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November 19, 2012

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Joe @ Retire By 40

I think the Chiropractic office is just grand standing. It's ridiculous to shut a profitable business because you'll pay a little more tax. Maybe just work less if you make too much money. Take Monday off. The rest of the list is great too. Sometime we worry about the wrong things and get bit in the behind.

Lucy Bronk

Some really good points raised and i like the issue you made with trick 3... even if you try your best to avoid the tax rates sometimes its best to just accept it and not try and avoid it.

Alex in Virginia

Hi, Sydney...

This is such a great post that you should try to give it wider exposure. Every single one of your cases in point is dynamite information that could save a whole bunch of people from messing up.

Cheers!

Baughman

Dividends are irrelevant. You can make your own dividends by selling shares of a non dividend paying stock. And the taxes will be lower as of 2013.

JF

Regarding point 1, it depends on the shapes of the utility curves for effort and wealth. Most economists assume increasing disutility for effort. So each incremental hour of work is more "costly." On the other hand, there is usually decreasing utility for wealth. So, for some people, an increase in the tax rate will result in a work decrease.

Retired Syd

Joe: Yes, I think there's a lot of that going around right now.

Lucy and Alex: Thank you!

Baughman: I agree--and you earn tax deferred "income" as the stock appreciates. Kind of like an IRA, you don't pay tax until you "take it out," but better (at least right now) because the rate is lower.

JF: I was an econ major so I get that, but the argument made a lot more sense in the 60's and 70's when rates topped 70%, or before that when they were over 90%! I don't think you truly drive a lot of economic behavior by a 4.6% increase, although as Joe points out, you do drive grandstanding behavior.

tom sightings

I certainly agree with your good advice (and I agree that Example #1 seems to be grandstanding.)But here's the thing: it would help if you could predict the future -- that internet stocks were going to collapse, for example, or that real-estate prices were going to go down. So help me out here. What investment should I NOT sell for tax purposes this year because it's going to appreciate next year?

Retired Syd

Tom: Well I seem to get that one wrong with 100% accuracy, so maybe you should just do the opposite of me.

Ken Miller

Hi Syd, I really like these examples! Especially #1 because I've heard this sort of thing from others. I guess many people don't understand how marginal income tax rates work.

Anyway, I'm glad to see you include the topic of taxes in your retirement blog.

-Ken

Ken Miller

Actually, #5 is a great story too! People can get so passionate about who they vote for, which is a good thing. But don't let your passion turn to fearful financial decisions.

Lynn

This is a fantastic post! All of the truths hold even in Canada. Where, by the way, the top marginal tax rate is closer to 46% depending on where you live. And amazingly, Canadians still enjoy one of the best lifestyles in the world...one very similar to Americans. People on both sides of the border need to stop fretting so much about taxes. Increased income tax tends to put pressure on the price of products which counter-balances the effect of the higher taxes...and the wheels on the bus go round and round.... - Lynn

Retired Syd

Ken: Actually, I was thinking about that today. With all the sound bites in the media, it occurred to me that it really is possible that people don't understand how marginal tax rates work. I think some people think that if they hit the threshold amount, ALL their income is taxed at the higher rate, not just the incremental dollars. I used to prepare taxes for a living, so I think I might take for granted that people understand how it all works.

Lynn: It's funny that many of those talking (or should I say screaming) heads insist that we will become "just like Canada!" But a 46% top marginal rate is lower than what our top rates were just a few decades ago!

deegee

Syd, this may not fall under any of your Stupid Tax Tricks, but #5's "Where’s he going to park that $650k now?" made me think of what I tell my friend who has been tempted to sell some shares of a muni bond fund we each happen to own.

As you probably know, the price (NAV) of many bond fund shares has risen a lot lately, creating a good selling opportunity to take some gains. But whenever me friend tells me this, I immediately respond with, "What are you going to do with the money?" It is not like anything else he invests in is going to generate much in terms of yield, even the ~3% tax-free dividend yield that bond fund is paying now.

He was lucky that he sold a lot of shares in that fund about a year ago when he was getting ready to buy his co-op apartment and used it for the down payment, closing costs, and new furnishings. At least in that instance, he DID have something good to do with the proceeds of the sale, and he turned a tidy profit, albeit taxable, on that big sale.

The only time I saw a year's income adjusted becasue of a tax change was back in 1987 after the 1986 Tax Reform Act was passed, lowering tax rates in 1987. Our biweekly pay period ended the week of the new year (1/1/87 was on a Thursday) but the payroll department was ordered to delay the paychecks from 12/31/86 to 1/1/87 so the income would be taxed at lower rates. The bigwigs, of which I was not, got their annual bonuses with that paycheck which is why thry did that. But the banks would not necessarily let us cash post-dated paychecks (we got them on 12/31, the last work day that week).

Good post anyway. :)

Retired Syd

One more thought on that increasing disutility for effort argument. Those small business owners that clear over $250k have already cleared the $114k (in 2013) limit for self-employment tax. Meaning that they get to keep 12.4% more of each dollar earned as opposed to the small business guy that makes under $114k who is still paying 12.4% more of each dollar earned to Social Security tax.

JF

Agreed but at the margin, an increase in the marginal tax rate may encourage some people to work less. (Do I want to work that extra hour or consume leisure?)

I may be a good example, higher marginal tax rates may encourage me to retire early..yea!!

Janette

Shhhh---don't tell people the sky will not fall! I am busy buying stock!

Retired Syd

Jeanette: Yep, sometimes while some folks are busy freaking out, the coolheaded folks seize opportunities.

Retired Syd

JF: Well of course, I'm all for people working less if they want to. That's what this blog is all about. If you've got so much money that you don't need the extra 60 cents, by all means, scale back. But don't tell me it's because you had to give up an additional 4.6 cents.

We have a progressive tax system in the U.S. If it were indeed true that people would start working less as their income tax rates rose, nobody would want to work past the first income tax bracket, because each additional dollar keeps getting taxed at marginally higher and higher rates.

The fact is most people need money to live, and the argument that giving up a few cents to earn a whole lot more encourages folks to drop out I think is a little offensive to the 12 million people here in the U.S. right now that would jump at the chance to give up some money to taxes just so they could start collecting a paycheck. It really sounds like whining to me.

Here in California we have pretty progressive tax rates including an additional 1% surtax on incomes over $1M. And yet 4 of our counties are in the top 10 counties for millionaires in the U.S. I just don't think we're there yet with the disincentives. In Econ 101 theory, maybe, but in real life, people still want to make lots of money.

JF

Hello Syd:

First, I really enjoy your blog, I have been lurking for the past few weeks.

Second, I agree my points are simplistic economic arguments. Twenty years ago, the assumption of work disutility would have been foreign to me. I loved to work. I enjoyed being paid, the prestige and satisfaction of being successful, and the social support. Now, however, I can relate to work disutility. The challenge and novelty have worn off.

Third, my main concern with the "only 4.6 cents" is that it is an argument that never ends. I am concerned that a couple of years from now we will hear the same arguments when we need another revenue enhancement. A couple of years later, it will happen again. The result is that the accumulation becomes significant. But in a couple of years I should be retired with little income, so ...

Again, love the blog. JF

Alex in Virginia

I can't let Baughman's (B) comment: "Dividends are irrelevant. You can make your own dividends by selling shares of a non-dividend paying stock" go by unchallenged. Readers deserve to have a contrasting viewpoint.

First: I assume as a given that B doesn't mean that one should sell a LOSING stock and call the proceeds a "dividend". That would be a real lose-lose proposition. So I have to assume that B is talking about selling winning stocks and taking a profit.

Second: Even though dividends can be lowered or suspended, actually being paid an expected dividend each quarter is at the very least a strong probability. Having a gain on a stock to realize is just a possibility that one cannot bank on. There's no comparison.

Third: Even if you could sell a stock at a gain, cashing that "dividend" out of one's investment account LOWERS the book value of one's portfolio by the amount withdrawn. Cashing out a dividend payment does not do that -- your portfolio's book value is unaffected.

Fourth (and I'll just stop here): a dividend-paying stock (1) pays you while you are waiting for the stock price to go up, and (2) has stronger downside support in a falling market.

To sum up, I go entirely in the opposite direction of B. For the last 4 years, I have NOT bought any stock that does not pay a substantial dividend. And guess what: not only have I made very decent money on the dividends, but in addition I have actually made twice as much money buying and selling those same dividend-paying stocks as their prices swing up and down. Best of both worlds, IMHO. ;-)

Retired Syd

JF: I didn't mean to minimize your point. Yes, if tax rates keep going up and up, this economic theory will influence real behavior. Not sure where the line is, but we're still at pretty historic lows in terms of marginal rates for our country.

I experienced the same disutility as you are describing but it had little to do with taxes. As I accumulated a larger and larger nest egg, my tolerance for stress and general workplace annoyances got lower and lower. At some point, working for an additional dollar was not worth the additional annoyance. While it's not really a tax in the true sense of the word, it's kind of work being too taxing, if you get my drift. So I'm with you on that.

Alex: I won't try and speak for Baughman, but I think you may have taken the comment too literally. I too, earn dividends (on mutual funds), which I reinvest. Frankly, it doesn't amount to much each year. I look at the growth in my whole nest egg to see how I'm doing, which includes dividends, interest, and appreciation. When I need money to live on, I take some out, either from the bond or stock side of my portfolio, which ever is needed to keep my asset allocation steady. It doesn't really matter where the money was generated from, but it generates the "income" on which I live. I won't call that a dividend, but that's how I saw the the point.

fred doe

Taxes, Taxes. We,re talkin about taxes. the other day my wife and I were out for a walk. I found a 20 dollar bill on the ground. Picking it up I threw it back on the ground and kept walkin. My wife said," what are you nuts" my reply was "what? keep it and pay the higher tax rate" HAPPY THANKSGIVING:)

dgpcolorado

Enjoyed this post Syd! I have been thinking of harvesting a long term gain next month; bought the stock in early 2009 when everyone else was freaking out. I am in the zero percent bracket—being poor has some advantages—so the plan was to immediately buy the stock back, the net effect being to raise my basis.

But I do wonder whether it is more trouble than it is worth. And that was before your cautionary tales!

Retired Syd

DGP: Actually, your's is a smart tax idea. Pick up the gain this year at zero taxable rate and buy it back for the higher tax basis. Go to the head of the class!

Scared

Appreciate the post but it misses the forest for the trees. We just asked the American people if they want to move back toward a Capitalistic system, or try 4 more years of moving toward Socialism. $1B in campaign advertising later and we voted to steal money from those evil rich guys standing behind the tree to pay everyone else's bills. And to really poor salt in the wound we did it in the name of "fairness". The reason people are cashing out, is because once the higher marginal rates get "decoupled" from the lower rates this pattern of theft will only accelerate. We know how this story ends. 4.6% is just the first step in a very ugly display of human greed, courtesy of the liberals using populism to stay in power. Look at Greece, Spain, USSR, et al to help decide whether you want to expand your business in this kind of environment. Take your profits and hide until a Republican can bring back some sanity.

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