With the economy still in its lackluster mode, many believe the worst is still in front of us. Unfortunately, as we head into the new year, there is a wide range of adverse tax changes that pertain to tax credits, tax deductions, sales taxes, and other tax rates you should know about. Having a better understanding of what tax law changes are coming can help you plan ahead to potentially lower your tax liabilities. Many of these projections are based of off Obama’s proposed budget. A lot of changes may be up in the air, but you can be pretty sure that on the whole taxes are going up! Although this list is not all inclusive, the major changes that could impact you are detailed below.

Changes With Income Tax Credits – Generally, a tax credit is a direct reduction in tax liabilities, and is usually put into place in order to encourage a certain behavior. Sometimes tax credits can even result in a refund. This is different from a tax deduction which only lowers your taxable income. Below are a few tax credit changes we will see in 2011 and a few weird ones that already went into effect:

• Child Tax Credit Reduced – In 2011, the child tax credit will be cut in half to $500 per child and may not even be applicable to all taxpayers. For those filing jointly, the tax credit begins to phase out at $110,000 (AGI) and for taxpayers completing a single tax return at $75,000. While President Obama has mentioned the possibility of increasing this tax credit for families that fall under the middle class, no action has thus far been taken.
• Making Work Pay Tax Credit Gone – This year workers are able to get a tax credit for 6.2% of their earned income with a maximum credit of $400 for single filers and $800 for married couples. In 2011, this tax credit will be eliminated unless Congress acts as Obama’s proposal seeks to extend this credit in 2011.
• Earned Income Tax Credit Reduced for Some – This is a tax credit for low-income working families with earned income less than or equal to $48,362. The income limits on this credit vary by your filing status and by the number of children you claim as dependents. In 2011, the EITC is expected to decrease for families with three or more children with higher income phase outs eliminated.
• Hope Tax Credit Changed – This tax credit goes back to being only applicable for the first 2 years of college and the limit goes from being $2500 to $1800. Of course there are income limits as well with this credit. Obama has stated he wants to make the changes with this tax credit in 2010 permanent but nothing is set in stone yet.
• Energy-Saving Credits Gone – The current 2010 credit for principal residence homes making changes to housing insulation, windows, doors, HVAC equipment, water heaters and more will expire next year. This tax credit allowed up to 30% ($1.5k max limit) back with applicable energy efficiency improvements.
• HomeBuyer Tax Credit for Veterans – If you or your spouse are part of the Armed Forces, Military Intelligence or Foreign service and have been engaged in activity duty for at least 90 days outside of the United States you have until Aprill 30th, 2011 to sign a real estate contract and close by at least June 30th, 2011. Be sure to make note of this date if you intend on purchasing a house and claiming this credit.

Changes With Income Tax Rates and Other Taxes – Tax rates refer to the percentage of taxes that need to be paid with regards to income tax rates, estate transfers, and capital gains.

• Estate Tax To Increase – The Estate Tax, also referred to as the Death Tax, a term that may hold more meaning to many taxpayers, is set to return. Through the Economic Growth and Tax Relief Reconciliation Act in 2001, the estate tax has been phased out over the past 10 years but will unfortunately reach an end this year. This means that unless Congress has a dramatic change of heart, the estate tax will not only return but is set to increase to 55% for homes valued over $1,000,000 dollars (under Obama plan this tax rate is 45%). Therefore, 2010 becomes the year to die!
• Capital Dividends and Gains Hikes – Those who fall within the upper tax brackets should prepare themselves for a changing rate. After this year, the current 15% long-term capital gains rate will return to 20%. However, those in the upper tax brackets will not bear the weight alone as most brackets will be affected. Under former President Bush, the lower 15% income tax bracket had a 0% capital gains rate but this number is expected to rise to 10% in 2011. For the upcoming year, dividends, excluding mutual fund capital gain distributions, will no longer be taxed at 15% for those in the upper tax brackets but will instead is set to be taxed as income. While President Obama is proposing that the dividend rate mentioned here simply be increased to 20% no action has been taken. Regardless of the outcome, those in the upper tax brackets will be faced with a higher tax on dividends.
• Income Tax Hikes – President Obama’s proposed budget for 2011 will extend changes to not only income tax rates but income brackets as well. However, tax breaks for single taxpayers with an income of less than $200,000 and married couples earning less than $250,000 will be exempt from any changes (under his plan). As far as brackets are concerned, the 28% tax bracket is predicted to rise. The 33% tax bracket is also forecasted to increase to 36%. Similarly the top 35% tax bracket is expected to be 39.6% by next year. More importantly, our government is expected to go back to discouraging marriage and the family as the well known “Marriage Penalty” will return with narrower tax brackets and the fact that the standard deduction will not be doubling for married couples what it is for single filers (those slated to get married this year or next will be discouraged to do so, if only marginally).

Changes With Tax Deductions – A tax deduction is not a tax credit. Instead, a tax deduction lowers a taxpayer’s gross income or tax base in exchange for a certain behavior or action. Therefore, it normally reduces indirectly by lowering the amount the taxpayer pays.

• Mortgage Insurance Premium Deduction Gone – Beginning January 1, 2011, taxpayers will no longer be allowed to deduct mortgage insurance premiums from their tax returns. Previously, homeowners who were paying insurance premiums for mortgage contracts that were signed after December 31, 2006 were able to take this deduction assuming they fell within the income cap of $100,000 for families.
• 179 Business Expense Deduction Lowered – For 2011 there are several business taxes that will be affected. The section 179 expense deduction that pertains to small companies and firms emerges as a prime example. Here, the maximum expenses deduction will see a significant decrease from $250,000. Of course, as with all tax deductions, other limitations apply.
• Student Loan Interest Deduction Limit Changes – For 2011, individuals or married couples can only deduct interest from the first 60 months of the repayment term. Moreover, the phase out income limits for claiming the deduction for both single filers and married couples will come down.

Sales Tax & Other Tax Increases That May Affect You:

• Tanning Tax – This tax is an excise or sales tax for those individuals who love to brown their skin. This tax will continue next year and it just started at the beginning of this month. Although it is a mid-year 2010 tax, it is still a new tax that will primarily impact individuals at the end of this year/start of next year as fall and winter approach.
• Brand Name Pharmaceutical Tax – This tax is an annual tax assessment on brand name pharmaceutical companies which amounts to a total of $2.5 billion for 2011. The end result is that many of us will see our brand name drug costs going higher.

Other Notable Tax Changes:

• Coverdell ESA and 529 Plan Alterations – Previously, under a 529 Plan, taxpayers with children were encouraged to invest after-tax money into an account that increased with tax free withdrawals assuming the money was being used to contribute towards educational plans. However, in 2011, 529 Plan withdrawals will not be tax free when paying for the cost of computers or internet access. Coverdell ESA Plan will see changes as well. This plan is similar to the 529 Plan but is directed towards elementary and secondary educational costs. In 2011, the maximum contribution limit per year on this plan will drop dramatically from $2,000 to $500 unless Congress moves quickly.
• HSAs, HRAs, and FSAs Cannot Be Used for Over The Counter Medicine - Americans will not longer be able to use Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs) and Health Reimbursement Accounts (HRAs) to purchase over the counter medicine if it is not insulin.
• Economic Substance Doctrine – This sounds confusing but basically is a new IRS provision that gives the IRS more power. If the Internal Revenue Service deems perfectly legal tax deductions as not having “economic substance” because the underlying transactions were enacted to avoid taxes, your business could face penalties. (Weakonomist note: this is very interesting.)

Many of these changes could be reversed if Congress acts as many bills in congress address many of these deductions, credits, and tax hikes. Given the economic environment, the President is in an inevitable tough situation as he doesn’t want the deficit to grow any more than it needs to but yet he doesn’t want to raise taxes especially during tough economic times. Pressure from Congress to curb the rapidly growing deficit coupled with cries from the public against increased taxes leave policy makers with little hope for compromise.

It looks like while I was traveling last weekend, I missed out on the beginnings of a debate that I had long forgotten about. That is, should employers be allowed to check the credit of their employees, especially when they are in the process of hiring them?

This is a practice that has gone on for many years, whether you knew it or not. Employers will look at your credit score and detailed report the same way they’d order a drug test or criminal history. What are they looking for? Signs of misdeeds, bad mojo, and irresponsibility perhaps.

More specifically, they are probably looking for people that are responsible, and in good financial health.

But there are issues with looking at the credit history. If you judge someone based on their credit score alone, you may miss that their score is low because of a terrible accident with high medical bills that wasn’t covered by insurance for some reason. Or maybe they’ve inherited wealth and never need to borrow money. Both of these can’t have a meaningful impact on someone’s employability.

But the issue goes deeper. Look at the standard process for hiring someone. Drug test, interview, criminal history check. What are they looking for? They want to make sure you aren’t taking illegal substances, are the right fit for the company, and don’t have a criminal past. The drug test is fine I suppose, though I could rip that apart in another post. The interview makes perfect sense. And what about the criminal history? They are looking at that because past actions are a predictor of future ones. You don’t want to hire the guy that did time for embezzlement to run your books.

My main concern with the credit history is that it doesn’t give you anything to work with. At worst, the candidate is a compulsive shopper and buys too much crap. Does that make them a bad employee? I don’t know, but I bet you can find out by doing an interview, and checking references and employment history. If someone has credit issues, I’d say they’re more likely to do whatever it takes to get the job done than they are to try and take money.

Perhaps now is the time to start doing some serious research into the correlation between credit history and job performance. It may actually be a good predictor of something, but as far as I know the jury is still out. Use them if you’re hiring tellers, accountants, and the people that pick up cash from stores. But as a general indicator of job performance, it’s more likely to be useless and should be excluded until a general body of research suggests otherwise.

Now what say you? Am I off-base? Do you have some experiences that say otherwise? I haven’t hired people before so my perspective is on the outside looking in.

Photo: Quinn Anya

I just got back from a wonderful trip to the beach with my extended family. My friends just got done playing host to some of their friends. We had very different experiences.

The family dynamic I’ve grown up in has been one of mutual contribution. When we all go to the beach the parents all threw in equal amounts to rent a house and equal amounts to purchase food. Everyone is trusting and no one has broken the trust. Nowadays the kids are all grown up. We had a separate house with our own budget. None of us can really stay the whole week so we broke it down to a metric of person/night cost. So of all the people staying there, we had a total of say 50 people/nights. If the place we rented cost $2000 then for every night you stay you pay $50. The system worked well and we’ll probably return to it in future years. People staying a whole week paid more, and people staying less paid less.

My friends experienced a different situation. It was one with less planning, but should be no more difficult. Friends came to visit them and my friends (we’ll call them the Smiths) rented a few places to stay on various evening excursions. They paid much of the upfront cost, thinking this was okay since their friends drove halfway across the country to see them. But it was never explicitly stated that the Smiths were going to pay for everything. The friends, let’s call them the Johnsons, never offered to pay for anything. We’re talking everything from gas for a boat to a hotel at the beach.

After a few days the Johnsons started to distance themselves somewhat. They made their own plans and did not make much effort to include the Smiths. And after a series of other events the Johnsons left a day early while the Smiths were away at breakfast. The status of the friendships between these couples is now in question.

Let me give everyone some advice on how to deal with the finances in situations such as these. It’s best to plan ahead so everyone knows who is paying for what. But that can’t always be the case, so we have to be a bit more flexible. This usually involves dealing with expenses as they come up. Getting food for the week? Offer to buy the groceries if they pick up the tab when you go out to eat a couple of times. It might not balance out but what’s a few bucks between friends. Or you can split everything 50-50 and just keep a running total.

There are a few red flags to watch out for though. Someone may take advantage of the situation. If so, take note, and either confront them about it or just not invite them back next time. Someone may object to the system being used, and want to opt out. They may have a legitimate reason, so listen to them and remember what’s a few bucks between friends.

Finally, how do you deal with a situation in which someone does promise to pay for everything or more than their fair share? Aside from numerous thank-yous and continued offers to pay for things, perhaps the most appropriate response is some kind of gift. A bottle of wine, a token keepsake, just something that merely acknowledges the effort made by the one paying.

These are not hard and fast rules, and this isn’t the way to do it every time. Whenever you think there is an issue with finances in groups like these, ask yourself if it is worth sacrificing the relationship. Sometimes it is, sometimes it isn’t.

Photo: mikebaird

I’m currently writing this post from my hotel room.  We arrived last night and will leave just as this post is published.  I cannot stress enough the importance of reading reviews for hotels.  This goes without saying for any product or service. 

But, reviews are always skewed and should be appropriatly discounted.  Allow me to offer the what the typical hotel reviewer might write about our experience here:

Now, let’s interpret what really happened.  The hotel had no vacancy, which means every room was filled and all the employees were going to be overworked (by design, this is how all hotels operate).  I spoke to an employee and they also mentioned they were short a cleaning lady.  This makes the process of cleaning up rooms properly difficult.  The reason the halways smelled funky was a combination of children running around from the indoor pool, and just the overal stench of people dealing with 100 degree temperatures.  And finally there is the price to consider.  People always take this for granted.  We paid below the market rate for this hotel.  While it is new and the rooms are nice, if you pay below market then you have to expect below market service.  This means sometimes an unfolded towel and a crappy breakfast.  Considering what we paid, we got our money’s worth of it.  Dealing with small annoyances is the price you pay for saving a few bucks.

There is one last issue with hotel reviews.  It is very unlikely that any of them actually told the hotel about their experiences.  Service is everything in a hotel, if you get bad service they want to know about it.  You may not see a discount or a refund, but if you don’t complain directly to those in charge and merely post an anonymous bad review online, then you aren’t really helping anything.  I’m going to notify those in charge about our somewhat unpleasant experience, but I will also discount the circumstances.  And because I still think I got what I paid for, I’m not going to post a review online at all.  It was neither good nor bad.

It’s no secret that Social Security is a mess. Way back in the days of George Bush the Republican Administration tried to get reform off the ground, but no one cared at the time because everyone was going to retire by selling their homes. When the economy does well, we don’t care about social security (SS) because it matters less. When times are bad we’re too focused on getting back to the good times to care.

Well good times or bad, SS is a mess. It was designed on the premise of a Ponzi scheme. And as long as the population kept growing it wasn’t a problem. But the post WWII adults weren’t into prophylactics so we ended up with a bloated generation. They stocked up the SS fund quite well, but because of more people living longer and Congress treating the trust like a money machine, SS has problems.

But there is good news about SS. People know that the system is broken and people like me generally expect to pay in and get nothing back. Even the old people expect to have their benefits cut or altered.

The part of me that thinks about what’s good for the country thinks this is the right time to go ahead and introduce reform. Since we already know the system is broken, let’s go ahead and fix it. But the politician in me knows that it’s not going to happen, because whichever side of the aisle introduces legislation will risk alienating the constituency partially by the other side objecting to every measure. The Democrats have control for the moment, but they wouldn’t dare doing anything that could lose a voter right now. And the Obama administration has seen the consequences of trying to do too much at once. DC is like a game of pool, as much as you want to just pick up the 8 ball and put in the corner, you have to knock all the other balls in first. Who is going to have the stones to break the rules? No one currently in office.

And just to review, what will reform look like? Could be anything, but we’ll probably see a combination of tax increases and raising the retirement age. The program should be phased out, but we’ll see that right around the time Medicare shuts down and Wall Street converts to non-profit.

Poor people, gross. They’re everywhere. They beg for food or money, live off the government, and work low wage jobs. Thank goodness they live in the cities and aren’t disturbing my queit, sheltered life in the suburbs. Whether you say it out loud or not, when you see someone you deem as poor, part of your subconscience is thinking what I just said. You feel guilty for thinking it, so do I. You also don’t 100% beleive it. You have some compassion for the poor, but the fact that most of them live in the cities is hardly what you would call “a bad thing”.

Well, sorry to burst your suburban bubble, but the poor are moving out of the beltways and into the burbs, at least according to a report by the Brookings Institute on income migration, which studied the geographic movement of the different income classes from 2000-2008. To say they found interesting stuff would be an understatement.

Before we get to some of the cooler stuff, let’s get the stuff you should know out of the way first. Let’s look at some cities with the highest poverty rates. If you live around the Great Lakes, you win. Rochester, Syracuse, Buffalo, Cleveland, and Detroit all are in the top 10, as well as Youngstown, OH. Sharing the top spot with Youngstown is Hartford CT with a urban poverty rate of 33.5%. When you look at towns with the lowest poverty rates, you’re looking at San Jose, Honolulu, Boise, and Norfolk VA. The average of the 10 with the lowest poverty rates works out to about 10% and the average among all the cities is about 18.2%. It’s no surprise why the towns stack up where they are. Rust belt jobs are few and far between these days thanks to automation and offshoring. Many of the towns with low poverty rates are vacation destinations so the people that live there tend to have made good money and settled in to the towns they like.

But what is much more insteresting is the poverty rates in suburbs. I won’t give away the juicy bits, but if you live south of I40 or in California’s case, east if I5, you’ll be disappointed. You also won’t be surprised with many of the suburbs with low poverty rates as they’re centered around titans of commerce such as LA, DC, Boston, and NY. All this can be found on page 6 of the report.

Again, no real surprises here. But let’s look at the migration of the poor over the last decade on page 9. This is much more interesting. Let’s look at Baltimore. Baltimore does really well in the category of having a low poverty rate in the suburbs. But all is not well. The poor are moving out of the city. In 2000, 41% of the poor lived in the burbs. In 2008, that number had jumped to more than 50%. If that swing doesn’t sound significant then let me rephrase it. Baltimore is third only to rust belt Cleveland and Katrina stricken New Orleans in terms of suburban poor migration. Atlanta isn’t far behind in growth of poor in the suburbs, but for them the stats are different. 85% of the poor in Atlanta live in the suburbs, which as far as I could tell is tops in the country.

What’s going on in the towns where the poor are moving to the suburbs? I’ve got a definitive answer, and a theory. The known cause is certainly the recession. Even though this data was for 2008, that was far enough along for people to start feeling the pinch. It may not have been so much as people in the suburbs getting new neighbors, just that those neighbors they had crossed the line into poverty. Of course the subprime loan fiasco put more poor people in homes, which I can imagine played its part as well. But I’ve got another theory.

Urban areas are pushing the poor people out. I’m not going to tell you where I’ve been lately, but I am in an area where I commute into the city via a rail system. Here’s what I see on the rail, white collar people are heading into town. As I get off at my stop I see who is waiting to head out of town for work. They’re wearing uniforms distinctive of retail and service jobs that pay low wages. You could sum my oberservation up as the high income workers are commuting in, and low income workers are commuting out. As we all get tired of commuting, we start moving closer to work. This hardly represents the majority of us, but especially the people of my generation, we’re interested in living closer to work.

But the poor are being forced out of cities in another way. Has your local urban area put in some hot new condos lately? I’ll bet they have, especailly since this recession is still very much a blue collar one. Chances are that condo flattened some kind of lower-income housing to move in. That is a direct displacement of the poor right there. Just the other day my wife and I scouted out some “green” residences we saw online close to the downtown area, only to discover they’re right in the heart of a rough urban area. Even though these houses only took up a couple of acres of space, older, low-income homes were clearly flattened to put them up.

Will there be an all out shift of the poor to the outskirts of town?  No.  But we are seeing a trend where the lines are starting to blur.  It will be interesting to see what happens as we recover from the recession.  Will the trend continue, or will there be a reversal?  It all depends on where the jobs are, which is where the people are.  Chicken, meet egg.

Photo: Wm Jas

Yesterday, I wrote about how behavioral economics doesn’t seem to do much for getting people to be smarter about what they’re eating. But because policy is so hard to implement, politicians don’t try to do introduce the kind of legislation that could actually make a difference.

Years ago, I’ll bet people said the cigarettes were bad for you. People knew this, but continued to smoke anyway. Thank goodness those days are behind us right? It took a generation of publicity announcements to get people off of smoking, but in the mean time taxes were introduced as a means of curbing some smoker’s desires. The effectiveness can be argued, but it surely works for some, especially if the tax revenues are used for awareness.

Which brings me back to fat people. I am myself, not skinny. I’m not fat, but I’m definetly in that “I’m married and don’t have to try anymore” category. My biggest vice is ice cream, which has plenty of sugar and fat. For other people their vice is steak, or doughnuts, or beer. Whatever it is, many of us have something that we take in too much of, and it adds pounds. Obviously, putting calorie information on packaging doesn’t work, I look at the calories every time I buy ice cream. But I do believe there is some kind of tax that would keep me from eating as much ice cream.

Fat tax.

Fat tax can come in many forms. A tax on high fructose corn syrup, fat, calories, desserts, whatever. But I have a different system in mind. Volunteer yourself to join a government program where you are weighed and measured for fat content. You pay a tax of a certain amount over an “ideal” amount. Next year, you go back and do it again. If you are still above the “ideal” you pay a tax again, proportionate to what is ideal. Once you get below the ideal amount, the goverment starts paying you in the form of tax breaks. But the deal is you have to continue to do the checkup every year to get the break. If you stop coming, you don’t get the break.

The fat people paying the tax would offset the skinny people getting a break. And of course, if you’re already skinny, you can get in on the game to make sure you stay skinny. There would be a downside limit to keep anorexics from bankrupting the program.

I know this system isn’t perfect, and there are plenty of ways to game it. But there are ways to game any system. Maybe a tax on calories or sugar would be better. You can use to the revenue to subsidize healthy foods, making it cheaper for people that can’t afford it. I currently pay $1.80/lbs for apples, I’d buy more if it were $1. Same goes for lettuce, I love salads.

The reason I like my system is that it’s opt-in. And if you don’t think huge people will sign up, think again. The program would be a one-time only enrollment. So if you ever want to get money back, you have to enroll at the start.

Again, this system may not be perfect, but I am all for some kind of fat tax. It will work on me, but I don’t have the willpower to do it to myself. Bring on the fat tax.

Photo: Michael Dawes

Why did behavioral economics get so popular so fast? What, you read a book about it and were fascinated so you started a blog just so you could talk about it? Oh wait, that’s me. But that is kind of how behavior economics did become so popular. People were fascinated by it because it offered simple solutions to real life problems.

For example: employers want to get their employees to enroll in 401ks, but they aren’t. They were given the materials on investments, told they need to do this if they want to retire, and even pointed out they’d get free money from the company in matching contributions. But many people still didn’t sign up. I’ll let you read the books to find out why, but behavioral economics has a solution. Auto-enroll people and the problem goes away. People are forced to opt-out, and few do so.

Behavioral economics focuses on the bad decisions we make, despite those decisions not being the rational ones. It’s rational to save for retirement, but many don’t. It’s no wonder behavior economics has become so popular, in many cases, the solution to a problem is simple.

But behavioral economics can only go so far, as we’re starting to learn. The minds inside the DC Beltway have caught on to the this new wave and legislation is starting to reflect some of the discoveries in this new field of research. For example, to deal with the problem of fat people in America, the healthcare reform bill includes items such as requiring calories on menu items in restaurants. A better-informed consumer will make smarter decisions. But studies are showing this doesn’t do much for getting people to eat less.

This is where traditional economics can step in where behavioral economics cannot. The problem is traditional economics pisses more people off. To fight the problem with obesity, we could start subsidizing fruits and veggies instead of high fructose corn syrup. This will drive the cost down of healthy foods. That will piss off corn growers, who I’m guessing have a stronger influence on Congress than restaurant owners. All this is a summary of what two dudes wrote in the NY Times last week about behavioral economics. But I want to take it one step further.

How do we solve the problem of Congress taking the easy way out? The solution is easy, but hard to implement. Limit Congressional terms. It doesn’t matter what the limit is, because once a Congressman can’t run anymore, then they’ll start passing stuff that’s good for the people. Just look at Chris Dodd. As chair of the Senate Finance Committee, he was no doubt in the pockets of Wall Street. He received some great contributions from the likes of AIG, Fannie and Freddie, and everyone else; even a great loan rate from Countrywide. During the financial crisis in 2008 he objected to the actions of Paulson’s Treasury Department while claiming these companies were fine.

But, I’m sure sometime in 2009 he decided he wasn’t going to run anymore so he got involved in the CARD act and the newly minted financial reform bill. Not only that, but he even flip-flopped on his position about gay marriage (he now supports it) in 2009. It’s amazing what you can accomplish when you don’t have to worry about raising money anymore. So let’s fix the real problem with policy by allowing Congress to make rational decisions not having to worry about raising money from wealthy donors with certain positions they want you to take.