Mixed Signals

October 1, 2010—The recession is over. In fact, according to the National Bureau of Economic Research, the economic trough was reached in June 2009, so the recession has been over for 16 months. This was the longest downturn since the Great Depression, lasting 18 months. The previous post-World War II recordholders were in 1973-75 and 1981-82, both lasting 16 months.

The economy remains very weak, operating well below its potential. Unemployment remains stubbornly high, nearly 10%, and underemployment is far higher. The Commerce Department revised the growth in Gross Domestic Product for the second quarter of 2010 to 1.7%, from its July 2.4% estimate. That’s a meaningful slowdown from the 3.7% real growth rate of the first quarter of the year. The housing sector remains weak, as the temporary tax credit provided only a temporary lift, not the pump priming that was hoped for.

Consumer confidence fell in September to its lowest level since February, resulting from the poor business and labor conditions. But on the bright side, the stock market had its best September in decades.

Tax breaks for small businesses
Perhaps the economic lethargy will be broken by the Small Business Jobs Act of 2010, signed by the President on September 27. Key provisions include:

• Up to $14 billion in new loans to small businesses, administered through the Small Business Administration.
• A one-year extension of bonus depreciation, which had expired in 2009, through the end of this year. Bonus depreciation is not limited by the size of the business, so large firms may benefit from this as well. That’s why it has an initial “cost” in lost revenue projected at $29.5 billion.
• An increase in the cap on expensing of certain business purchases from $250,000 to $500,000 for this year and next.
• A 100% exclusion from capital gains taxes and the alternative minimum tax for purchases of certain small business stock before the end of this year. A five-year holding period applies.
• Doubling the deduction for start-up expenses from $5,000 to $10,000 for one year, 2010.
• A better deduction for health insurance costs for the self-employed.
• Relief from reporting provisions for the use of company cell phones.

Strict substantiation of business and personal use of the phones had been required, and any personal use was treated as taxable income. Now if a cell phone is provided to an employee and used predominately for business, the value of the personal usage may be excluded from income.

How will these benefits be "paid for"? A number of loopholes have been closed, of course. More interestingly, for those approaching retirement, state and local government 457(b) plans can have after-tax Roth accounts, beginning in 2011. Of greater significance, rollovers from 401(k) accounts to Roth 401(k) accounts are permitted, as of September 27. As with the conversion of an IRA to a Roth IRA, the rollover is a taxable event. Also, a similar rule applies for reporting the taxable income. If the conversion to a Roth 401(k) occurs in 2010, the resulting income may be reported in 2011 and 2012, with the tax deferred until those years. Alternatively, the income may be reported this year, locking in this year’s tax rates.

Although these retirement savings incentives may cost the Treasury money in the long run, they were scored as an increase in revenue of $7.6 billion.

The election
Public disappointment with the weak economy, especially the jobs situation, is expected by many to have an important influence in the November elections. If control of the House or Senate, or both, changes hands, we could see a material change in tax and spending policies. The precise impact of such changes is, of course, a subject of debate. Each investor’s reactions are likely to turn upon his or her politics.

© 2010 M.A. Co. All rights reserved.%uFEFF