Tax Credit and Unemployment Extended

After unanimous passage in the Senate and a 403-12 passage in the House of Representatives, President Obama signed H.R. 3548 into law on November 6. The bill extends and expands a key tax credit for homebuyers while also offering more help for those out of work.

The $8,000 credit for “first-time” homebuyers continues. This tax break is now extended until May 1, 2010. If you have never owned a home or haven’t owned a home in the previous three years, you are considered a “first-time” buyer and therefore eligible for the credit (it is a credit of up to $8,000, by the way). You must sign your purchase agreement before May 1, 2010 and close the transaction before July 1, 2010 to qualify for this tax break.

The $6,500 tax break for move-up buyers. Okay, maybe you aren’t a “first-time” buyer. You may still qualify for this new real estate credit. Have you lived in your current home for more than five consecutive years? You may be eligible for a credit of up to $6,500 if you move out of that home and buy another. Again, you have to sign your purchase agreement before May 1 and close before July 1 to get the tax break.

Worth noting: BusinessWeek.com contacted Sen. Chris Dodd’s office (the Connecticut lawmaker chairs the Senate Banking Committee) and received word that move-up buyers can qualify for this $6,500 credit even if they have signed a purchase contract prior to November 6, provided the purchase closes before July 1.

Does everyone qualify for these credits? Not quite. They phase out for individuals with adjusted gross incomes of more than $125,000 a year and couples with AGI of more than $225,000 a year. (The old phase-outs respectively kicked in at $75,000 and $150,000. These higher phase-outs mean that the credit can now help an additional segment of the housing market.)

You can’t buy a vacation home and claim one of these credits – they only apply to principal residences. In fact, the home you buy has to have a sale price of $800,000 or lower.
What will this do for the economy? “Every economist will tell you we have to steady the housing market before the economy will turn around,” Sen. Dodd expressed on November 5. “We can't afford to let this tax credit expire now.” Respected Moodys.com economist Mark Zandi agrees, saying that “from a macroeconomic perspective, nothing is more important than stabilizing housing values.” Zandi thinks that the $8,000 credit has led to 400,000 additional home sales in 2009. On the other hand, Dean Baker, the co-director of the Center for Economic and Policy and Research, questions why the extension is necessary: “For the most part, you're just giving people money for something they would have done otherwise.” The Joint Committee on Taxation estimates that extending these credits into 2010 will cost $10.8 billion across the next decade.

An extension of unemployment benefits. H.R. 3548 – sponsored by Rep. James McDermott (D-WA) – additionally extends state jobless benefits by up to 20 weeks. This will happen as a result of another extension – an extension of the federal unemployment tax on employers until June 30, 2011.

If you are one of nearly two million Americans whose jobless benefits are set to run out at the end of 2009, this extension will help you. Your benefits will last at least another 14 weeks into the new year – in fact, they will last for another 20 weeks if you live in a state where the unemployment rate exceeds 8.5%. Have our unemployment checks already stopped? You may reapply for benefits.

A chance for companies to convert losses into cash. What? Really? Yes. There is one provision of the new legislation that many have overlooked: it widens the window of time on the net-operating loss carryback. It lets all businesses apply losses from either 2009 or 2008 to any five years prior to 2008. So business owners, by virtue of the new legislation, have the potential for an IRS refund on the taxes they paid for the five years prior to 2008. There are two asterisks here. One, refunds for taxes in the fifth year of the carry back shrink by 50%. Two, any business that received TARP funds can’t take advantage of this tax break.

Interest Rates Will Rise! When is the Question!

How long can the federal funds rate stay so low? The Federal Reserve has publicly stated that it will keep the federal funds rate between 0% and 0.25% for an “extended period”. Many economists don’t see the Fed raising rates until well into 2010. Yet rates will move north someday. How soon might that happen? And how could the Fed delicately move rates north without hampering the recovery?

The Barron’s argument. On October 19, Barron’s published a piece titled “C’mon, Ben!” in which senior editor Andrew Bary called for short-term interest rates of 2.0%. Why? “Super-low short rates are fueling financial speculation, angering our economic partners and foreign creditors, and potentially stoking inflation.” One concern is that by keeping rates so low for so long, the Fed might risk an asset bubble – recall how the housing bubble was aided by low interest rates. The article called for the Fed to exit the crisis mode policy of the last 12-18 months.

What would raising short-term interest rates to 2% possibly accomplish? Well, the tactic could prove a decisive and wise move to control inflation (CPI is on track to come in at 2% for 2009, so Bary argues that inflation is indeed back) and aid the dollar. The downside, of course, is that the move would amount to a right cross to the jaw for the stock market (and possibly the commodities markets)..

The challenge for the Fed. The stock market is having a great year; the economy is not, with unemployment currently around 10% and the business and real estate sectors taking a long time to recover. Given this, most economists and market analysts see no incentive for the Fed to make a move. (In fact, St. Louis Fed President James Bullard has cited “jobs growth and unemployment coming down” as a “prerequisite” for increasing interest rates.) The challenge for the Fed is how to signal or hint at a move in the coming quarters in a way that seems reasonable or non-disruptive to the recovery.

There are possible hints of inflation here and abroad (renewed strength in emerging market economies, gold prices soaring and the dollar hurting). On October 22, Philadelphia Fed President Charles Plosser told Bloomberg Radio that he felt the time to raise rates would come sooner than most Fed officials believed. The next day, a Bloomberg data survey showed that traders had increased the probability of a federal funds rate hike in 1Q 2010 to 48% from 37% the day before.

The prevailing notion. TheStreet.com published a rebuttal of sorts to the Barron’s article – a piece titled “It’s Absolutely Not Time to Raise Rates, Ben!” in which author Ron Insana argued that the recovery was too fragile to prompt any notion of raising the federal funds rate. Many analysts feel that a rate increase is simply unwarranted without a demonstrably healthier job market, housing market and banking system.

Out west, San Francisco Fed President Janet Yellen told reporters that she didn’t anticipate a rate increase or any tightening of the Fed’s rescue programs in the next several months. So the question remains “when” – and the Fed must move as carefully as ever.

Year End Planning

The end of the year is a good time to review your personal finances. What are your financial, business or life priorities for 2010? Try to specify the goals you want to accomplish. Think about the consistent investing, saving or budgeting methods you could use to realize them. Also, consider these year-end moves.

Think about adjusting or timing your income and tax deductions. If you earn a lot of money and have the option of postponing a portion of the taxable income you will make in 2009 until 2010, this decision can bring you some tax savings. You might also consider accelerating payment of deductible expenses if you are close to the line on itemized deductions – another way to potentially save some bucks.

Max out your IRA contribution at the start of 2010. If you can do it, do it early. The sooner you make your contribution, the more interest those assets will earn. For 2010, the contribution limits are unchanged for both traditional and Roth IRAs: $5,000 if you are age 49 and below, $6,000 if you are age 50 and above. Remember that you can still make an IRA contribution for the 2009 tax year through April 15, 2010.

While we’re talking about maxing things out, don’t forget your 401(k), 403(b) or Thrift Savings Plan if you are still working. You can contribute up to $16,500 to these plans in 2010, with a $5,500 catch-up contribution also allowed if you are age 50 or older.

Consider a Roth IRA conversion for 2010. Next year, anyone may convert a Roth IRA. The $100,000 modified adjusted gross income (MAGI) ceiling that often prevented that move will be gone - forever. The MAGI phase-out limits for contributing to Roth IRAs will be $167,000 for joint filers and $105,000 for single filers in 2010, but if your MAGI will exceed those limits, you may still contribute to a traditional IRA in 2010 and immediately roll it over to a Roth.

More good news: if you do a Roth conversion during 2010, you can choose to divide the taxes on the conversion between your 2011 and 2012 federal returns. This nice opportunity won’t be available if you make a Roth conversion in 2011.

Another detail to remember: in 2009, withdrawals from a traditional IRA may be used to fund a Roth IRA. (This relates to the 2009 suspension of Required Minimum Distributions.) So even if you don’t want to convert a traditional IRA to a Roth account, you may still fund a Roth IRA using a withdrawal from a traditional IRA through the end of this year (provided your 2009 MAGI is $100,000 or less).

Be sure to consult a tax or financial advisor before you arrange a Roth conversion or make any IRA moves. You will want see how it may affect your overall financial picture. The tax consequences of a Roth conversion can get sticky if you own multiple traditional IRAs.

Should you take a distribution from your IRA this year? It’s an interesting question. Barring an act of Congress, RMDs will be back for 2010. If you think taxes will be higher next year, you could opt to take a distribution before the end of this year to lower your IRA balance as of the end of 2009. As RMDs are based on an IRA’s value as of Dec. 31 of the previous year, taking a distribution in 2009 will reduce a 2010 RMD.

If you are age 70½ or older, you may want to make an IRA charitable rollover. It will lower your 2009 IRA balance and your 2010 RMD. The sun is setting on this tax break: the IRA charitable rollover option is currently set to expire at the end of 2009.

You may wish to make a charitable gift before New Year’s Day. If you make a charitable contribution this year, you can claim the deduction on your 2009 return.

You could make December the “13^th month”. Can you make a January mortgage payment in December, or make a lump sum payment on your mortgage balance? If you have a fixed-rate mortgage, a lump sum payment can reduce the home loan amount and the total interest paid on the loan by that much more. In a sense, paying down a debt is almost like getting a risk-free return.

Are you marrying next year, or do you know someone who is? The top of 2010 is a good time to review (and possibly change) beneficiaries to your 401(k) or 403(b) account, your IRA, your insurance policy and other assets. You may want to change beneficiaries in your will. It is also wise to take a look at your insurance coverage. If your last name is changing, you will need a new Social Security card. Lastly, assess your debts and the merits of your existing financial plans.

Are you returning from active duty? If so, go ahead and check the status of your credit, and the state of any tax and legal proceedings that might have been preempted by your orders. Review the status of your employee health insurance, and revoke any power of attorney you may have granted to another person. Don’t delay – get it done.