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Will Taxes Soon Skyrocket?

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Fire! Mayhem! Dogs and cats, living together! And worst of all, rising taxes!

Doomsayers who claim that we'll soon be crushed by a bevy of new taxes -- including dividend taxes that could skyrocket from 15% to 39.6% -- may be exaggerating the severity of the situation. True, some tax rates will inevitably rise, and a few people will feel a greater pinch. But most individuals and companies won't see much of a change at all.

False alarm
I can see why the thought of losing recent years' tax cuts would alarm many people -- especially those dreading a 39.6% hit. Imagine buying Verizon (NYSE: VZ  ) , in hopes of enjoying its 7.1% dividend yield for the long haul. On an investment of $10,000, you'd collect about $710 annually right now, with a maximum 15% tax hit of just $107 on those payouts. Now imagine hearing that your tax bill might soar to $281 in 2011. Goodbye, gains?

Not necessarily. Yes, the currently reduced dividend rate is due to revert to citizens' ordinary income tax rate. That would be 39.6% under the proposed budget, but only if you have taxable income of more than $375,700 in 2011. (The Tax Policy Center has estimated that only about 2% of American households earn more than $250,000 per year.)

Furthermore, the Obama administration seems to want to limit the increase in dividend taxes to just five percentage points, from 15% to 20%. That's a meaningful jump, especially for those collecting a lot of dividends in retirement, but it's not 39.6%. On your $710 dividend, you'd pay an extra $35 a year on top of your current $107.

Safe estates
Critics are also trying to spread alarm about the estate tax, or as some opponents like to dub it, the "death tax." Unless Congress decides otherwise, it will revert in 2011 from 45% to 55%, with an exemption of $1 million. It's estimated that a $1 million exemption would lead to just 44,200 households owing estate tax in 2011 -- and they'd only pay taxes on any value beyond that initial $1 million.

Yes, that'll put a crimp in some folks' wealth. But those problems can be significantly avoided by simply hiking the exemption, which seems likely sooner or later. Even rich people like Warren Buffett and Bill Gates have argued that keeping an estate tax will go a long way toward restoring our nation's economic health.

Pity the corporations?
Pro-business advocates lament that our corporate tax rate is too high. According to the World Bank, our effective corporate tax rate is higher than some developed peers, such as France and England, but lower than many others, including Germany, Canada, and Japan. And indeed, many companies have been able to avoid paying many U.S. taxes by basing subsidiaries in tax shelters abroad, among other loopholes.

Here are several ways that well-known companies reduce their U.S. tax bills. Forbes recently noted that these companies paid relatively little in taxes in 2009, based on accounting provisions:

  • Many companies take advantage of lower tax rates abroad. For instance, Chevron (NYSE: CVX  ) had an $8 billion tax bill globally, but it only paid $200 million to the United States. General Electric (NYSE: GE  ) was cited for losing money on paper, and therefore not owing taxes in the U.S., while at the same time making "lots of money overseas, where tax rates are lower." And Hewlett-Packard (NYSE: HPQ  ) paid $1.8 billion in taxes -- but that represented just 19% of its pre-tax income, thanks to lower tax rates abroad.
  • Companies are using tax losses in past years to shelter current and future income. Bank of America (NYSE: BAC  ) reported $4.4 billion in pre-tax income, but was able to take advantage of deductions and credits to lower that below zero. It still has tens of billions of dollars in credit losses that will shield it from taxes for quite a while. Ford (NYSE: F  ) reported $3 billion in pre-tax income, but only paid $69 million, thanks to losses carried over from previous years.
  • Even companies that pay income tax now may get huge breaks later. Wells Fargo (NYSE: WFC  ) paid a solid 30.3% of its pre-tax income in taxes, but investors have reason to smile about the future: The company has a $25 billion allowance for losses on loans. When those losses are realized, they will offset tax liabilities.

The Government Accountability Office found in 2008 that 55% of U.S. corporations actually reported no federal income tax liability in at least one year between 1998 and 2005. Suddenly, the thought that changing tax laws might make they pay a bit more to the IRS doesn't seem so bad.

Resist scare tactics designed to get you alarmed. Dig a little deeper into the facts about tax changes, and keep the big picture in mind. Yes, some taxes may go up in the coming years, but most of us won't be affected. Besdies, our nation is facing massive financial challenges right now. Perhaps a few more taxes might not be a bad thing.

If you expect to lose hundreds via raised taxes, consider aiming to make thousands by investing in some overlooked winners

Longtime Fool contributor Selena Maranjian owns shares of General Electric. Ford Motor is a Motley Fool Stock Advisor selection. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.


Read/Post Comments (4) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 13, 2010, at 1:55 PM, smikey055 wrote:

    TAX RATES WON'T EVER QUIT RISING UNTIL EITHER THE MAJORITY OF THE COUNTRY BECOMES EMPLOYED BY THE GOVERNMENT OR THE RICH AND DILLEGENT DIE OFF. IT'S INFLATION IN IT'S MOST SIMPLE FORM. THE MENTALITY THAT "IT'S ONLY A $35 INCREASE" IS WHAT CAUSES PEOPLE TO IGNORE INFLATION AND REGARD IT AS INSIGNIFICANT. WHERE DO YOU DRAW THE LINE? JUST LIKE A $0.85 INCREASE IN THE PRICE OF A CHICKEN SANDWICH COMBO. IT DOESN'T SEEM SIGNIFICANT, UNTIL 20 YEARS DOWN THE ROAD WHEN YOUR SANDWICH COSTS $20.

    AS INCENTIVE DECREASES, PEOPLE WILL RISK LESS AND WHINE MORE.

    ON A DIFFERENT NOTE: 1) HEALTHCARE REFORM, 2) FINANCIAL REFORM, 3) ENERGY REFORM.... AT WHAT POINT DOES THE HONORABLE POLITICIAN PUSH FOR GOVERNMENT REFORM (SPEND LESS, SAVE MORE, ALLOCATE RESPONSIBLY).

  • Report this Comment On July 13, 2010, at 4:00 PM, CSense74 wrote:

    Take a minute and think about how much we really pay in taxes. First you pay Federal, State and local income tax. Then when you buy items with the money you have left you pay a sales tax. If you drive a vehicle you pay a tax for registration each year. If you invest what you have left you pay taxes on what you make. If by some chance you make enough to leave over $1Million to someone when you die, they pay taxes on it. They pay taxes again on the money that you've already paid taxes on! The taxes go on and on. I challenge people to keep track of ALL of the taxes that you pay and see what percentage of your income you actually get to keep. The results may suprise you.

    As far as corporate income tax, If it goes up at all the corporation will simply raise prices to cover the extra taxes. Now the cost of goods and services goes up. The average working American's money buys less. 55% of U.S. corporations paid no taxes in 2008. How many of them were mom and pop corporations that service a small area? I'd bet that the corporations that most of us buy from fell into the 45% that did pay taxes. Those taxes were passed down to us. It's time the government cut spending and cut taxes to bring the economy back.

  • Report this Comment On July 13, 2010, at 8:55 PM, ChrisBern wrote:

    While I agree with the overall sentiment of the article, I would submit that we will most definitely see a significant rise in taxation in the next 2-3 years, if our politicians can't stop spending an increasing amount of money each year. Personally I'd prefer to see spending cuts, but the politicians don't have the backbone for that, so I fully expect to see tax rises. There's no way around it, because without one or the other we'll have trillion dollar deficits for the foreseeable future, which isn't sustainable.

  • Report this Comment On July 14, 2010, at 1:48 AM, cordwood wrote:

    Since our tax codes are enveloped in a fog,generated in "foggy bottom, who the heck knows what the "effective" tax rate is?

    Taxes are manipulated by the "Gummint" as well as the taxpayers.

    Until a simple flat rate tax is enacted, discussion of taxes is futile.

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Selena Maranjian
TMFSelena

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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