For Some Americans, Your Tax Rate Will Double

As of April 1st many Americans are finally beginning to see bigger paychecks as a result of the Trump tax cuts. In fact, major media outlets have had a field day tabulating the average tax savings for the average American (and how many loaves of bread can be bought with those additional savings).

But all this good news in the short term is tempered when considered within the context of our country’s long-term fiscal outlook. For a little more perspective, consider the following: In 2011, former Comptroller General of the Federal Government David Walker wrote a CNN op-ed entitled Why Your Taxes Could Double. In this article he laid out the case that, sooner or later, tax rates will have to rise, perhaps even double, if our country is to avoid fiscal calamity. The cost of unfunded obligations like Social Security and Medicare will begin to crowd out all other budget items until the government is forced to either double taxes, reduce spending by half, or some combination of the two.

When Congress and the President lowered taxes January 1st , 2018, they did so at a cost of $1.5 Trillion over the next 10 years. They gave us the dessert before the spinach! We will experience historically low tax rates until we revert to pre-2018 levels in 2026. As a result, the increase in tax rates beyond 2026 will have to be all the more severe and draconian just to keep our country solvent.

While many economists predict that tax rates will likely have to rise dramatically beyond 2026, very few are willing to put a firm date on when. So, some ambiguity persists as to how much longer beyond 2026 we will continue to enjoy relatively low tax rates.

Despite the general uncertainty about the timing of further tax increases beyond 2026, there is a certain segment of the population that will see a near doubling of their tax rate no matter what. This doubling of taxes is guaranteed because it’s written into the IRS tax code. I’m referring to the husband or wife in the 12% tax bracket that survives the death of their spouse.

Think about it: If you’re a married couple and have $65,000 of taxable income, you’re still in the 12% marginal federal tax bracket (the 12% tax bracket ends at $77,400). While nobody relishes paying taxes, 12% is a good deal of historic proportions. Taxes for you will never be lower than they are right now.

In other words, taxes are on sale. However, if one spouse dies, and the surviving spouse continues to experience that same $65,000 of taxable income, he suddenly finds himself catapulted from the 12% marginal bracket to the 22% marginal bracket (the 22% tax bracket for a single filer starts at $38,700). Going from a 12% tax bracket to a 22% tax bracket is a near doubling of your tax bracket!

In other words, for a couple in the 12% marginal tax bracket, they don’t have to read the tea leaves to divine the exact date when our nation’s tax load will double. It’s not a question of studying economic forecasts or analyzing our country’s unfunded obligations. Why? Because if you’re in the 12% tax bracket, all it takes for your tax rate to double is for your spouse to die. It’s a time bomb that’s set to go off at the death of the first spouse.

All this of course begs the question: How can a retired couple defuse this tax time bomb? The answer is to pay your taxes while they are on sale. Pay your taxes while they’re historically low, and while you’re enjoying your comparatively low tax rates as married joint filers. If you are currently in the 12% tax bracket, not a year should go by where you’re not fully maxing out your 12% tax bracket. This can be done by converting IRAs to Roth IRAs.

Here’s an example: If line 43 of your tax return (taxable income) is $50,000, then reposition $27,400 in order to get to the top of the 12% tax bracket ($77,400). If your taxable income is less than $50,000, then you’ll want to shift even more. Just remember, tax rates for a married couple in a 12% tax bracket will never be lower than they are today.

In short, our country’s tax rates are going up, however uncertain the timing. If you are a married couple in the 12% marginal tax bracket, however, the near doubling of your tax rate is nearly inescapable, unless you undertake proactive planning. This planning involves a repositioning of assets from the tax- deferred bucket to tax-free in a thoughtful, systematic and intentional way.

David McKnight is the president of McKnight & Company