Taxmageddon Approacheth

Posted On Oct 29, 2012 By Dave Gonigam

October 29, 2012

  • With one nervous eye on Hurricane Sandy and another nervous eye on Washington, D.C., The 5 begins a new week…
  • Two takes on the year-end “fiscal cliff”: Byron King on the dire consequences if there’s not an “AMT patch”… while our income desk revisits a successful strategy from two years ago
  • “If and when things get choppy”: How Barry Ritholtz is bracing for a new cyclical bear market
  • Shocking fakes in the gold market… the 3-D gun project resurrected… a reader’s unfortunate encounter with Customs and Border Protection… and more!

  The stock market is closed… but The 5 is up and running. At least for the moment.

By noon EDT today, the forecast calls for Hurricane Sandy to assault Agora Financial headquarters in Baltimore with 35-45 mile-per-hour winds, and gusts as high as 70. Most of our team is working out of their home offices scattered hither and yon — a decentralized system that we hope will prove resilient; if power goes off in one neighborhood or suburb, perhaps it will remain on elsewhere.

Meanwhile in New York the NYSE and the Nasdaq are both closed today. Last night the buzz was that floor trading would close but electronic trading would still be available. In the end, they decided to shut the whole thing down. A decision about tomorrow will come later today.

Naturally the politicos are trying to look as if they’re in control…

We’re not sure which was more disturbing about the president’s briefing yesterday afternoon: That guys in combat fatigues were sitting behind him… or that someone made a conscious PR decision to sit guys in combat fatigues behind him because the military is the only institution left in which substantial numbers of Americans feel confidence (75% according to a Gallup poll last summer).

And now to your regularly scheduled programming…

  “It’s like ripping the bandage off a bloody wound,” Byron King vividly describes the upcoming “Taxmageddon.”

“You’ve got less than three months before the tax asteroid hits,” he announces.

Byron is back on the tax beat, and this time it’s all about the Alternative Minimum Tax (AMT).

“The short answer,” Byron says between a long breath, “is that it’ll be brutal.”

We’ve called upon no less than three of our editors this morning to give you a few things to think about as you approach year-end tax planning.

Starting with Byron and the AMT.

  “You may be surprised,” says Byron, “to learn that the U.S. has two tax codes. The AMT is a standalone system, paralleling the one with which most wage-earning Americans are familiar.”

Where did it start? In the late 1960s, in the thick of the Vietnam War, it was discovered that certain millionaires were paying zero taxes. The media latched onto the story and Congress promptly created a new tax system — the AMT.

Because of this new tax system, Byron explains “every taxpayer is responsible for paying the higher amount of ‘regular’ income tax, or AMT.”

100  Here’s how it works. You (or, more likely, your accountant) calculate your tax using the IRS Form 1040. Then you calculate your AMT obligation under a less well-known form, IRS 6251. If the AMT number is larger, then the difference applies to your overall tax calculation.

“The bottom line,” Byron writes, “is that AMT doesn’t allow the standard deduction, personal exemptions or many itemized deductions — like those for state taxes, children, medical expenses, etc. Also some income that’s not otherwise subject to regular tax gets added back for AMT purposes.

“The AMT isn’t meant to be kind to taxpayers,” Byron explains. “It was a Vietnam-era wartime tax.”

  Although only about 20,000 were hit by the AMT in 1970, by 2011, that number rose to 4 million. “That’s during a period when overall national population rose by 55%,” Byron points out. “So now, AMT is much better known.”

What’s in store for next year? “According to the Tax Policy Center of the Brookings Institution, more than 31 million Americans will be subject to AMT in 2013.” That’s a leap of 27 million in a year… hardly a petty figure.

  There are two main reasons that AMT will reach out and touch more and more taxpayers. First, unlike the case with the regular income tax, AMT is not indexed for inflation.

“In that sense,” he writes, “AMT is a tax on inflation.”

Second? “The famous “Bush tax cuts” of 2001-06 reduced tax liability for regular income (the 1040 kind), without any permanent adjustment to the parallel AMT rates.

“Whoa! Wait! What does that last item mean?” asks Byron. In the past, as inflation rose, “Congress passed temporary ‘patches’ to the rates to keep AMT from impacting millions of otherwise middle-income individuals each year.

Guess what expires on Dec. 31, 2012? Yep… the patches.

“Clearly, the U.S. — and its taxpayers — is in a heap of trouble. There’s a tax avalanche coming. The most economically productive citizens are about to get slammed by a tax that was, originally, about ‘fairness’ during the Vietnam War. Yet Congress is in a complete bind over how to deal with it.

“I suspect that things will get worse before they get better.”

  “In November 2010, the tax situation looked exactly like it does today,” our income duo Jim Nelson and Kelly Green write, trying to lighten the mood a little.

“After all, that was the original expiration date for the Bush tax cuts. But as expected, Congress and the president kicked the can.

“This time around,” they go on, “the tax debate is also accompanied by the so-called ‘fiscal cliff’ that would trigger more than $1 trillion in budget cuts starting next year.

“That said, we noted an alternative way to protect a portion of your wealth in 2010. And there’s absolutely no reason you shouldn’t have the same this time around…”

What did they recommend their readers look at? Real estate investment trusts, or REITs. To learn why, let’s rewind a couple years…

“REITs don’t pay corporate taxes,” Jim wrote in December 2010. “Much like our master limited partnerships, the only taxes are paid by shareholders. Of course, just like MLPs, REITs have to pass almost all of their income to shareholders (90% in this case)… not a bad thing for us income investors.

“But the most important and often overlooked aspect of the REIT tax structure is its personal tax obligation. Investors in REITs are taxed at different rates depending on where that income comes from.”

Mr. Nelson and Ms. Green have come up with a total of three tax-advantaged investments. And they “are all great ways to trim at least a portion of your tax obligations… or defer it, if nothing else.”

Want to learn more about their income-inducing strategies? Click here.

  Stocks aren’t trading today… but futures are. And early on a Monday morning S&P futures are down ten points — below 1,400 now.

Commodity and currency markets remain open. Briefly keeping score…

  • Spot gold is nearly unchanged from Friday’s close at $1,709. Silver has slipped below $32 again
  • Crude is down three-quarters of a percent to $85.60
  • The dollar index has firmed a bit to 80.2.

Weather notwithstanding, the Commerce Department issued its monthly “income-and-spend” report this morning. Americans are either depleting their savings again, or running up the credit card: Consumer spending rose 0.8% in September, the biggest increase in seven months. Incomes, however, rose only 0.4%.

This report also includes the Federal Reserve’s preferred measure of inflation, “core PCE.” At 1.7% year-over-year, it’s still lower than the Fed’s explicit 2% target. As usual, any resemblance to your own cost of living is purely coincidental.

  I have cut back on some major holdings, and raised our cash levels to 25% in the asset allocation model I manage,” wrote Fusion IQ chief and Vancouver favorite Barry Ritholtz at his blog Friday.

“I removed half of our energy positions, eliminated our emerging markets exposure. The biggest move was cutting S&P 500 exposure by 50%. A handful of clients who had outsized Apple exposure saw those positions reduced by a third. We maintain a heavy bias in long portfolios in health care and in consumer staples. I have no desire to reduce Treasuries or munis, which will become a safe harbor if and when things get choppy.

“This is NOT a batten-down-the-hatches, go-to-100%-cash, looking for a 50-60% crash type of expectation. (We, um, already had that one.) Instead, this is looking like a regular earnings- and revenue shortfall-driven recession, with equity markets at risk for a 20-30% correction.”

In other words, another cyclical bear within the secular bear that began in 2000…

  As Chinese fakes go, this is as outrageous as it gets.
A factory in Wenzhou has been pumping out fake gold bars carrying the insignia of Australia’s highly respected Perth Mint.

Like a knockoff Coach bag, the resemblance isn’t perfect… but the kicker is that the bars — surprise, surprise — aren’t made of gold. Or not much gold. “First, we did the silver plating, then the gold plating,” a worker told an undercover reporter from Australia’s Seven Network.

Gold at $1 an ounce!The reporter paid A$300 for 300 bars. The real thing would have been worth A$510,000.

“If it looks like a deal that’s too good to refuse,” says the Perth Mint’s Ron Currie, “you should refuse it.”

  The Wiki Weapon is back in action…

Last we heard of the 3-D printable gun called the ‘Wiki Weapon,’… its creator, Defense Distributed, hit a snag. Stratasys, their 3-D printer provider, hastily collected the machines once realizing what was up.

Three weeks later, “the weaponeers have quietly restarted plans to build a gun entirely of printed parts,” Wired reports. “The group has also begun expanding their operation with outside help, including space for ballistics testing provided by a mysterious firm involved in the defense industry.”

The anonymous owner of the firm “wanted to offer me a safe haven, basically,” project founder Cody Wilson explains.

Shortly after, Wilson’s “safe havens” expanded when another company near his Austin, Texas, home already fitted with 3-D printing technology volunteered manufacturing space, too.

Which would never have happened had they not gotten their 3-D printers seized and gained attention from the media, Wired points out. As they say, all press is good press.

Mastermind Cody Wilson explains the logisticsDespite gun control advocates labeling Wilson an “extremist” involved in a “blatant, undisguised attempt to radically alter our system of government,” Defense Distributed pushes on.

Who supports the “extremist”? According to Wired, “a loose coalition of gun enthusiasts, techies, libertarians and Reddit geeks.”

  “I am a retired automobile dealer,” writes a reader in reply to the fellow who bought a car with a cashier’s check and was told by his dealer he had to be checked out on the government’s no-fly list.

“The list referred to is mandated under the Patriot Act, and while it may not be exactly the no-fly list, it is mandated to be checked for all sales, not just cash ones. It takes seconds to check and is not really a problem.”

The 5: Unless one believes that ordinary day-to-day transactions shouldn’t always come under government scrutiny. More grist for Addison’s “Liberty Manifesto“…

  “To continue the ‘War on You’ theme,” another reader writes, “my wife and I recently returned from a road trip to Mexico that we have made countless times before, incident free. The entry into Mexico was easy as usual, as there is no inspection typically required when driving a standard passenger car. Wave, smile and continue on your way… what a concept!

“The same, unfortunately, cannot be said for our esteemed U.S. Border Patrol. After having sat in line for two-plus hours, we finally reached the point where our documents would be checked and we would be on our way. Not so fast. After a few minutes, the officer came back and asked if I had ever reported my car as stolen. Since this unfortunate event had never occurred, I replied no.

“He walked around the car again and then disappeared for a few more minutes. Upon his return, he asked the same question again, to which I provided the same reply. He then informed me that my license plate number had been reported stolen by a woman in East LA. Even though I had every document imaginable to prove it was my car, he sent us to secondary inspection.

“Upon arrival, we waited for quite some time before another officer came to our car and started the Gestapo level of questioning again. He then went away with all of my documents in hand, not to return for over 30 minutes. At this point, he informed us that Border Control could not clear this up, as this was a California Highway Patrol (CHP) issue. Their only recourse was to contact the local police and ask them to come over and sort the problem out.

“After another 30-40 minutes, two local police arrived and started asking the same ridiculous questions yet again. They actually tried every trick in the book to ‘trip me up,’ as I was assumed guilty of stealing my own car, even though I had two government-issued photo IDs and vehicle registration with matching information, including my address in Northern California some 500-plus miles away from the location where the ‘theft’ was reported. Net result: four-plus hours wasted trying to get back into a country for which I continue to wonder if the effort was justified.

“Love the 5, and keep up the great work. You just need to get some talking head to read the 5 every night on the evening news in place of the Soylent Green propaganda that is spoon-fed to us now.”

The 5: You’re welcome.

It’s worth noting that you don’t have nearly as many rights at border crossings as you do elsewhere. Customs and Border Protection asserts the authority to search “documents, books, pamphlets and other printed material, as well as computers, disks, hard drives and other electronic or digital storage devices.”

Yes, they can sweep the contents of your laptop or smartphone. According to federal documents turned over only after a Freedom of Information request by the ACLU, 6,600 travelers had their electronic devices searched at the border between Oct. 1, 2008 and June 2, 2010. Half of those travelers were U.S. citizens.

If you suspected “land of the free” is more slogan than reality, you don’t know the half of it.


Dave Gonigam
The 5 Min. Forecast

P.S. “Worse than Katrina” is how meteorologist Mike Smith from AccuWeather Enterprise Solutions calculates the damage potential from Sandy.

“Katrina” is almost shorthand now for civilizational breakdown. In Baltimore, with Sandy, the looting is already underway.

Yesterday afternoon before the first hint of rain, my wife was carving a pumpkin when she noticed a man on our porch helping himself to a handful of our firewood.

We ran out and confronted him, and he promptly dropped the ill-gotten gains.

It would be one thing if it was a homeless guy who figured on using it to keep warm under the Interstate 83 overpass a few blocks away. Instead, he was wearing a Ralph Lauren Oxford shirt. He looked to be in his 20s.

“The store ran out,” he lamely tried to justify.

“As if that’s my problem,” I replied.

He climbed into the passenger side of a Volvo S60. Abashed, he and his accomplices slunk off.

P.P.S. You’re getting today’s episode a little earlier than usual, because we’re not sure how long the power will stay on.

Meanwhile, every indication is that Sandy will shut down stock trading tomorrow as well.

The 5 is going into hunker-down mode and will return on Wednesday. To all in Sandy’s path, stay safe…

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