Let's Face It: Our Taxes Are Going to Go Up

With all those politicians promising things, tax rates may just go up from here.
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As you race to the deadline for filing your income tax return, it's easy to get buried in last-minute tax tips.

Sure, you want to maximize every deduction and avoid taking those likely to trigger an audit. But don't get so preoccupied with the task in front of you that you forget to look at the big picture. And that big picture is likely to be big tax increases ahead.

It doesn't matter which political candidate you support.

This is an election year, a year in which politicians running for office are promising they'll make things better.

Almost all of those promises cost money.

If the government can't borrow the money to make good on all those promises, you can be sure they'll be figuring out how to raise your taxes to pay for them!

This year, Tax Freedom will fall on April 23rd -- meaning we will have worked, on average, 74 days to cover federal taxes, and another 39 days to cover state and local taxes. (Residents of high-tax states such as Connecticut, New York, New Jersey and California will have to work even longer to be free of taxes.)

Now, can you imagine working five or even six months of the year simply to support our government in the future?

Financial Planning for Higher Taxes

If you accept the premise that the government is going to be digging deeper into taxpayers' pockets -- whether to fund an ongoing war or social projects -- then you need to think about doing some long-term tax planning.

For example, the basic principle of tax-deferred retirement savings is the belief that when you retire you'll earn less, and thus be in a lower tax bracket. So you typically opt for the immediate tax deduction of a 401(k) plan or Individual Retirement Account, expecting that when you withdraw from the plan, your taxes won't be so burdensome.

Maybe that's the wrong approach.

It's entirely possible that we are at the lowest level of ordinary income taxes and capital gains taxes that we're likely to see in our immediate lifetime.

Much rhetoric has revolved around a desire to do away with "tax breaks for the rich." If Congress raises taxes only on the truly "rich," they'll certainly pay more -- but hardly enough to cover our deficits. Logic and mathematics dictate that in order to collect enough money to make good on promises, much less pay down debt, the middle class will bear the tax burden -- again. (Of course, raising taxes could slow the economy and actually reduce tax collections.)

If you believe higher tax rates are on the way, the Roth IRA (or Roth 401(k), if your company offers that option) looks more enticing, if you are eligible. You won't get an immediate deduction for your contribution, but you

will

get tax-free withdrawals -- if the government keeps its promises.

Similarly, the current lower taxes on capital gains and dividends should capture your attention. All withdrawals from retirement plans and annuities are taxed as ordinary income -- at rates that are likely to rise. That might make the capital gains tax rate (still likely to be lower than ordinary income) a more attractive choice, suggesting riskier investments be made outside retirement plans.

On the plus side, saving for college in a

state 529 college savings plan

becomes far more attractive, since the growth of that money is promised to come out tax-free when used to pay for college.

When it comes to estate planning and the tax code, it's anybody's guess. The current estate tax laws increase the exemption to $3.5 million next year. Then, the estate tax is scheduled to be completely repealed in 2010! Don't bet on that with your estate plan.

You might want to buy extra life insurance, held in a trust outside your estate, to provide liquidity to pay the higher estate taxes that are surely on their way. Life insurance could be a bargain now, compared with later when there is more demand (and when you're older, making you less likely to qualify).

By all means,

pay attention

to your tax-filing chores. Check your arithmetic before you file. Be sure to sign your return. Think twice about taking the home office deduction, which will invite IRS scrutiny. Double-check the impact of the alternative minimum tax.

File online

to get a faster refund -- and beware paying your taxes on your credit card, because there's an extra fee. Please remind seniors who don't usually file a return that they must do so this year to collect their rebate.

And do read

every tax-tip article you can find

in the next ten days. They'll all save you a little money.

But only some serious, big-picture tax planning can mitigate the onslaught of tax increases that are surely on the horizon. And that's The Savage Truth.

Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage's personal finance column in the Chicago Sun-Times is nationally syndicated. She was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. Savage currently serves as a director of the Chicago Mercantile Exchange Corp.