Thursday, December 20, 2012

Political Magic with Smoke & Mirrors

Not since the late 1990s has there been such a political illusion as we are currently witnessing!

During President Bill Clinton’s Presidency they came up with ways to balance the Federal budget.  I believe a large part of this was allowing individuals to move their IRA accounts into Roth IRA accounts.

A little back ground is needed here:

  1. An IRA account is designed to help individuals prepare for retirement by:
·                    Allowing individuals to put pre-tax dollars into an IRA.
·                    Allowing the investments in the IRA account to grow tax free.
The investments in an IRA account are then taxed when they are withdrawn during retirement.

  1. A Roth IRA account is designed to help individuals prepare for retirement but with a few twists:
·                    Dollars invested in a Roth IRA account are after tax dollars, rather than pre-tax as in a normal IRA account.
·                    Investments in the Roth IRA account still grow tax free while they are in the account.
·                    However, when the money comes out of the Roth IRA it comes out tax free.

During President Clinton’s Presidency they allowed individuals to switch from their individual IRA accounts to new Roth IRA accounts during 1 year, but pay taxes on the money transferred into the Roth IRA account over a 5 year period of time.  There were a large number of very wealthy individuals who took the government up on this and many of which no longer pay taxes.

President Obama tried something like this a few years back, but only allowed the taxes to be paid over a 2 year period of time and few people found this tempting.

Fast forward to today and the fiscal cliff:

The threat of much higher individual taxes, capital gains taxes, AMT taxes and dividend taxes on people who have incomes above $250,000 a year has put America’s wealthiest citizens into a panic. They have:

  1. Started selling stocks with extremely high gains, to avoid the high capital gain taxes in 2013.
  2. They have persuaded companies like Johnson Controls and Bon-Ton Stores to pay their normal dividends early. Instead of paying out their dividend as scheduled in, say, January, they will pay it instead in December to allow shareholders to pay less taxes on the dividend.
  3. They have persuaded other companies, like Oracle, to go even further and bundle several future dividend payments into one bigger pre-December 31 payment.
  4. They have persuaded other companies like Costco, Carnival and Brown-Forman to borrow money in order to pay a big dividend before the end of the year, on the theory that they are paying future earnings to shareholders at current tax rates, rather than at higher tax rates down the road.

All this is going on as the President, Congress and the Senate appear to be fighting like little children; each wanting to get their way, or they will take their toys and go home.  Or are they really?

Let’s take a step back and look at this.  There have been so many people selling investments and companies declaring larger than normal dividends before the end of the year, to avoid higher taxes in the future, that the taxes that will be collected for the year 2012 tax year should jump up substantially!

If I were the President, Congress and Senate I would not want to settle the budget and tax issues by the end of the year.  I would want just what is going on right now. I would want to have the wealthiest American’s panicked even more, selling more and more of their investments to avoid higher future taxes that may or may not actually happen and/or last.  It helps Washington to reduce the budget deficit. In the long run it might even make all those people in Washington look smarter than they actually are?

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