American Families Plan Would Provide Benefits for Some, More Taxes for Others
On April 28, 2021, the White House released a fact sheet for President Biden’s American Families Plan (AFP), which proposes about $1 trillion in investments and $800 billion in tax cuts. There would also be tax increases for those making more than $400,000 per year. Major provisions proposed in the plan are summarized here, including some tax provisions.
Education
The AFP proposes the following:
- Free universal pre-school for all three- and four-year olds.
- Two years of free community college.
- Increased assistance to low-income students by raising the maximum Pell Grant award that pays for college education by about $1,400.
Child care
Low- and middle-income families would pay no more than 7% of their income on child care.
Nutrition
Summer and school meal programs would be expanded for low-income families.
Unemployment insurance
Funds would be provided for unemployment system modernization, equitable access, and fraud prevention. The plan proposes to automatically adjust the length and amount of unemployment insurance benefits depending on economic conditions.
Paid leave
A national comprehensive paid family and medical leave program would be created and scaled in over a 10-year period.
Health insurance
- The American Rescue Plan Act of 2021 (ARPA 2021), enacted in March 2021, provided that persons who bought their own health insurance through a government exchange might qualify for a lower cost through December 31, 2022. The AFP would make that provision permanent.
- The AFP would also lower prescription drug prices by letting Medicare negotiate prices.
- In addition, the AFP would create a public option and the option for people to enroll in Medicare at age 60.
Child tax credit
ARPA 2021 made the following temporary changes to the child tax credit. For 2021, the credit amount increased from $2,000 to $3,000 per qualifying child ($3,600 for qualifying children under age 6), subject to phaseout based on modified adjusted gross income. The legislation also made 17-year-olds eligible as qualifying children in 2021. For most taxpayers, the credit is fully refundable for 2021 if it exceeds tax liability. The Treasury Department is expected to send out periodic advance payments (to be worked out by the Treasury) for up to one-half of the refundable credit during 2021.
The AFP would make permanent the full refundability of the child tax credit, and extend the other child tax credit provisions through 2025. Longer term, the plan would seek to make all these provisions permanent.
Child and dependent care tax credit
ARPA 2021 made the following temporary changes to the child and dependent care tax credit. For 2021, the legislation increased the maximum credit up to $4,000 for one qualifying individual and up to $8,000 for two or more (based on an increased applicable percentage of 50% of costs paid and increased dollar limits). Most taxpayers will not have the applicable percentage reduced (can be reduced from 50% to 20% if AGI exceeds a substantially increased $125,000) in 2021. However, the applicable percentage can now also be reduced from 20% down to 0% if the taxpayer’s AGI exceeds $400,000 in 2021. For most individuals, the credit is fully refundable for 2021 if it exceeds tax liability.
The AFP would make these provisions permanent.
Earned income tax credit
In addition to some other changes to the earned income tax credit (some temporary, some permanent), ARPA 2021 made the following temporary changes to the earned income tax credit for 2021. The legislation generally increased the credit available for individuals with no qualifying children (bringing it closer to the amounts for individuals with one, two, or three or more children which were already much higher). For individuals with no qualifying children, the minimum age at which the credit can be claimed was generally lowered from 25 to 19 (24 for certain full-time students) and the maximum age limit of 64 was eliminated (there are no similar age limits for individuals with qualifying children).
The AFP would make these provisions permanent for individuals with no qualifying children.
Increase in top tax rate on wealthiest taxpayers
The AFP would raise the top income tax rate on individuals back up to 39.6%, applying only to the top one percent. The 39.6% rate would also apply to the capital gains and dividends of households making over $1 million (the top 0.3 percent).
Stepped-up basis
The tax basis of most property is stepped-up (or down) to fair market value when an individual dies. The AFP would eliminate this step-up in basis for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions). There would be provisions designed with protections for family-owned businesses and farms.
Like-kind exchanges
Current tax law allows real estate investors to defer taxes when they exchange property. The AFP would eliminate the tax deferral on like-kind exchanges for gains greater than $500,000.
Rising Inflation: Where Will It Go from Here?
In March 2021, the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.6%, the largest one-month increase since August 2012. Over the previous 12 months, the increase was 2.6%, the highest year-over-year inflation rate since August 2018. (By contrast, inflation in 2020 was just 1.4%.). 1
The annual increase in CPI-U — often called headline inflation — was due in part to the fact that the index dropped in March 2020, the beginning of the U.S. economic shutdown in the face of the COVID-19 pandemic. Thus, the current 12-month comparison is to an unusual low point in prices. The index dropped even further in April 2020, and this “base effect” will continue to skew annual data through June. 2
The monthly March increase, which followed a substantial 0.4% increase in February, is more indicative of the current situation. Economists expect inflation numbers to rise for some time. The question is whether they represent a temporary anomaly or the beginning of a more worrisome inflationary trend. 3
Measuring Prices
In considering the prospects for inflation, it’s important to understand some of the measures that economists use.
CPI-U measures the price of a fixed market basket of goods and services. As such, it is a good measure of prices consumers pay if they buy the same items over time, but it does not reflect changes in consumer behavior and can be unduly influenced by extreme increases in specific categories. Nearly half of the March increase was due to gasoline prices, which rose 9.1% during the month, in part because of production interruptions caused by severe winter storms in Texas.4 Core CPI, which strips out volatile food and energy prices, rose 0.3% in March and just 1.6% year over year. 5
In setting economic policy, the Federal Reserve prefers a different inflation measure called the Personal Consumption Expenditures (PCE) Price Index, which is even broader than the CPI and adjusts for changes in consumer behavior — i.e., when consumers shift to purchase a different item because the preferred item is too expensive. More specifically, the Fed looks at core PCE, which rose 0.4% in March and 1.8% for the previous 12 months, slightly higher than core CPI but still lower than the Fed’s target of 2% for healthy economic growth. 6
A Hot Economy
Based on the core numbers, inflation is not yet running high, but there are clear inflationary pressures on the U.S. economy. Loose monetary policies by the central bank and trillions of dollars in government stimulus could create excess money supply as the economy reopens. Pent-up consumer demand for goods and services is likely to rise quickly, fueled by stimulus payments and healthy savings accounts built by those who worked through the pandemic with little opportunity to spend their earnings. Businesses that shut down or cut back when the economy was closed may not be able to ramp up quickly enough to meet demand. Supply-chain disruptions and higher costs for raw materials, transportation, and labor have already led some businesses to raise prices. 7
According to the April Wall Street Journal Economic Forecasting Survey, gross domestic product (GDP) is expected to increase at an annualized rate of 8.4% in the second quarter of 2021 and by 6.4% for the year — a torrid annual growth rate that would be the highest since 1984. As with the base effect for inflation, it’s important to keep in mind that this follows a 3.5% GDP decline in 2020. Even so, the expectation is for a hot economy through the end of the year, followed by solid 3.2% growth in 2022 before slowing down to 2.4% in 2023. 8-9
Three Scenarios
Will the economy get too hot to handle? Though all economists expect inflation numbers to rise in the near term, there are three different views on the potential long-term effects.
The most sanguine perspective, held by many economic policymakers including Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen, is that the impact will be short-lived and due primarily to the base effect with little or no long-term consequences. 10 Inflation has been abnormally low since the Great Recession, consistently lagging the Fed’s 2% target. In August 2020, the Federal Open Market Committee (FOMC) announced that it would allow inflation to run moderately above 2% for some time in order to create a 2% average over the longer term. Given this policy, the FOMC is unlikely to raise interest rates unless core PCE inflation runs well above 2% for an extended period. 11 The mid-March FOMC projection sees core PCE inflation at just 2.2% by the end of 2021, and the benchmark federal funds rate remaining at 0.0% to 0.25% through the end of 2023. 12
The second view believes that inflation may last longer, with potentially wider consequences, but that any effects will be temporary and reversible. The third perspective is that inflation could become a more extended problem that may be difficult to control. Both camps project that the base effects will be amplified by “demand-pull” inflation, where demand exceeds supply and pushes prices upward. The more extreme view believes this might lead to a “cost-push” effect and inflationary feedback loop where businesses, faced with less competition and higher costs, would raise prices preemptively, and workers would demand higher wages in response. 13
Maintaining Perspective
Although it’s too early to tell whether current inflation numbers will lead to a longer-term shift, you can expect higher prices for some items as the economy reopens. Consumers don’t like higher prices, but it’s important to keep these increases in perspective. Gasoline, jet fuel, and other petroleum prices are rising after being deeply depressed during the pandemic. Airline ticket prices are increasing but remain below their pre-pandemic level. Used cars and trucks are more expensive than before the pandemic, but clothing is still cheaper. 14 Food is up 3.5% over the last 12 months, a significant increase but not extreme for prices that tend to be volatile. 15
For now, it may be helpful to remember that “headline inflation” does not always represent the larger economy. And with interest rates near zero, the Federal Reserve has plenty of room to make any necessary adjustments to monetary policy.
Projections are based on current conditions, are subject to change, and may not come to pass.
1, 5, 15) U.S. Bureau of Labor Statistics, 2021
2-4, 7) The Wall Street Journal, April 13, 2021
6, 9) U.S. Bureau of Economic Analysis, 2021
8) The Wall Street Journal Economic Forecasting Survey, April 2021
10, 13) Bloomberg, March 29, 2021
11) The Wall Street Journal, April 14, 2021
12) Federal Reserve, 2021
14) The New York Times, April 13, 2021
High-Frequency Indicators: Where to Look for Signs of Recovery
Since the pandemic began, disruptions in business activity have varied greatly from region to region, and often from one week to the next, according to the severity of local COVID-19 outbreaks. Unfortunately, many of the official government statistics used to gauge the health of the U.S. economy are backward looking and somewhat delayed.
Changes in the nation’s gross domestic product (GDP) indicate the rate at which the economy is growing or shrinking, but the first GDP estimate is not published by the Bureau of Economic Analysis until about one month after each quarter ends. GDP increased at a 4.3% rate in the fourth quarter of 2020 but posted the worst annual decline (-3.5%) since 1946. 1.
Rapid changes in virus conditions — for better or worse — can make many of the monthly reports that gauge employment, consumer spending, and production seem outdated and irrelevant by the time they are released. Consequently, economists and investors have been focusing on more timely data sources to monitor the economic impact of the pandemic throughout the nation. This information is reported every week, and in some cases every day, by government agencies or private companies with access to key business insights.
Here are some of the high-frequency indicators that may be helpful in evaluating the progress of the economic recovery.
Employment picture
A weekly report from the Department of Labor includes the number of new claims for unemployment insurance benefits under state programs filed by workers who recently lost their jobs, as well as the number of continuing claims filed by those who remain unemployed. This provides an early look at whether the labor market is improving or worsening on a state-by-state and national basis. For the week ending March 20, 2021, first-time claims for unemployment benefits fell to 684,000, the lowest level since before economic lockdowns began in mid-March of 2020. 2.
The ASA Staffing Index from the American Staffing Association tracks weekly changes in temporary and contract employment. Many employers rely on temporary help before hiring additional permanent employees, so staffing agency trends tend to lead nonfarm employment by three to six months. As of March 8-14, 2021, there were 11.2% more staffing jobs than there were one year earlier. 3
Consumer behavior
The proprietary Johnson Redbook Index captures consumer spending trends based on weekly data from a representative sample of thousands of large general merchandise and apparel retailers. In an encouraging sign, this key index improved 9.4% year-over-year on March 23, 2021. 4
The reservation app OpenTable has been monitoring the impact of COVID-19 on the hard-hit restaurant industry, providing data that doubles as an indicator of the “openness” of local economies around the world. Daily data shows changes in the number of people dining at restaurants compared with the same day of the same week in 2019. As of March 28, 2021, the weekly average number of U.S. seated diners was still down 29% from 2019, but had bounced back considerably from the last week in February, when the average was 40% below 2019. 5
Mobility and travel
Other technology companies rolled out tools designed to help public health officials and policymakers around the world monitor day-to-day mobility trends with data collected from smartphone apps. Google’s Community Mobility Reports show changes in visits to places like grocery stores, retail shops, and parks. Apple’s Mobility Trends Reports show changes in routing requests (since January 2019) for walking, driving, and public transportation trips, the latter of which have been slower to recover.6
The number of people who pass through U.S. airport checkpoints is posted daily by the Transportation Security Administration. On March 21, 2021, a spring-break surge caused the number of air travelers to rise above 1.5 million for the first time in about a year. Still, this total was far below the 2.2 million air travelers on the same Sunday in 2019. 7
The hotel occupancy rate (released weekly by STR) is another good indicator of the willingness of consumers and businesses to spend money on travel. U.S. hotel occupancy hit 58.9% in the week ending March 20, 2021, the highest level in a year. More importantly, the industry had recovered nearly 85% of comparable 2019 occupancy. 8
Real-time tracker
In May 2020, Harvard-based nonprofit Opportunity Insights, in partnership with several private-sector providers of high-frequency data, launched a real-time Economic Tracker as a free public service. Interactive charts show day-to-day changes in U.S. debit- and credit-card spending, small-business revenue, employment, online job postings, and time spent outside the home. In addition to nationwide statistics, disparities in progress can be broken down by income and industry, as well as by state or metro area.
Fed indexes
The Weekly Economic Index (WEI), which is published by the Federal Reserve Bank of New York, signals the state of the U.S. economy based on 10 different indicators of consumer behavior, the labor market, and production that are available daily or weekly. The WEI is scaled to the four-quarter GDP growth rate, which means the weekly result is the economic growth that could be expected if current activity continued for a year. For the week ending March 20, 2021, the WEI jumped to 4.14% from -0.33% the previous week. 9
In addition, the Federal Reserve Bank of Atlanta keeps a running estimate of GDP changes — GDPNow — that is updated based on a model that incorporates incoming economic data. On March 26, 2021, the growth estimate for the first quarter of 2021 was 4.7%. 10
These estimates are based on current conditions, are subject to change, and may not come to pass. Neither is an official forecast of the Federal Reserve. When investing, it’s generally wise to maintain a long-term approach based on your personal goals, time frame, and risk tolerance, rather than react too quickly to shifting economic dynamics
1) U.S. Bureau of Economic Analysis, 2021
2) U.S. Department of Labor, 2021
3) American Staffing Association, 2021
4) Investing.com, 2021
5) OpenTable, 2021
6) Apple Mobility Trends, 2021
7) Transportation Security Administration, 2021
8) STR, 2021
9-10) Federal Reserve, 2021
U.S. Credit-Card Debt Levels See Record Drop in 2020
Despite the financial challenges experienced by Americans as a result of the coronavirus pandemic, U.S. credit-card debt dropped to record levels in 2020, decreasing by almost $83 billion. 1) This unprecedented drop was likely the result of individuals receiving financial assistance through the Coronavirus Aid, Relief, and Economic Security (CARES) Act and having access to more cash. Economic aid in the form of stimulus payments, suspended student loan payments, and broad state-sponsored unemployment benefits, allowed Americans to pay down their balances. 2) In fact, according to a U.S. Census Bureau survey, almost 60% of adults in households that experienced a loss in employment income during the pandemic used their second stimulus check to pay down debt. 3)
If you are still struggling to pay down your balances, here are some strategies to help eliminate your credit-card debt.
- Pay off cards with the highest interest rates first. If you have more than one card with an outstanding balance, one option is to pay the most to the card with the highest interest rate and continue making payments to your other cards until the card with the highest interest rate is paid off. You can then focus your repayment efforts on the card with the next-highest interest rate, and so on, until they’re all paid off.
- Apply for a balance transfer. Many credit-card companies offer highly competitive balance transfer offers (e.g., 0% interest for 12 months). Transferring your credit-card balance to a card with a lower interest rate may enable you to reduce interest charges and pay more against your existing balance. Keep in mind that most balance transfer offers charge a fee (usually a percentage of the balance transferred), so be sure to do the calculations to make sure it’s cost-effective before you apply.
- Pay more than the minimum. If you pay only the minimum payment due on a credit card, you’ll continue to carry the bulk of your balance forward without reducing your overall balance. Instead, try to make payments that exceed the minimum amount due. For more detailed information on the impact that making just the minimum payment will have on your overall balance, refer to your monthly billing statement.
- Look for other sources of available funds. If you always seem to find that you don’t have the extra cash available to pay down your balances, you may want to look for other sources of available funds. Are you expecting an employment bonus or other financial windfall in the near future? If so, consider using those funds to help eliminate or pay down your credit-card debt.
1) Credit Card Debt Study, WalletHub, March 2021
2) Credit Card Debt in 2020, Experian, November 2020
3) Household Pulse Survey, U.S. Census Bureau, March 2021
Due Date for Federal Income Tax Returns and Payments Postponed to May 17
Due to the unusual conditions related to the coronavirus pandemic, the due date for individuals to file 2020 federal income tax returns and make tax payments has been postponed by the IRS from Thursday, April 15, 2021, to Monday, May 17, 2021. No interest, penalties, or additions to tax will be incurred by taxpayers during this approximately one-month relief period for any return or payment postponed under this relief provision.
The relief applies automatically to all taxpayers and no additional forms need to be filed to qualify for the relief. The new deadline applies to federal income tax payments for taxable year 2020, including payments of tax on self-employment income. It does not apply to estimated tax payments for 2021 that are due on April 15, 2021. There is no limit on the amount of tax that can be deferred.
Note: Under this relief provision, no extension is provided for the payment or deposit of any other type of federal tax, or for the filing of any federal information return. The IRS urges taxpayers to check with their state tax agencies regarding state tax filing and payment deadlines.
Note: Earlier this year, the IRS announced that victims of the February winter storms in Texas, Oklahoma, and Louisiana have until Tuesday, June 15, 2021, to file various individual and business tax returns and make tax payments.
Need more time?
If you’re not able to file your federal income tax return by the May due date, you can file for an extension by the May due date using IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Filing this extension gives you an additional five months (until October 15, 2021) to file your federal income tax return. You can also file for an automatic five-month extension electronically (details on how to do so can be found in the Form 4868 instructions). There may be penalties for failing to file or for filing late.
Filing for an extension using Form 4868 does not provide any additional time to pay your tax. When you file for an extension, you have to estimate the amount of tax you will owe and pay this amount by the May filing due date. If you don’t pay the amount you’ve estimated, you may owe interest and penalties. In fact, if the IRS believes that your estimate was not reasonable, it may void your extension.
Tax refunds
The IRS encourages taxpayers seeking a tax refund to file their tax return as soon as possible, and to file electronically with direct deposit. The IRS issues most tax refunds within 21 days of the IRS receiving a tax return. However, the IRS has experienced delays in processing paper tax returns due to limited staffing during the coronavirus pandemic.
IRA contributions
Contributions to an individual retirement account (IRA) for 2020 can be made up to the due date (without regard to extensions) for filing the 2020 federal income tax return. The postponement of the 2020 tax filing due date by the IRS also generally extends the time to make IRA contributions for 2020 to May 17, 2021.
American Rescue Plan Act Provides Relief to Individuals and Businesses
On Thursday, March 11, 2021, the American Rescue Plan Act of 2021 (ARPA 2021) was signed into law. This is a $1.9 trillion emergency relief package that includes payments to individuals and funding for federal programs, vaccines and testing, state and local governments, and schools. It is intended to assist individuals and businesses during the ongoing coronavirus pandemic and accompanying economic crisis. Major relief provisions are summarized here, including some tax provisions.
Recovery rebates (stimulus checks)
Many individuals will receive another direct payment from the federal government. Technically a 2021 refundable income tax credit, the rebate amount will be calculated based on 2019 tax returns filed (or on 2020 tax returns if filed and processed by the IRS at the time of determination) and sent automatically via check, direct deposit, or debit card to qualifying individuals. To qualify for a payment, individuals generally must have a Social Security number and must not qualify as the dependent of another individual.
The amount of the recovery rebate is $1,400 ($2,800 if married filing a joint return) plus $1,400 for each dependent. Recovery rebates start to phase out for those with an adjusted gross income (AGI) exceeding $75,000 ($150,000 if married filing a joint return, $112,500 for those filing as head of household). Recovery rebates are completely phased out for those with an AGI of $80,000 ($160,000 if married filing a joint return, $120,000 for those filing as head of household).
Unemployment provisions
The legislation extends unemployment benefit assistance:
- An additional $300 weekly benefit to those collecting unemployment benefits, through September 6, 2021.
- An additional 29-week extension of federally funded unemployment benefits for individuals who exhaust their state unemployment benefits.
- Targeted federal reimbursement of state unemployment compensation designed to eliminate state one-week delays in providing benefits (allowing individuals to receive a maximum 79 weeks of benefits)
- Unemployment benefits through September 6, 2021, for many who would not otherwise qualify, including independent contractors and part-time workers.
For 2020, the legislation also makes the first $10,200 (per spouse for joint returns) of unemployment benefits nontaxable if the taxpayer’s modified adjusted gross income is less than $150,000. If a 2020 tax return has already been filed, an amended return may be needed.
Business relief
- The employee retention tax credit has been extended through December 31, 2021. It is available to employers that were significantly impacted by the crisis and is applied to offset Social Security payroll taxes. As in the previous extension, the credit is increased to 70% of qualified wages, up to a certain maximum per quarter.
- The employer tax credits for providing emergency sick and family leave have been extended through September 30, 2021.
- Eligible small businesses can receive targeted economic injury disaster loan advances from the Small Business Administration. The advances are not included in taxable income. Furthermore, no deduction or basis increase is denied, and no tax attribute is reduced by reason of the exclusion from income.
- Eligible restaurants can receive restaurant revitalization grants from the Small Business Administration. The grants are not included in taxable income. Furthermore, no deduction or basis increase is denied, and no tax attribute is reduced by reason of the exclusion from income.
Housing relief
- The legislation allocates additional funds to state and local governments to provide emergency rental and utility assistance through December 31, 2021.
- The legislation allocates funds to help homeowners with mortgage payments and utility bills.
- The legislation also allocates funds to help the homeless.
Health insurance relief
- For those who lost a job and qualify for health insurance under the federal COBRA continuation coverage program, the federal government will generally pay the entire COBRA premium for health insurance from April 1, 2021, through September 30, 2021.
- For 2021, if a taxpayer receives unemployment compensation, the taxpayer is treated as an applicable taxpayer for purposes of the premium tax credit, and the household income of the taxpayer is favorably treated for purposes of determining the amount of the credit.
- Persons who bought their own health insurance through a government exchange may qualify for a lower cost through December 31, 2022.
Student loan tax relief
For student loans forgiven or cancelled between January 1, 2021, and December 31, 2025, discharged amounts are not included in taxable income.
Child tax credit
- For 2021, the credit amount increases from $2,000 to $3,000 per qualifying child ($3,600 for qualifying children under age 6), subject to phaseout based on modified adjusted gross income. The legislation also makes 17-year-olds eligible as qualifying children in 2021.
- For most individuals, the credit is fully refundable for 2021 if it exceeds tax liability.
- The Treasury Department is expected to send out periodic advance payments (to be worked out by the Treasury) for up to one-half of the credit during 2021.
Child and dependent care tax credit
- For 2021, the legislation increases the maximum credit up to $4,000 for one qualifying individual and up to $8,000 for two or more (based on an increased applicable percentage of 50% of costs paid and increased dollar limits).
- Most taxpayers will not have the applicable percentage reduced (can be reduced from 50% to 20% if AGI exceeds a substantially increased $125,000) in 2021. However, the applicable percentage can now also be reduced from 20% down to 0% if the taxpayer’s AGI exceeds $400,000 in 2021.
- For most individuals, the credit is fully refundable for 2021 if it exceeds tax liability.
Earned income tax credit
For 2021 only:
- The legislation generally increases the credit available for individuals with no qualifying children (bringing it closer to the amounts for individuals with one, two, or three or more children which were already much higher).
- For individuals with no qualifying children, the minimum age at which the credit can be claimed is generally lowered from 25 to 19 (24 for certain full-time students) and the maximum age limit of 64 is eliminated (there are no similar age limits for individuals with qualifying children).
- To determine the credit amount, taxpayers can elect to use their 2019 earned income if it is more than their 2021 earned income.
For 2021 and later years:
- Taxpayers otherwise eligible for the credit except that their children do not have Social Security numbers (and were previously prohibited from claiming any credit) can now claim the credit for individuals with no qualifying children.
- The credit is now available to certain separated spouses who do not file a joint tax return.
- The level of investment income at which a taxpayer is disqualified from claiming the credit is increased from $3,650 (as previously indexed for 2021) to $10,000 in 2021 (indexed for inflation in future years).
National Consumer Protection Week: Beware of Pandemic Scams
This past year, scam artists have taken advantage of people’s concerns over the coronavirus pandemic to defraud them of money. According to the Federal Trade Commission (FTC), consumers reported losing more than $3.3 billion to fraud in 2020, up from $1.8 billion in 2019. (1)
This week is National Consumer Protection Week, the perfect time to take steps to protect yourself from the increase in fraud, identity theft and other scams. Here are some of the latest ones to watch out for.
Unemployment benefit scams
According to the U.S. Department of Labor, there has been a surge in identity theft related to unemployment insurance claims. In fact, over $5 billion in potentially fraudulent unemployment claims were paid between March and October of 2020. (2)
Typically, these types of scams involve a fraudster trying to use your personal information to claim unemployment benefits. If you receive an unexpected prepaid card for unemployment benefits, see an unexpected deposit from your state in your bank account, or receive a Form 1099-G for 2020 unemployment compensation that you did not apply for, report it to your state unemployment insurance office as soon as possible.
Economic impact payment scams
Scammers have come up with a number of schemes related to the economic impact payments sent to taxpayers by the federal government. It is important to note that at this time, all first and second economic impact payments have already been sent out. A third economic impact payment may be sent out to taxpayers in March.
The IRS is warning taxpayers to be aware of scammers who:
- Use words such as “stimulus check” or “stimulus payment” instead of the official term, “economic impact payment”
- Ask you to “sign up” for your economic impact payment check
- Contact you by phone, email, text or social media for verification of personal and/or banking information to receive or speed up your economic impact payment
In most cases, the IRS will deposit economic impact payments directly into accounts that taxpayers previously provided on their tax returns. If the IRS does not have a taxpayer’s direct-deposit information, a check or prepaid debit card will be mailed to the taxpayer’s address on file with the IRS. For more information visit irs.gov.
Fraudulent products and vaccine scams
This past year, the Federal Trade Commission has warned about scam artists attempting to sell fraudulent products that claim to treat, prevent or diagnose COVID-19.
With the arrival of new COVID-19 vaccines, the FTC is warning consumers to also be wary of possible vaccine scams. The FTC is urging consumers to contact their state or local health department in order to find out how, when and where to get a COVID-19 vaccine. In addition, the FTC warned consumers to avoid scammers who:
- Offer to put your name on a vaccine list or get early access to a vaccine for a fee
- Call, text or email you about the vaccine and ask for financial information
Protecting yourself from scams
Fortunately, there are some things you can do to protect yourself from scams, including those related to the coronavirus pandemic:
- Don’t click on suspicious or unfamiliar links in emails, text messages or instant messaging services — visit government websites directly for important information.
- Don’t answer a phone call if you don’t recognize the phone number — instead, let it go to voicemail and check later to verify the caller.
- Keep device and security software up to date, maintain strong passwords and use multi-factor authentication.
- Never share personal or financial information via email, text message or over the phone.
- If you see a scam, be sure to report it to the FTC at ftc.gov, the Treasury Inspector General for Tax Administration (TIGTA) at tigta.gov and your local police department.
(1)Federal Trade Commission, February 2021
(2)U.S. Department of Labor, February 2021
Pandemic Relief Measures and Your Tax Return
Two emergency relief bills passed in 2020 in response to the COVID-19 pandemic will make this an unusual tax season for many taxpayers. The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed in March, and a second relief package was attached to the Consolidated Appropriations Act, 2021, in December.
The federal government relied on the tax system to deliver financial lifelines to struggling households, boost consumer spending, and help speed the economic recovery.
The following provisions may affect many households when they file their personal tax returns for 2020. You might consult a tax professional who can further explain the relevant changes and recommend strategies to help reduce your tax liability for 2021.
Recovery Rebate Credit
Most U.S. households received two Economic Impact Payments (EIPs) from the federal government in 2020. They are not taxable because technically they are advances on a refundable credit against 2020 income taxes.
The CARES Act provided a Recovery Rebate Credit of $1,200 ($2,400 for married joint filers) plus $500 for each qualifying child under age 17. The second bill provided another $600 per eligible family member.
Any individual who has a Social Security number and is not a dependent generally qualifies for the payments, up to certain income limits. The amounts are reduced for those with adjusted gross incomes (AGIs) exceeding $75,000 ($150,000 for joint filers and $112,500 for heads of household) and phase out completely at AGIs of $99,000 ($198,000 for joint filers and $112,500 for heads of household).
In order for the money to be delivered quickly, eligibility was based on 2019 income tax returns (or 2018 if a 2019 return had not been filed). Eligible taxpayers who did not receive two full payments, possibly due to errors or processing delays, may claim the money as a Recovery Rebate Credit on their 2020 tax return. Households that reported a lower AGI in 2020 (or added a dependent) might be eligible for additional funds. To calculate the credit, filers will need to know the amounts of any payments they already received. The credit amount will increase the refund or decrease the tax owed, dollar for dollar.
Taxpayers who received two full payments don’t need to fill out any additional information on their tax returns. The IRS began accepting 2020 tax returns on February 12, 2021; filing electronically usually results in a faster refund.
Coronavirus-related distributions
Another measure in the CARES Act allowed IRA owners and employer-plan participants who were adversely affected by COVID-19 to withdraw up to $100,000 of their vested account balance in 2020 without having to pay the 10% tax penalty (25% for SIMPLE IRAs) that normally applies prior to age 59½.
Still, withdrawals from tax-deferred retirement accounts are typically taxed as ordinary income in the year of the distribution. To help manage the tax liability, qualified individuals can choose to spread the income from a coronavirus-related distribution (CRD) equally over three years or report it in full for the 2020 tax year, with up to three years to reinvest the money in an eligible employer plan or an IRA.
Taxpayers who elect to report income over three years and then recontribute amounts greater than the amount reported in a given year may “carry forward” the excess contributions to next year’s tax return. Taxpayers who recontribute amounts after paying taxes on reported CRD income can file amended returns to recoup the payments.
Qualified individuals whose plans did not adopt CRD provisions may choose to categorize other types of distributions — including those normally considered required minimum distributions — as CRDs on their tax returns (up to the $100,000 limit).
Other notable changes
The special rules for charitable gift deductions enacted for 2020 have been extended through 2021. For those who itemize deductions, the limit on the charitable gift deduction increased to 100% of AGI for direct cash gifts to public charities. For nonitemizers, a new $300 charitable deduction for 2020 and 2021 direct cash gifts to public charities is available. For joint filers, this deduction increases to $600 for 2021 cash gifts to charitable organizations.
The floor for deducting medical expenses has been permanently lowered to 7.5% of AGI. (It was scheduled to increase to 10% in 2021.) And starting in 2021, there is no deduction for qualified tuition and related expenses. Instead, the modified adjusted gross income (MAGI) phaseout range for the Lifetime Learning credit was increased to be the same as the phaseout range for the American Opportunity credit ($80,000 to $90,000 for single filers; $160,000 to 180,000 for joint filers).
A temporary provision that allows taxpayers to exclude discharged debt for a qualified principal residence from gross income was extended through 2025, though the limit has been reduced from $2 million to $750,000. Also, through 2025, employers can pay up to $5,250 annually toward employees’ student loans as a tax-free employee benefit.
Yes, unemployment aid is taxable!
The number of unemployed workers spiked above 22 million in March 2020, and more than 9 million people were still out of work at the end of the year.1 Both relief bills expanded unemployment benefits and provided them to many workers who normally are not eligible (including the self-employed, independent contractors, and part-time workers).
Unemployment benefits, which sustained many families impacted by the pandemic, are considered taxable income, and many recipients may not have correctly withheld taxes from their 2020 payments. Avoiding a surprise tax bill typically requires opting into a 10% withholding rate and, in some cases, paying additional quarterly taxes during the year.
Last year was unpredictable, and your financial situation may have been far from normal. You should file your 2020 tax return by the April 15 deadline, even if you are worried that it’s going to show a balance due. Being up-to-date on filing is generally required to pursue a payment agreement with the IRS. If you owe $50,000 or less, you may even be able to apply online for a short-term extension (up to 120 days) or a longer payment agreement. Paying as much as you can afford can help limit penalties and interest that accrue on unpaid amounts.
1) U.S. Bureau of Labor Statistics, 2021
GameStop, Reddit, and Market Mania: What You Need to Know
Over the course of 11 trading days from January 13 to January 28, 2021, the stock of GameStop, a struggling brick-and-mortar video game retailer, skyrocketed by more than 2,200% — creating a mix of excitement and concern throughout the financial world, as well as among many people who pay little attention to the stock market.1 Other stocks of small, struggling companies made similar though less dramatic moves.
At the heart of this story are two very different sets of investors: (1) professional managers of multibillion-dollar hedge funds, who took large, risky positions betting that GameStop stock would drop in price; and (2) a small army of individual investors, connected through social news aggregator Reddit and other social media sites, who worked together to buy large numbers of shares in order to drive the stock price up.
As the stock price rose, fund managers were forced to buy more and more shares at ever-increasing prices to “cover their bets,” while individual investors continued to buy shares in hopes of continuing the momentum. The opposing forces created a feeding frenzy that sent the stock to dizzying heights far beyond the fundamental value of the company.2 The stock price peaked on January 28 and lost almost 90% of its peak value over the next five trading days.3
If you are confused, concerned, intrigued — or a combination of all three — here are answers to some questions you may have about the recent market volatility triggered by “meme” stocks, an Internet term for stocks heavily promoted through social media.
1. What is a hedge fund, and what were the hedge funds doing?
A hedge fund is an investment company that uses pooled funds to take an aggressive approach in an effort to outperform the market. These funds are typically open to a limited number of accredited investors and may require a high minimum investment. Hedge funds use various high-risk strategies, including buying stock with borrowed money or borrowing stock to sell, called buying or borrowing on margin. This enables the fund to increase potential profits but also increases potential losses. (Individual investors can use these high-risk techniques, but the investor must meet certain financial requirements in order to establish a margin account and accept the increased risk.)
In this case, certain hedge funds borrowed shares of GameStop and other struggling companies on margin from a brokerage firm and sold the shares at the market price, with the expectation that the share prices would drop significantly by the time they had to return the shares to the lender. The funds could then buy shares at the lower price, return the shares, and pocket the difference, minus fees and interest. When GameStop share prices began to rise quickly against expectations, the “short sellers” began to buy shares at market prices in order to protect against future losses. These purchases helped drive share prices even higher — supply and demand — which led to more purchases and even higher prices. This created a situation known as a short squeeze.4
To understand the level of risk faced by the short sellers, consider this: An investor who owns shares of a company can lose no more than 100% of the investment, but there is essentially no limit to the potential losses for a short seller, because there is no limit to how high a stock price might go. This is why short sellers were willing to buy at ever-increasing prices, accepting large losses rather than risking even larger losses. In addition, they were forced to add additional funds and/or other securities to their accounts to meet margin requirements; investors must keep a certain percentage of the borrowed funds as collateral, and the higher the stock prices went, the more collateral was required in the margin accounts.5
2. What is Reddit, and what were the Reddit investors doing?
Reddit is an online community with more than a million forums called subreddits in which members share information on a particular topic. Members of a subreddit dedicated to investing coalesced around a strategy to buy GameStop stock in order to push the price up and squeeze the hedge funds. The potential for this strategy was first suggested on the forum in April 2020, but it exploded on Reddit and other social media sites in January 2021, after a change in the GameStop board of directors that encouraged bullish investors coupled with an announcement from a well-known short seller predicting that the stock price would quickly drop.6
While some investors genuinely believed that GameStop was undervalued, the movement developed into a crusade to beat the hedge funds in what amateur investors perceived to be a “game” of manipulating stock values, as well as a more pragmatic belief that there was money to be made by buying GameStop low and selling high. The fact that many young investors were gamers who felt an affinity for GameStop added to the sense of purpose.7
The strategy worked more powerfully than the amateur investors expected, and some who bought the stock in the early stages of the rally and sold when it was flying high earned large profits. However, those who joined the excitement later faced large losses as the stock plummeted. Once some hedge funds had accepted losses and begun to close their short positions, there was no longer demand for shares at inflated prices.8
3. Why did brokerage firms limit trading activity for certain stocks?
At various points during the peak trading activity, some brokerage firms stopped the trading of GameStop and other heavily shorted and heavily traded stocks. They also placed restrictions on certain stocks, limiting trading to very small lots and/or raising margin requirements. In a typical situation, an investor must maintain a 50% margin, meaning the investor can borrow shares or funds equal to the shares or funds in his or her account. Restrictions varied in response to the recent trading, but at least one brokerage firm raised margin requirements on certain stocks to 100% for long positions (purchasing stocks to hold) and 300% for short positions.9
The stoppages and restrictions elicited accusations of unfairness from investors and some members of Congress, who believed the brokerage firms were protecting the hedge funds. In fact, the moves were dictated in large part by clearinghouses that process trades from the brokers. These clearinghouses require that brokers keep a certain level of funding (collateral) on deposit in order to cover both sides of any given trade. As trading and values increased, clearinghouses asked for larger deposits. By halting and/or restricting trading of highly volatile stocks, brokers were able to reduce the required collateral, which enabled them to meet the new deposit requirements in a timely manner.10
The restrictions also helped protect investors from being overextended and suffering outsized losses amid extreme volatility. And to an extent, they protected the broader stock market. The New York Stock Exchange (NYSE) regularly suspends trading of individual stocks when price swings exceed certain limits. On February 2, when the price of GameStop was plunging, the NYSE suspended trading five times throughout the day, with each suspension lasting less than 12 minutes. Although GameStop remained in the spotlight, more than 20 other stocks also had trading suspended throughout that day.11
4. What happens next?
It may take months or years before the full effects of the recent activity play out in the financial markets, but one clear takeaway is that social media, combined with accessible low-cost trading platforms, allows like-minded groups of retail investors to exert power that matches large-scale institutional investors. More than 10 million new brokerage accounts were opened in 2020, and many new investors are trading securities online and through smartphone apps.12
Some hedge fund managers have already stated that they will rethink their focus on short selling.13 And new services aimed at providing tools for professional investors to track investing discussions on social media platforms have quickly risen and may become a staple of investment research.14
Although the larger stock market remained resilient throughout the episode, extreme volatility is always a concern, and the Securities and Exchange Commission issued a statement saying, “The Commission is closely monitoring and evaluating the extreme price volatility…[which] has the potential to expose investors to rapid and severe losses and undermine market confidence. As always, the Commission will work to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate capital formation.”15
What about GameStop and other companies involved in the volatility? The huge price swings had little or nothing to do with the actual value of the companies, and they will need to make fundamental business changes to address the underlying weakness that caused them to be targeted for short sales in the first place. The changes on the GameStop board that helped spark the rally, adding leaders with online expertise, may help the company compete in the marketplace, but that remains to be seen.16
As an investor, the lesson for you might be to tune out market mania over “hot stocks,” especially when there is little to back up the sudden interest other than speculation. The wisest course is often to build a portfolio that is appropriate for your risk tolerance, time frame, and personal situation and let your portfolio pursue growth over the long term. This strategy may not be as exciting as the wild ups and downs of stocks in the spotlight, but it’s more likely to help you reach your long-term goals.
The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Investments offering the potential for higher rates of return also involve higher risk.
Margin accounts can be very risky and are not appropriate for everyone. Before opening a margin account, you should fully understand that: you can lose more money than you have invested; you may have to deposit additional cash or securities in your account on short notice to cover market losses; you may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities; and your brokerage firm may sell some or all of your securities without consulting you to pay off the loan it made to you.
1, 3) Yahoo! Finance, for the period January 13, 2021, to February 4, 2021
2, 4–5) Kiplinger, January 30, 2021
6–7) Bloomberg, January 25, 2021
8) The New York Times, February 3, 2021
9) CNBC, January 28, 2021
10) The Wall Street Journal, January 29, 2021
11) New York Stock Exchange, 2021
12) The Wall Street Journal, December 30, 2020
13) Barron’s, January 29, 2021
14) MarketWatch, February 1, 2021
15) Securities and Exchange Commission, January 29, 2021
16) The New York Times, February 1, 2021
Revisiting the 4% Rule
Saving for retirement is not easy, but using your retirement savings wisely can be just as challenging. How much of your savings can you withdraw each year? Withdraw too much and you run the risk of running out of money. Withdraw too little and you may miss out on a more comfortable retirement lifestyle.
For more than 25 years, the most common guideline has been the “4% rule,” which suggests that a withdrawal equal to 4% of the initial portfolio value, with annual increases for inflation, is sustainable over a 30-year retirement. This guideline can be helpful in projecting a savings goal and providing a realistic picture of the annual income your savings might provide. For example, a $1 million portfolio could provide $40,000 of income in the first year with inflation-adjusted withdrawals in succeeding years.
The 4% rule has stimulated a great deal of discussion over the years, with some experts saying 4% is too low and others saying it’s too high. The most recent analysis comes from the man who invented it, financial professional William Bengen, who believes the rule has been misunderstood and offers new insights based on new research.
Original research
Bengen first published his findings in 1994, based on analyzing data for retirements beginning in 51 different years, from 1926 to 1976. He considered a hypothetical, conservative portfolio comprising 50% large-cap stocks and 50% intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. A 4% inflation-adjusted withdrawal was the highest sustainable rate in the worst-case scenario — retirement in October 1968, the beginning of a bear market and a long period of high inflation. All other retirement years had higher sustainable rates, some as high as 10% or more.1)
Of course, no one can predict the future, which is why Bengen suggested the worst-case scenario as a sustainable rate. He later adjusted it slightly upward to 4.5%, based on a more diverse portfolio comprising 30% large-cap stocks, 20% small-cap stocks, and 50% intermediate-term Treasuries.2)
New research
In October 2020, Bengen published new research that attempts to project a sustainable withdrawal rate based on two key factors at the time of retirement: stock market valuation and inflation (annual change in the Consumer Price Index). In theory, when the market is expensive, it has less potential to grow, and sustaining increased withdrawals over time may be more difficult. On the other hand, lower inflation means lower inflation-adjusted withdrawals, allowing a higher initial rate. For example, a $40,000 first-year withdrawal becomes an $84,000 withdrawal after 20 years with a 4% annual inflation increase but just $58,000 with a 2% increase.
To measure market valuation, Bengen used the Shiller CAPE, the cyclically adjusted price-earnings ratio for the S&P 500 index developed by Nobel laureate Robert Shiller. The price-earnings (P/E) ratio of a stock is the share price divided by its earnings per share for the previous 12 months. For example, if a stock is priced at $100 and the earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE divides the total share price of stocks in the S&P 500 index by average inflation-adjusted earnings over 10 years.
5% rule?
Again using historical data — for retirement dates from 1926 to 1990 — Bengen found a clear correlation between market valuation and inflation at the time of retirement and the maximum sustainable withdrawal rate. Historically, rates ranged from as low as 4.5% to as high as 13%, but the scenarios that supported high rates were unusual, with very low market valuations and/or deflation rather than inflation.3)
For most of the last 25 years, the United States has experienced high market valuations, and inflation has been low since the Great Recession.4-5) In a high-valuation, low-inflation scenario at the time of retirement, Bengen found that a 5% initial withdrawal rate was sustainable over 30 years.6) While not a big difference from the 4% rule, this suggests retirees could make larger initial withdrawals, particularly in a low-inflation environment.
One caveat is that current market valuation is extremely high: The S&P 500 index had a CAPE of 34.19 at the end of 2020, a level only reached (and exceeded) during the late-1990s dot-com boom and higher than any of the scenarios in Bengen’s research.7) His range for a 5% withdrawal rate is a CAPE of 23 or higher, with inflation between 0% and 2.5%.8) (Inflation was 1.2% in November 2020.9) Bengen’s research suggests that if market valuation drops near the historical mean of 16.77, a withdrawal rate of 6% might be sustainable as long as inflation is 5% or lower. On the other hand, if valuation remains high and inflation surpasses 2.5%, the maximum sustainable rate might be 4.5%.10)
It’s important to keep in mind that these projections are based on historical scenarios and a hypothetical portfolio, and there is no guarantee that your portfolio will perform in a similar manner. Also remember that these calculations are based on annual inflation-adjusted withdrawals, and you might choose not to increase withdrawals in some years or use other criteria to make adjustments, such as market performance.
Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, including your withdrawal strategy.
All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Asset allocation and diversification are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss. Rebalancing involves selling some investments in order to buy others; selling investments in a taxable account could result in a tax liability.
The S&P 500 index is an unmanaged group of securities considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.
1-2) Forbes Advisor, October 12, 2020
3-4, 6, 8, 10) Financial Advisor, October 2020
5, 9) U.S. Bureau of Labor Statistics, 2020
7) multpl.com, December 31, 2020
