Category Archives: Taxes

National Debt and Fiscal Deficits are Dire and Critical

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The current U.S. National Debt is over $35 trillion and growing.

To pay for annual fiscal budget deficit, the federal government borrows money by selling Treasury bonds, bills, and other securities. The national debt is the accumulation of this borrowing along with associated interest owed to the investors who purchased these securities.

U.S. Annual Federal Tax revenue or receipts are approximately $5 trillion. 

U.S. federal tax revenue is made up of the total tax receipts received by the government each year. Most of it is paid either through income taxes or payroll taxes. The rest is made up of estate taxes, excise and customs duties, and interest on the Federal Reserve’s holdings of U.S. Treasuries.

The U.S. government estimates its total revenue to be $5.49 trillion for fiscal year 2025.

Per the White House’s projections, income taxes are slated to contribute $2.6 trillion. Another $2.2 trillion should come from payroll taxes. This includes $1.3 trillion for Social Security, $399 billion for Medicare, and $56 billion for unemployment insurance. Corporate taxes would add another $467 billion.

U.S. Annual Fiscal Deficit is running approximately $2 trillion. 

A fiscal deficit occurs when the federal government’s spending exceeds its revenues. The federal government has spent $1.83 trillion more than it has collected in fiscal year (FY) 2024.

To pay for government programs while operating under a deficit, the federal government borrows money by selling U.S. Treasury bonds, bills, and other securities. The national debt is the accumulation of this borrowing along with associated interest owed to investors who purchased these securities.

National Debt to Gross Domestic Product (GDP) is currently 120%, according to St. Louis Federal Reserve. 

The debt-to-GDP ratio compares a country’s sovereign debt to its total economic output for the year. Its output is measured by gross domestic product (GDP).

U.S. Government Revenue (or Tax receipts) per GDP is 29%.

How much national debt is too much and is there a tipping point at which it becomes a big problem for a country?

One way to gauge the size of a country’s national debt is to compare it with the size of its economy—the ratio of debt to GDP. (GDP serves as a measure of an economy’s overall size and health, measuring the total market value of all of a country’s goods and services produced in a given year.)

National Debt

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The U.S.National Debt grows because the Federal government consistently spends more than it collects in revenue. This persistent gap between spending and revenue has existed for over two decades.

As of 8:40 am on August 19, 2024 (https://www.usdebtclock.org/)

Excessive fiscal spending and changes in tax policy play a significant role. Policies like the Inflation Reduction Act, the Chips Act and Obama Care, impact government spending, extensions of tax cuts and new tax legislation, like the Tax Cuts and Jobs Act of 2017, impact government revenues.

Essentially, new federal spending without offset taxes to pay for it and tax cut without correlated cuts in spending are the root causes of increasing deficit spending and skyrocketing National Debt

Lawmakers must focus on long-term fiscal sustainability. Delaying action will make addressing the debt even harder. A gradual, spending-focused approach is essential, including reforms to mandatory programs like Social Security and Medicare.

Tax increases must be part of the solution, and policymakers should prioritize less distortionary taxes (such as consumption taxes) or tax reforms that broaden the tax base. For instance, returning to Clinton-era policies could bring more working families back onto the tax rolls.

In summary, addressing the debt requires a balanced approach, thoughtful policies, and a commitment to fiscal responsibility.

References:

  1. https://econofact.org/addressing-rising-us-debt

IRS Tax Refunds: Interest Free Loan to Federal Government

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“We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.” – Winston S. Churchill

Most Americans perceive a tax refund as a government benefit, rather than recognizing it as an interest-free loan they provided to the government.

According to the IRS, “If you paid more in federal taxes throughout the year than you owe in tax, you may get a refund after you file your tax returns. Even if you didn’t pay tax, you may still get a refund if you qualify for a refundable credit.”

Tax refund, or a refund of overpayment of taxes, are often a source of joy for many U.S. households. For calendar year 2023, the average refund check is expected to be approximately $3,050 according to the IRS.

People use these refunds to pay bills, start emergency funds, or treat themselves to something special. However, it’s essential to understand that these refund checks aren’t free money from the government. Instead, they represent reimbursements from the IRS for overpaid income taxes throughout the year. In fact, last year alone, taxpayers overpaid by a staggering $360 billion.

Essentially, a tax refund isn’t free money. Here’s why:

  • Overpaid Taxes: Throughout the year, you pay income taxes based on your earnings. Sometimes, due to various factors (like incorrect withholding or changes in income), you end up paying more than your actual tax liability.
  • Refund Process: When you file your tax return, the IRS calculates your actual tax liability. If you’ve overpaid, they issue a refund—sending back the excess amount you paid.
  • Interest-Free Loan: Essentially, the refund represents an interest-free loan you provided to the government. Instead of having that money in your pocket throughout the year, you lent it to the IRS without earning any interest.
  • Financial Implications: From a financial perspective, it’s better to adjust your withholding so that you receive more in your paycheck each month. This way, you can use the extra funds for savings, investments, or other financial goals.

Interest-Free Loan Perspective:

Many experts caution that tax refunds essentially represent interest-free loansgiven to the federal government. When you overpay your taxes, you’re effectively lending money to the IRS without earning any interest.

Financially, it’s better to have that money in your paycheck throughout the year. For instance, if the average tax refund is $3,079, that’s equivalent to a $3,000 interest-free loan you’ve provided to the government. Instead, you could have had an extra $250 per month in your budget.

Enforced Savings Perspective:

Some financial professionals argue that receiving a refund can serve as an enforced savings plan. For individuals who struggle to save money, having a lump sum at tax time can be helpful.

However, it’s important to note that adjusting your withholding during the current tax year can impact next year’s refund. If you want to avoid overpaying, consider adjusting your withholding with your employer.

In summary, while tax refunds may feel like a windfall, it’s financially wiser to have that money in your paycheck throughout the year. Ultimately, the choice between a refund and a net-zero tax return depends on individual circumstances and financial goals.

When to expect your refund 

To process your refund, it usually takes:

  • Up to 21 days for an e-filed return
  • 4 weeks or more for amended returns and returns sent by mail
  • Longer if your return needs corrections or extra review. However, you’ll receive interest for delayed tax refund.

References:

  1. https://www.irs.gov/refunds

Five Tax Strategies

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Five tax-aware strategies that could help you discover opportunities to save on taxes.

At the end of the calendar year, if you take the time now to learn the tax rules, you may discover opportunities to help save on your taxes.

Here are five tax-aware strategies to consider now.

1. Make charitable donations now to get a 2023 tax deduction or consider “bunching” gifts to climb over the standard deduction.

Do you itemize your taxes? If yes, you may be able to reduce your taxable income through charitable deductions if you are eligible. Let’s dig into the rules.

For 2023, the standard deduction is $13,850 for single filers and $27,700 for married couples filing jointly. But what if you are very close—but not touching—the standard deduction? There is a strategy you can consider: bunching your 2023 and 2024 charitable donations together in 2023 to climb above the standard deduction.

2. Harvest your investment losses.

While you are reviewing your portfolio, consider if your current asset allocations still align with your long-term goals. If you discover losses in a taxable account, you could use those losses to offset any realized capital gains for 2023. If appropriate, you can always repurchase the investments, but be sure to do it at a later date and avoid the wash sale rule.

To set this strategy into motion, tally up your potential losses, then sell out of losing positions that no longer make sense to hold. You can use those losses to offset any realized capital gains. If you still have losses left over, you can offset up to $3,000 of ordinary income annually and carry forward any remaining losses to be utilized in subsequent years.

3. Be strategic with your annual exclusion gifts.

Annual exclusion gifting is a common way to help your estate pass on assets tax-free.

Here are the basics: You can give any number of people up to $17,000 in 2023 without triggering a taxable gift, according to the IRS. That number climbs to $34,000 for married couples. The IRS calls these amounts the “annual gift tax exclusion,” which simply means if you give that amount or less you generally don’t need to report it to the IRS. But be aware that a married couple “gift splitting” does require the filing of a Gift Tax Return (709), regardless of the amount.

4. Review your investment location with an eye toward taxes.

In investing, “location” can matter when it comes to taxes. For example, there are different tax implications depending on which types of investment accounts you choose.

With a taxable brokerage account, you are taxed on interest, dividends, capital gains, or distributions from mutual funds as they occur.

In a tax-deferred retirement account, like an individual retirement account (IRA) or 401(k), you’ll generally pay taxes when you eventually withdraw the assets.
In a Roth IRA, earnings and distributions are tax-free as long as you are over age 59 ½ and the account is at least five years old.

Depending on your long-term investment goals and investment preferences, you could benefit from a tax standpoint by investing in more actively-managed mutual funds in your retirement accounts and by investing in exchange traded funds (ETFs)—which are generally more tax-efficient because they tend not to distribute a lot of capital gains—in your taxable account.

Consider this: There’s a saying: Don’t let the tax tail wag the investment dog. While this move may be right for you, it reminds us not to make moves to minimize taxes in your portfolio unless it aligns with your long-term investment strategy.

5. Contribute to or max out your retirement plan if you are able.

Contributing to a retirement account can lower adjusted gross income and taxable income. In 2023, the 401(k) contribution limit stands at $22,500, and if you are 50 or older, you can save an additional $7,500 in catch-up contributions for a total of $30,000. The IRA contribution limit totals $6,500 in 2023, with a catch-up contribution of an additional $1,000 for those 50 or over.  And if your plan allows and you believe your income tax rates may be higher in retirement, you may also want to consider the Roth option. It doesn’t have to be one or the other—you can make contributions to both as long as the total contribution does not exceed the overall contribution limit. Be aware, however, that Roth accounts are funded with after-tax dollars, so those contributions won’t lower AGI.

Get started now.

As you review your financial picture, consider these five ideas to help you prepare your way to a successful tax season.

References:

  1. https://www.schwab.com/learn/story/pickleball-and-taxes-end-year-with-smash

Federal Fiscal Deficit vs. National Debt

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Democrats spend money when they don’t raise taxes; and, Republicans cut taxes when they don’t decrease spending. Tax and spending reforms are needed desperately.

“The government has basically three gigantic programs and it’s the US military, Social Security, and Medicare,” Marc Goldwein, a senior policy director at Committee for a Responsible Federal Budget (CRFB) said. As Nobel-Prize-winning economist Paul Krugman once wrote, the US government is “best thought of as a giant insurance company with an army,” and increasing interest payments.

If the government wants to get serious about its fiscal spending and reducing the national debt, all government spending would have to be reduced by 27% to get budgets balanced in the next decade — and, if tax increases, defense spending, Social Security, and Medicare are all off the table, 78% of federal spending would have to be cut, according to CRFB.

The federal deficit vs. Debt — they’re two separate concepts.

  • The deficit is the difference between the money that the government makes and the money it spends during a fiscal year. If the government spends more than it collects in revenues, then it’s running a deficit.
  • The federal debt is the running total of the accumulated deficits.

The combination of spending increases, tax cutsc, and increasing interest expenses on the debt inflates deficits. While the rise in spending tends to be bi-partisan, tax cuts tend to be enacted by Republicans.

Reference:

  1. https://news.yahoo.com/want-balance-budget-without-raising-100000676.html
  2. https://www.politifact.com/factchecks/2019/jul/29/tweets/republican-presidents-democrats-contribute-deficit/

Taxing Unrealized Capital Gains

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For U.S. companies that report over US$1 billion in profits to shareholders, the Inflation Reduction Act implements a 15% corporate alternative minimum tax (CAMT) based on book income.

A 15% corporate alternative minimum tax for a corporation whose financial statement income exceeds $1 billion was included in the Inflation Reduction Act in 2022.  Since the passage of the law, there has been uncertainty about whether corporations would owe taxes on paper profits, or unrealized capital gains, on stocks starting in 2022.

The new tax will require companies to compute two separate calculations for federal income tax purposes and pay the greater of the new minimum tax or their regular tax liability. To determine whether the new tax applies, companies must first ascertain whether their “average annual adjusted financial statement income” (AFSI) exceeds $1 billion for any three consecutive years preceding the tax year.

The historic tax treatment has long been that paper profits (or unrealized capital gains) created a deferred tax liability that is only paid when the stocks or assets are sold, and the profits realized.

Recent guidance from the Internal Revenue Service, while not definitive, suggests that paper profits on stocks could be subject to a 15% tax this year, according to New York tax expert Robert Willens. The issue involves the tax treatment of applicable financial statement income (AFSI), a measure of earnings.

“The IRS left open the question of whether ‘mark to market’ gains and losses should be disregarded when computing AFSI,” Willens wrote to Barron’s. “As of now, they are included in AFSI. The IRS solicited the comments of investors as to whether these gains and losses should be backed out of AFSI or whether they should remain in the tax base.”

The beauty of the previous tax rules is that a company could defer the taxes indefinitely on unrealized gains in long-held stocks, especially when the preferred holding period is “forever.”

Individuals can defer capital-gains taxes until the sale of assets and can often avoid taxes entirely if the assets are left in their estates, assuming the estates are below the current threshold for inheritance taxes.

There have been proposals floated in Congress from some lawmakers to tax unrealized gains held by individuals, but they haven’t gained traction.

References:

  1. https://www.barrons.com/articles/warren-buffett-berkshire-hathaway-tax-51673028329
  2. https://www.ey.com/en_gl/tax-alerts/us-inflation-reduction-act-includes-15-corporate-minimum-tax-on-income

Minimum Book Corporate Income Tax

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Book income is the amount of income corporations publicly report on their financial statements to shareholders. This measure is useful for assessing the financial health of a business but often does not reflect economic reality and can result in a firm appearing profitable while paying little or no income tax. ~ Tax Foundation

In August, President Biden signed a minimum book income tax into law under the 2022 Inflation Reduction Act. The law was passed in both chambers of congress by Democrats.

Book income is the amount of income corporations publicly report on their financial statements to shareholders, explains the Tax Foundation.

The appeal of the minimum book tax for Democrats is two-fold, explains Laura Davison, in an article written for Bloomberg.com.

  • First, the minimum tax goes after corporations that many Democrats say don’t pay enough in taxes.
  • Second, it’s a way to raise taxes on corporations without increasing the 21% headline tax rate.

Senator Joe Manchin, Democrat (WV), says the minimum tax doesn’t so much raise taxes as close a loophole — even though it would mean that some corporations have to pay more to the federal government.

The law enforces a 15% corporate minimum tax targeted at companies that earn more than $1 billion a year. President Joe Biden cited a report in his State of the Union address that found that 55 companies paid no federal income taxes in 2020, despite earning profits under the standards of GAAP.

The corporate minimum tax would require companies with at least $1 billion in income to calculate their annual tax liability two ways:

  • One using longstanding tax accounting methods, which is 21% of profits less deductions and credits;
  • The other by applying the 15% rate to the earnings they report to shareholders on their financial statements, commonly known as book income.

Whichever amount is greater would be what they owe to the IRS.

A corporation’s profits for tax purposes and for financial reporting to shareholders often vary. Book income sticks more closely to generally accepted accounting principles, or GAAP, while the Internal Revenue Service code includes a slew of deductions and credits that companies can use to offset their income. 

This roundabout method to collect more money from corporations provides much of the new revenue to fund the energy investments and deficit reduction that Democrats are hoping to tout in the midterm elections this November.

References:

  1. https://www.bloomberg.com/news/articles/2022-08-01/how-the-15-us-minimum-corporate-tax-would-work-quicktake
  2. https://taxfoundation.org/tax-basics/book-income-vs-tax-income/

Will Higher Interest Rates Tame Inflation?

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Interest rates don’t determine inflation; the amount of money circulating in the economy determines inflation.  At this point, there are over $5 trillion in excess money in the system. Brian Wesbury

While inflation roars at its highest level in four decades, President Joe Biden tried to downplay skyrocketing inflation, insisting it was only up “just an inch” in the short term.

“Well, first of all, let’s put this in perspective. Inflation rate month to month was just– just an inch, hardly at all,” President Joe Biden on Sixty Minutes

Despite the fact that consumer prices rose in August by one-tenth of a percentage point to 8.3 percent, economists had expected inflation to go down. Additionally, median inflation hit the highest level ever recorded.

The median CPI, which excludes all the large changes in either direction and is better predicted by labor market slack, is extremely ugly at 9.2% annual rate in August, the single highest monthly print in their dataset which starts in 1983 (second highest was in June).

The Federal Reserve has been raising interest rates since March to slow the economy in a bid to tame America’s worst bout of inflation in four decades. However, the data suggested that their efforts have not yet had much of an effect.

The Federal Reserve raising interest rates may reduce economic growth, make capital more expensive and may throw the US economy into recession, however there is no guarantee that these actions will tame or fix inflation, opines Brian Wesbury, Chief Economist, First Trust Advisors L. P. Interest rates, supply disruptions or Russian’s war in Ukraine don’t determine inflation; the amount of money circulating in the economy determines inflation.  

“Inflation is always and everywhere a monetary phenomenon.” ~ Milton Friedman

The Fed’s balance sheet held $850 billion in reserves at the end of 2007.  Today, the balance sheet is close to $9 trillion.  Most of these deposits at the Fed are bank reserves which the Fed created by buying Treasury bonds, much of which was money the Treasury itself handed out during the pandemic.  At this point, there are over $5 trillion in excess money in the system.

Technically, banks can do whatever they want with these reserves as long as they meet the capital and liquidity ratio requirements set by regulators.

  • They can hold them at the Fed and get the interest rate the Fed sets, or
  • They can lend them out at current market interest rates.  

In turn, the big question is whether the Fed can pay banks enough to stop them from lending in the private marketplace and multiplying the money supply.

The Fed has never tried to stop bank lending in an inflationary environment by just raising the interest rate on excess reserves (IOER). Moreover, the Fed is now losing money on much of its bond portfolio because it bought so many bonds at low interest rates. At some point the Fed will be paying out more in interest than it is earning on its securities.

Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today.

References:

  1. https://www.ftportfolios.com/Commentary/EconomicResearch/2022/9/19/will-higher-interest-rates-tame-inflation
  2. https://www.breitbart.com/economy/2022/09/13/underlying-inflation-reaches-scorching-new-record-high/

“Taxes now impose a greater burden on the average American household than the combined cost of food, clothing, education, and health care.”

Inflation Reduction Act and IRS Enforcement

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Inside the Inflation Reduction Act is $80 billion in new funding for the IRS over the next 10 years. More than half of that new funding is slated for increased enforcement, including 87,000 new agents.

The president and IRS Commissioner say they won’t go after anyone making less than $400,000 a year with the increased enforcement. But, in reality, they won’t go after any wage earners making less than $400,000 on a W-2.

Yet, small business owners don’t appear to be included in this limitation. Thus, many law-abiding small business owners and high-net-worth individuals will find themselves the target of increased scrutiny, enforcement and costly audits.

If Congress were accurate, this bill would be called the Small Business Disruption Act, writes Tom Wheelwright, CPA, CEO of  WealthAbility, and the bestselling author of  Tax-Free Wealth: How to Build Massive Wealth By Permanently Reducing Your Taxes.

Bottomline, high net worth individuals, growth-minded entrepreneurs, small business owners and strategic investors need a plan for the IRS pending increased enforcement.

Here are three ways, according to Wheelwright, to protect yourself from the upcoming onslaught of audits.

1. Get a CPA Who Isn’t Afraid of the IRS

The question isn’t will you get audited by the IRS; it’s when. The IRS has been getting more aggressive in how it approaches certain types of taxpayers for years. Rather than make an effort to root out actual tax cheats, the IRS has been challenging legitimate tax incentives.

You’ll need a CPA who isn’t afraid to stand up to them. As the client, you should never speak with the IRS. That’s what your CPA is for. If your tax advisor seems uncomfortable with this idea, that’s a clear sign that it’s time to make a change.

2. Make Sure Your CPA Is Preparing Your Tax Return in Ways That Minimize Your Chance of an Audit

While you may not be able to avoid an audit forever, there’s no reason to position yourself at the front of the pack. There are choices that your tax preparer makes in creating your return that will either raise or lower potential flags to the IRS. All of these choices are legal options, but the terminology and methodology make a difference.

Ask your CPA for specific examples of how they are reducing your risk of an IRS audit. You want someone who can give you a clear plan and who demonstrates a level of confidence that reassures you they can deliver.

This shouldn’t mean missing out on tax deductions to which you are entitled. Missing out on tax incentives and deductions is like making a voluntary donation to Washington, D.C. No solid tax strategy makes this tradeoff.

3. Invest in Education and Advice

The government offers many compelling tax incentives to encourage investment. One of the keys to tapping into these incentives is ensuring you have the information and guidance you need to maximize your results. Take the time to learn how these programs work and, when needed, bring in an expert.

It’s not enough to have the right technology and equipment at the right price. You need to make sure you’re also structuring and documenting your purchase to maximize the available tax incentives.

With the IRS bearing down on small business owners, now is the time to surround yourself with high-powered tax professionals who will protect your interests.

References:

  1. Tom Wheelwright, What The Inflation Reduction Act Could Mean For You, Worth, August 22, 2022. https://www.worth.com/inflation-reduction-act-irs-80-billion-funding-increase-audits/

Qualified Dividends vs. Ordinary Dividends

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The distinction between Qualified and non-Qualified dividends has to do with how you’re taxed on those dividends.

  • Qualified dividends are taxed at 15% for most taxpayers. (It’s zero for single taxpayers with incomes under $40,000 and 20% for single taxpayers with incomes over $441,451.)
  • Ordinary dividends (or “nonqualified dividends”) are taxed at your normal marginal tax rate.

The concept of qualified dividends began with the 2003 tax cuts. Previously, all dividends were taxed at the taxpayer’s normal marginal rate.

The lower qualified rate was designed to fix one of the great unintended consequences of the U.S. tax code. By taxing dividends at a higher rate, the IRS was incentivizing companies not to pay them. Instead, it incentivized them to do stock buybacks (which were untaxed) or simply hoard the cash.

By creating the lower qualified dividend tax rate that was equal to the long-term capital gains tax rate, the tax code instead incentivized companies to reward their long-term shareholders with higher dividends. It also incentivized investors to hold their stocks for longer to collect them.

Qualified Dividends

To be qualified, a dividend must be paid by a U.S. company or a foreign company that trades in the U.S. or has a tax treaty with the U.S. That part is simple enough to understand.

Importance of dividends

From 1871 through 2003, 97% of the total after-inflation accumulation from stocks came from reinvesting dividends. Only 3% came from capital gains.”

To put this into perspective, take a look at the example used by John Bogle, where he writes: “An investment of $10,000 in the S&P 500 Index at its 1926 inception with all dividends reinvested would by the end of September 2007 have grown to approximately $33,100,000 (10.4% compounded). If dividends had not been reinvested, the value of that investment would have been just over $1,200,000 (6.1% compounded)—an amazing gap of $32 million.” The reinvestment of dividends accounted for almost all of the stocks’ long-term total return.

Dividends are an important consideration when investing in the share market as they provide a reliable source of return while you wait.

References:

  1. https://www.kiplinger.com/investing/stocks/dividend-stocks/601396/qualified-dividends-vs-ordinary-dividends