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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.
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.
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.