provides money for the nation from those in the best position to provide it. Incidentally, those are the very people who received so much from that nation.

Our tax system is far from perfect (or even good). But repealing arguably the most progressive tax in the code is insane.

Sources:

OMB Watch

Center for Budget and Policy Priorities

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I’ve read two articles in as many days about the Alternative Minimum Tax (AMT) and how it’s fix might delay refunds for everyone due one. Whether you are affected by the AMT or not, if a fix doesn’t pass soon, you’ll likely have to wait months for your refund.

The AMT ‘fix’

The back story is that the AMT, originally designed to make sure the very wealthy pay at least some tax is, in a word, broken. As the law was written, it wasn’t indexed for inflation. As a result, more and more people are falling into the AMT’s clutches every year.

Our far-sighted federal government annually does what it is best at and dodges the issue temporarily. That is, they pass a one-year fix, each year. This year’s no exception.

The problem is they’ve taken the issue up so late in the year. The IRS has to program computers and print forms based on the current tax code. If that code isn’t set, they either have to delay that work or redo it when changes are made.

The upshot of all this is that if a compromise on the AMT is not reached very soon (like, mid-December soon), it’s likely every U.S. household due a refund will have to wait months to get it.

Don’t rush to file

So you probably shouldn’t be in a hurry to file your 2007 tax return, even if you’re owed money. If you do file early (like most due a refund do), it’s entirely possible you’ll have to file again - this time filing an amended tax return, a 1040X.

I’ve had to file a 1040X before and it’s a pain. The form is short enough and it’s not especially difficult to understand. It’s just that I absolutely hate having to do something twice. I’m not sure if this is still the case, but the year I had to file a 1040X, I had to do so on a paper form, even though I’d filed electronically.
For me, I think I’ll just keep an eye on the situation and, if necessary, file later than usual once the dust settles. Grrr.

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One of the main appeals of municipal bonds (munis) to investors is their commonly tax free yield.  That is, in 43 U.S. states, the interest received from munis is tax free at both the federal and state level.

Soon, though, that may all change.  On November 5, the U.S. Supreme Court heard arguments in a case pitting Kentucky against a pair of retirees (George and Catherine Davis) in that state.  Essentially, at issue is whether states can tax other states’ munis while exempting their own from taxation.

If the Court decides to uphold the lower court ruling in favor of the Davises, it could rock the municipal bond market.  That ruling would mean prices for munis would likely crash, potentially spilling over into bonds in general.

Most observers, though, expect the Court to rule in favor of the states (every one of them sides with Kentucky).  Even if it didn’t, many believe Congress would move to nullify the ruling through some kind of legislation.

A ruling is expected in the first half of 2008.

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