Wednesday, November 02, 2005

New tax proposal

I spent most of my subway ride this morning gasping at the various provisions of the new tax plan proposed by President Bush's advisory commission, as I realized that almost every single facet of the plan seems to negatively impact me.

New tax brackets: I would pay more tax on my income. Not that much more, maybe, but if I assume $70,000* of taxable income, under the 2005 brackets, I'd pay tax of $14,165 and under the new plan I'd pay $14,500.

But some of the deductions are also changing. Since I itemize my deductions every year, I might not be able to reduce my taxable income as much, and I'd end up paying even more than that $14,500 in tax. For example, they want to deny any tax break for charitable donations that are less than 1% of your income. My charitable donations (cash donations and the value of stuff I give to the Salvation Army) wouldn't come to much more than that, so I would lose most of what I can currently deduct for that.

Also, if you've been reading this site for long, you may have guessed that I am somewhat interested in possibly owning a home someday! One of the great benefits of doing so would be the tax break on mortgage interest-- it's one of the things I am counting on to make home ownership affordable. Under current law, if I took out a $200k mortgage, the interest payments in the first year would lower my taxable income by almost $12,000. Going back to the scenario above, if my taxable income was $70k before, that would bring it down to $58k, and my tax would go down to $11,165. Under the new scenario, I would only get a tax credit of 15% of my mortgage interest, so my tax would be $12,700.

They also plan to eliminate the deduction for state income taxes-- since New York has quite high state taxes, this would be a real hit for me.

Are there any mitigating factors in this plan that would benefit me? One thing cited as an upside is that families with many children will make out better-- should I try to get pregnant instead of buying a home?? I don't think so! And profits from stock sales and dividends will be taxed less-- my stock holdings aren't large, and I hardly ever sell them. My dividends are not huge either, and I may be wrong about this but I think many of them are non-taxable anyway, since they are from bond funds or Roth IRA holdings. The proposed simplification of retirement plans might benefit me in the long term, but the amount I could contribute each year would be lowered (from 2006's $15k limit to $10k), again preventing me from cutting my taxable income.

Who knows if this thing will come to pass, but I sure hope it doesn't. Maybe these changes would only make a difference of a couple thousand dollars to me, but for someone in my position, that money is significant. Meanwhile, tax rates are being cut for people making over $300,000, and those who make make large profits from stocks and dividends. The NY Times article gives the example of a top-bracket taxpayer who sells stocks for $1 million of profit. That person would most likely pay $150,000 of tax on that profit under current law-- under the new plan, they'd only pay $82,500. Does an extra $67,500 really make a big difference to a person who is making million dollar stock sales? Do they run out and spend that money in ways that drive the US economy or do they take a private jet to Europe and spend the money there? And on the flip side, if you told that person they would be taxed $67,500 MORE, would they really throw up their hands and decide being productive wasn't worth it anymore? Would their spending and charitable donations come to a grinding halt?

I won't rant on and on about it... I'm sure you get the picture.

*I don't have the real number handy but I believe it was somewhat less because of all my deductions-- this is just a ballpark example.


Anonymous said...

Ugh - I hear you. I just hope this tax revisal goes the way of his privitization of social security (meaning goes no where).

Great post!

Anonymous said...

People in NYC are gonna to get killed. It should be called the anti northeast tax changes. Our mortgages are higher, we pay the highest state and city taxes, and we don't have kids.

Anonymous said...

Have your cake and eat it too.

Been reading your posts on buying a house, and I have one question for you.

Why are you thinking of it as Buy OR Rent? Why not Buy AND Rent?

You have a low rental cost - as you've remarked, it's financial folly to trade that in for a higher instalment payment.

In the long term, you don't know if that'll remain, and buying a house seems to make most financial sense. If so, better early than late.

Combine the two. Look for a house that you like (and would like to live in).

Next - plan on renting it out for the immediate future. So evaluate your costs based on that.

If you can get a house that's cashflow positive i.e.rental income > PITM (Principal, Interest, taxes and maintenance) - that's a beautiful situation to be in. Because the tenant pays for your house.

If it's cash flow negative i.e. rental < PITM - then you've got to evaluate it. But even then, if the extra is marginal - imagine, an additional payment of $100 / 200 per month gets you that house worth a quarter of a million. That's a lot better than payments of $1000 + for the same house!

As long as you have a good rental deal, stay put! Even if the rent were to be slightly increased, as long as it's significantly lower than your rental inflow, it makes sense to keep renting - and if you need to, check out alternative rentals before chucking out that tenant.

I don't know NYC property well, nor am I able to comment on the tax aspects, but I'm betting you could either do it yourself, or find advice on these.

Hope this helps. Best wishes.

Madame X said...

You're right, in some ways that would be the best of both worlds, but unfortunately, in NYC right now, it is pretty impossible to make that cash flow positive. Rents have not increased much over the past few years, while the cost of owning has gone way up. If I could afford to buy a 2-family home where I could live in one part and rent out the other, it might be profitable-- but that kind of property starts at around $750,000 if it's kind of sketchy, and easily soars over $1 million.
But to buy a studio or one-bedroom co-op apartment or condo, which is all I can afford, would probably cost me about $200 a month more than what I could rent it for.

Caitlin said...

I wasn't too thrilled with these proposals either when i saw the neat little table in the free USA today. Ugh indeed.

Anonymous said...

Madame X

I tried to download your spreadsheet from the link in Hi-Tech Vacillations, but looks like it's no longer available. Do you still have a copy available? I'd like to run the numbers and check it out.


PS : I made an article out of this for my blog, and have referred to your post as the inspiration - FYI.