Slideshow of the Fiscal Cliff Resolution

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Fiscal Cliff Resolution’s Impact on Taxes and Investing

Given the large US budget deficits of the past several years, tax increases were inevitable. No doubt, this will be a drag on economic growth going forward. For starters, those earning wages will experience an increase in payroll taxes. The withholding for Social Security taxes will revert back to 6.2%, the amount it was before the financial crisis.

The Bush-era tax cuts will remain in effect for those earning less than $400,000 per year with the top tax bracket being 39.6%. Long-term capital gains and dividends will remain at 15% for those earning less than the $400,000 threshold. The top rate for long-term capital gains and dividends has risen to 20%.

Most importantly, however, is the permanent patch to Alternative Minimum Tax (AMT). Previously, AMT had to be patched every single year, leaving an element of uncertainty for many filers. Had this not been resolved this year, many taxpayers would have been caught by surprise with a stiff tax increase.

Although this resolution will be a fairly minor drag on the economy, it will not be sufficient for solving our budget problems. Our budget deficits are too massive and spending cuts will still be needed to bring our budget to a reasonable level. Simply put, the government will still spend far more than it receives in taxes.

One of the buggest dangers is a sharp increase in interest payments for the national debt. Interest alone on the national debt is around $29 billion per month. A spike in inflation and interest rates could make this amount multiply. Currently rates on US government bonds are near zero with the 30 year bond being around 3%. This is why any increase will be huge. These rates are historically low and cannot get much lower. That being said, the risk involved does not favor US taxpayers.

The Fiscal Cliff consisted of mostly media hype. The real problem involves the mushrooming amount of debt. If this is not dealt with, then we will experience a real crisis. According to Reinhart and Rogoff’s This Time is Different, once debt-to-GDP rises to over 90%, it becomes a significant drag on the economy (We have already passed this level). In most cases cited by the authors, governments eventually default. Currency devaluations, resulting in inflation from printing money, are considered to be an indirect form of default. And is the most common method used by governments with fiat currencies.

Slower Growth Impacts Equities

Currently, the stock market is priced with the assumption of GDP growing at the rate of its historical trend. This is roughly 3% per year. Since the Great Recession, we have not been anywhere near that. Corporate earnings for the majority of S&P 500 companies have been disappointing for the last 2 quarters. This suggests that earnings are near their peak for this business cycle.

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Medicare Taxes Set to Rise

Medicare surtaxes will be levied on high income earners. As it stands now, there will be 2 separate taxes for both earned income and unearned income.

The 3.8% Medicare surtax policy was passed in 2010 and is scheduled to take effect in 2013. This will affect those making over $200,000 per year ($250,000 if married). Currently, the top tax rate on dividends and capital gains is 15%. The surtax alone would increase this to 18.8%. Bear in mind that this does not take into account the expiring Bush tax cuts. That said, more increases for tax on investment income could be coming.

What effect will this have? It will make dividends worth less than what they are today. Because of the anticipation of higher dividends, many companies are currently paying special, lump sum dividends to avoid shareholders paying higher rates. Dividends you receive before the end of 2012 will still have a maximum tax rate of 15%.

The tax increase will have unintended consequences. If dividends are worth less in the future, companies will be more reluctant pay them. They will likely use other “tricks” like share repurchases. This increases earnings per share because it reduces the number of shares in the market.

Higher taxes for dividends will place downward pressure on stock prices. Because we are in a low yield environment, many investors have deployed more cash into dividend paying stocks. This is because interest rates are too low to provide a reasonable return.

If you plan on selling stocks in the near future, selling large gains before the end of 2012 will likely result in tax savings. This is especially true for high income earners.

The Medicare payroll tax will also increase for high income earners. An extra 0.9% will affect single filers with earned income over $200,000, married couples filing joint with income over $250,000, and married filing separate taxpayers with an income over $125,000. The top rate on Medicare overall will be a combined total of 2.35%.

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Fiscal Cliff is Mostly Media Hype

Each time I turn on CNBC, there’s a clock showing the countdown of the fiscal cliff (regardless of which show is on). This is merely a recurring theme: make you think the world is ending in dramatic fashion to keep you watching the news. CEO’s like to come on the shows to tells us it’s armageddon if we raise taxes. Isn’t this just an attempt by them to avoid paying more taxes themselves?

The real truth is that the economy is already weak. Corporate profits have been below analysts’ forecasts in the second half of 2012. In addition, we are interwoven in a global economy which includes a European recession and a slowing Chinese economy. Because the global economy is so interconnected, recessions elsewhere will have an impact.

Politicians also add drama. That is, they have an interest in “standing tough”. If an agreement were reached right off the bat, it would appear as one side lost the battle or was not doing it’s job. In other words, the longer they drag this out, the more it appears they are not letting the other party win.

In the end, the US government will be forced to deal with its budget problems. Because of the massive gap between tax revenue and its expenditures, there will be no options left except higher taxes and reduced benefits. Whether a consensus is reached in the short term or not, the huge deficit will be a drag on the economy for years to come.

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How I Estimate My Taxes Without Preparing the Whole Return

You may have a ballpark idea of how much income you have. Or, how much money you will make next year. Perhaps you need to just get an idea of what your tax situation is likely to be quickly and easily. Taxes PhD Tax Estimator will accurately calculate Form 1040 components without all the clutter of standard income tax software.

The aim: to understand your tax situation in as few steps as possible and see how changes will affect you going forward. This productivity tool will aid in:

  • Predicting a refund or balance due amount
  • Calculating accurate estimated tax payments
  • Revealing the impact of deductions and credits
  • Adjusting withholding amounts

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Taxes PhD is also available on Android smartphones.

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On Time and Money

Simply put, we are a nation of instant gratification. That said, it may not be such a bad thing. We should spend the bulk of our time doing what we’re best at. Just because you can do something doesn’t always mean that you should.

If you’re putting in long hours at work, it’s more feasible to get a sandwich from Subway than to cook at home (going to McDonald’s is a different story). Convenience goods generally cost more. Like getting a gallon of milk from 7-Eleven.

Many people are do-it-yourselfers. I’m not one of them. Why go through the trouble of learning how to fix something that you’ll likely deal with just once?

Changing you own oil for your car is the perfect example. Why do this yourself when you can take to a shop, and get it done within minutes? The cost for this service is low. In addition, you don’t need to worry about getting dirty and disposing the oil when you’re done.

Doing a task in which you’re not good at is a mis-allocation of resources. If your time is worth more in your primary business, you should seek to outsource tasks that are not your core business. These generally include tasks that are redundant in which you can write a simple to-do list for. These tasks require little or no creative thought. If you cannot completely outsource them or automate them, you may need to hire an employee to perform them.

Ultimately, the value of your time and specific situation will dictate what things you spend your time on. When I was younger, my time was worth less than it is now. So, it was a rational decision to carry out a few of the tasks that I wouldn’t do today. Back then, I have more time and less money. Thankfully, things have changed now.

We have limited room for how many tasks we can handle. We can’t focus on a long laundry list of high priority tasks. Therefore, reality eventually forces us to prioritize. Knowing where your critical path lies and staying on it are critical elements of being successful.

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Everything Can Always be Made Better

Innovation doesn’t stop once we become experts. Becoming an expert can have serious consequences if you’re not careful. When you rely on your expertise, it’s easy to become complacent. And resistant to change.

No matter what level you achieve you should always be questioning yourself. Is the way you’ve always done something still the best? Often times. the ultimate solution for continued success lies on something far outside our circle of competence. For example, industries become outdated. A better typewriter, for example, will not achieve anything when the world is shifting to computers. The same can now be said for traditional desktop PC’s because the market is shifting to laptops and mobile.

Indeed, it’s important to continuously be studying your closest competitors. That said, disruptive technologies can affect your business even when they’re outside your industry. This is how Apple became a dominant force in the music industry. Samsung, being a large conglomerate, has become a leader in mobile computing through manufacturing Android phones. Traditional computer manufacturers including Dell and HP could have been big players in mobile.

A disruptive technology is generally a breakthrough that causes a revolution within an industry. This causes many new entrants to strike it rich while many established businesses go bankrupt. As stated earlier, this breakthrough often comes from companies that were outside of the industry being disrupted. Or, they had not traditionally been a direct competitor.

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