Beware Four “Gotcha” Taxes

Beware Four “Gotcha” Taxes

Seriously, the Big Beautiful Bill couldn’t address any of the “gotcha taxes” sprinkled throughout the tax code?

As we said yesterday, it’s a good thing the tax brackets that came into effect with the Trump tax cuts of 2017 will now stay in effect beyond this year. Otherwise, nearly everyone would have faced a significant tax increase.

But it could have been so much better.

A few weeks before Trump’s inauguration, we submitted a wish list of fixes for what some financial planners call “gotcha taxes.”

These are taxes you might not even be aware of. They take a big bite out of higher earners, homeowners and especially senior citizens.

Addressing them would ease the burden of inflation — which still hasn’t returned to pre-pandemic levels and probably won’t until the early 2030s.

As noted yesterday, Social Security benefits are still subject to income tax. Worse, there’s a huge gotcha tax that’s built into the system.

First, the background. When Social Security was overhauled during Ronald Reagan’s first term, Social Security benefits became taxable income for the first time.

Since 1984, seniors have paid tax on “provisional income” above $32,000. The figure is calculated by adding up your gross income, tax-free interest and 50% of Social Security benefits.

Even though this formula came into effect over 40 years ago, it’s never been adjusted for inflation. If it were, the threshold would be $99,270.

Another gotcha tax is more recent: It affects homeowners and it came into effect under Bill Clinton.

Under the Taxpayer Relief Act of 1997, there’s an exemption on any capital gains you rake in from the sale of a personal residence — $250,000 for individuals, $500,000 for couples. (You have to have lived in the home for at least two of the last five years, and the exemption is allowable only once every two years.)

Even though this legislation was passed more than a generation ago, those thresholds have never been adjusted for inflation. If they were, they’d be $501,930 for individuals and just over $1 million for couples.

And even those higher figures wouldn’t be fair — considering that home prices have risen much faster than the inflation rate.

Imagine a just-retired couple looking to downsize and sell a home where they’ve lived for the last 20 or 30 years. Ouch.

➢ Related: If you’re well-off enough to have a “jumbo” mortgage, you’re probably aware that the mortgage interest deduction is allowed only for up to $750,000 of eligible debt. This figure was set during the major tax reforms of 1986 — and it too has never been adjusted for inflation. If it were, it would be just over $2.2 million.

And then there’s the Obamacare tax.

Strictly speaking, it’s a Medicare surtax, but it took effect along with Obamacare in 2013. There are two main features to this surtax…

• A 3.8% levy on dividends and long-term capital gains for individuals earning over $200,000 and couples earning over $250,000

• A 0.9% levy applied to all income over $200,000 for individuals and $250,000 for couples (on top of the 1.45% Medicare tax everyone pays on every dollar of wages)

Even though these income thresholds came into effect more than a decade ago, they’ve never been adjusted for inflation. If they were, they’d be $276,680 for individuals and $345,850 for couples.

(And even with those higher thresholds, there’d still be a heckuva marriage penalty.)

One more gotcha tax — and this one even precedes the tax on Social Security benefits.

As you might be aware, you can write off investment losses on your income taxes — up to a point.

Tax-loss selling, it’s called: You sell an underperforming investment and apply the loss to reduce your taxable capital gains. If your losses are greater than the gains, you can offset as much as $3,000 of your ordinary income.

Sounds generous, you say? Not so much. Under the Tax Reform Act of 1976, this $3,000 cap took effect way back in 1978 — when Grease was the No. 1 movie and the year’s top-charting song was Andy Gibb’s “Shadow Dancing.”

Yeah, it’s never been adjusted for inflation. If it were, it would be approaching $15,000 now.

And now with the passage of major tax legislation, the chance that any of these gotcha taxes will be addressed in the next few years is nil.

Oh, well. At least you know what’s in store now and you can plan around it.

Which is more than one can say about tariffs. On to Bullet No. 2…

Tariff Tremors

The stock market is trying to shrug off the return of tariff jitters. So far today, those efforts are coming up short.

When we left you yesterday afternoon, the market was tumbling amid mixed signals from the Trump administration about its tariff plans.

After we hit “send,” the White House dispensed with at least some of the confusion: The original deadline for “reciprocal” tariffs to kick in was formally moved from Wednesday July 9 to Friday Aug. 1.

In addition, the president issued letters to leaders of 14 countries — informing them of the reciprocal tariff rate that would take effect Aug. 1. In some cases, the number was slightly different from the original number announced back on “Liberation Day,” April 2.

Of special note is this sentence included in all the letters: “These tariffs may be modified, upward or downward, depending on our relationship with your country.”

As we’ve said now and again amid the ever-changing tariff headlines this year, businesses can handle bad news. But they can’t handle uncertainty.

If they know a tariff of X percent will be imposed against Y country on Z date and it will be a permanent part of the landscape… well, they can adjust.

But if tariffs are a forever moving target, depending on what side of the bed the president wakes up on from day to day… that’s a different matter.

Conventional wisdom on Wall Street last winter was that there’d be “clarity” about tariffs by the spring or summer. In the spring, the thinking was there’d be clarity by the fall.

Now the realization is setting in: There may never be clarity.

Little surprise that yesterday’s sell-off accelerated after the resetting of the date and some of the rates.

As we write today, the S&P 500 sits at 6,220, down slightly from yesterday’s close. The Dow and the Nasdaq are also modestly in the red. In contrast, the Russell 2000 — packed with small-cap companies less exposed to global trade — is up three quarters of a percent.

Elsewhere “Mr. Slammy” is showing up for the precious metals. Gold is back under $3,300; silver is holding up better at $36.33. Crude is up to another two-week high at $68.12. Bitcoin remains under $110,000.

Steady as she goes in small-business America — but there’s a dark cloud on the horizon.

The National Federation of Independent Business is out with its Small Business Optimism Index for June. At 98.6, the headline number is down slightly from May — but still above the long-term average of this survey, which has been conducted since 1974.

The biggest drag on the headline number, says the NFIB’s report, is “a substantial increase in respondents reporting excess inventories.”

On the portion of the survey asking respondents to identify their single-most important problem, taxes top the list — cited by 19%. The last time this many people cited taxes was mid-2021. In second place, “quality of labor” was cited by 16% — suggesting that for many businesses, good help is still hard to find.

Inflation has retreated to 11% — followed by poor sales and labor costs, both cited by 10%.

Hmmm… The number of respondents citing “poor sales” keeps creeping higher. Combine that with the bit about excess inventories, and suddenly the outlook for Main Street isn’t looking so hot after all…

Trump’s Vietnam Moment, Continued

The longer this goes on, the more Donald Trump owns the Russia-Ukraine war.

The president is promising to send more weapons to Ukraine “We have to,” he said yesterday. “They have to be able to defend themselves.”

Way back in February, Paradigm’s macroeconomics maven Jim Rickards warned in this space that Ukraine could derail Trump’s presidency if he’s not careful.

“Trump can’t afford to become consumed by Ukraine if he wants to achieve the rest of his agenda on trade, immigration and real growth,” Jim said.

As Jim saw it, Trump had three choices…

1. “Basically, agree to Putin’s terms with some face-saving measures.
2. “Keep fighting, which will continue indefinitely and end in Ukraine’s collapse.
3. “Escalate, which will push the world closer to World War III.”

Increasingly it appears Trump is opting for choice No. 2. Even now, he seems to think he has leverage over Russia’s Vladimir Putin that simply does not exist: “I’m disappointed, frankly, that President Putin hasn’t stopped,” he said yesterday.

Much more of this and Trump will fail the “Vietnam moment” Jim warned about last winter: Republican Richard Nixon promised to end the Vietnam War that he inherited from his Democratic predecessor, only to wage it four more years.

Comic Relief

As long as we have taxes on the brain today…

Cynicism

“Cynical, you?” a reader writes. “Don’t change a damn thing … you’re pretty much always bang-on!”

As I said yesterday, the inbox overflowed with replies to our Independence Day edition — which was in fact a reprise of “the cynicism issue” I penned in the spring.

Says another: “I love reading your articles, Dave. I don't view your writings as negative but as insightful thoughts to reflect and inspect. Isn’t that a purpose you hope or strive for: a reader who presses on with another reason to go beyond 'just Information' gaining, hopefully, wisdom of analogy.”

I heard from several readers who said they’re in their 70s (or maybe older) — folks who’ve had a few more spins around the sun than I have. Space is limited, but a sampling follows…

I look at it this way. When I said sell (short) in 1987, 2000 and 2008, they said I was too negative. When I said buy in 1982, they looked at me as crazy. In the end I got the money and they lost. So I don’t really care what they think. Anything you say will not set right with some. But if you did your homework and are right, their opinion is not important. What they need to do is check it out. What I THINK is not important. What do the facts show? That counts. You are doing well. You are a “keeper.”

So insightful, and I couldn't agree more with the analysis of our history. I have seen our glorious country go from an internal place of peace, trust and goodwill to a place of anger, hatred, fear and mistrust. The American people have been lied to and deceived by our government and the media…. As I read your 5 Bullets on this Fourth of July, I reflected back on my life and the changes I have seen in the last 76 years. I love the USA, but it saddens me to see the negative things that continue to tear down this great nation.

You mentioned in your July 4 column your reason for writing is "to do something of greater service... than working in a newsroom." By Jove, I think you've done it — but I see it in a different way than you articulated. If I can summarize, what I think you do is you make people think… I think this encompasses the mission of Paradigm Press and you do an excellent job of this. I believe if you focus on this mission and make people think, the sarcasm that some seem to notice in your writings will become less of an issue.

Our final contributor today picks up where the previous one left off…

“I'd have to say that I disagree with those readers that consider these missives ‘cynical.’ I prefer to consider 5 Bullets an educational experience.

“Coming from a scientific educational background I find the information provided very thought-provoking at the least. This article made me think and reflect on several things:

1. I find myself continually amazed at the insight of the Founding Fathers and the depth of understanding they had of the pitfalls that could occur with what they were creating. I'm sure they would be horrified to see where we are today with the federal government.

2. “As a Paradigm Press subscriber I use the info provided by you and the other contributors to help me as a small investor to be able to grow my portfolio so that my children might have the ‘right to study painting, poetry, music, architecture, statuary, tapestry and porcelain.’ You all provide the info I use to make my investing decisions.

3. You can tell your wife that you have taken another step toward your goal.....you've helped ME!!!

4. Today I will be heading to the library to find a copy of The Fourth Turning.

“Thank you for all you do.”

Dave responds: Truly, I’ve never sought to educate per se. Rather I seek to engage, and without resorting to pandering.

As I say at the end of our periodic foray into “Who We Are and What We’re All About,” all I really want is for a reader to learn one new and interesting thing they didn’t know before — interesting enough that they’ll come back the next day. Everything else is gravy!

Best regards,

Dave Gonigam
Managing editor, Paradigm Pressroom's 5 Bullets

P.S. One of the above readers asked as an aside what I think of the “flat tax.” Answer: I prefer the 16th Amendment be repealed!