Archive for September 25th, 2011

Now that we’ve had some time for the smoke to clear with regards to the President’s most recent proposal for tax reform (see earlier proposals here and here) it’s time for a quick overview as to what’s happened, and where we’re headed.

So what went down last Monday?

The President rolled out his $3 trillion federal budget Deficit Reduction Plan. It’s a veritable economic stew filled with succulent spending cuts, tasty tax increases, and robust revenue raisers. And much like my Mom’s mystery meat-and-vegetable concoction, many have had a difficult time choking it down. The plan — which targets the amount of tax paid by the nation’s cultural elite —  has been met with the expected Republican backlash, including accusations of class warfare and the standard shortsighted, incomprehensible rhetoric from Bill O’Reilly.[1]

So what does this mean to me?

Perhaps the most important thing is this: the plan takes aim at “wealthy taxpayers.” Unfortunately, whether or not a taxpayer is “wealthy” depends on which tax proposal we’re talking about. As you’ll see below, for some purposes of the proposal, you would be considered wealthy if your taxable income exceeds $200,000, while for other purposes, you’ll need to have taxable income in excess of $1,000,000 to meet the “wealthy” standard. 

How do these proposals effect the Bush-era tax cuts?

If the President were to do nothing, the Bush-era tax cuts are set to expire after December 31, 2012. As a result, the top two tax rates would revert to 36 and 39.6 percent.

The most recent proposal would allow these two higher rates to return for 2013 and beyond, but only for “wealthy”  taxpayers of the $200,000 variety. In other words, if your taxable income exceeds $200,000 ($250,000 for MFJ) in 2012, you’ll be paying tax at up to a 39.6 percent rate.

Will we still have the favorable 15 percent rates on long-term capital gains and qualified dividends?

This isn’t entirely clear, but even if the 15 percent rates remain in the taxing structure, it likely won’t remain for everyone. The goal of the President’s proposed tax reform is to require a wealthy taxpayer who generates mostly long-term capital gains or qualified dividend income to pay tax at an effective rate much closer to 35 percent than 15 percent. So while taxpayers with income below $200,000 may well continue to enjoy the benefits of the current 15 percent rates, taxpayers with more than $200,000 of taxable income likely will not.

Is this where the “Buffet Rule” comes in?

Precisely. While the “Buffet Rule” is not a specific proposal in terms of increased tax rates or a reduction in certain deductions, the goal is to insure that individuals with taxable income in excess of $1,000,000 pay tax at an effective rate of close to 35 percent. This could be accomplished in a number of ways; by increasing the graduated tax rates, phasing out certain deductions, or incorporating a second alternative to the alternative minimum tax. At this moment, the President is leaving it to Congress to figure out the details and methodology.

The Buffet Rule wouldn’t have a tremendous impact on taxpayers with more than $1,000,000 of “ordinary” taxable income, as this income is already taxed at the highest possible rates. Rather, the Buffet Rule takes aim at wealthy individuals earning the majority of their taxable income from long-term capital gains and qualified dividends taxed at preferential rates. These taxpayers could see a marked jump in their tax liability under this hypothetical new minimum tax should the President’s proposals become law.

Another alternative minimum tax? Are you #*@!ing serious?

Unfortunately, yes. While the President says he wants to overhaul and simplify the Code, implementing the Buffet Rule would most assuredly complicate matters. Congress would likely have to implement an entirely independent taxable income computation for individuals with taxable income in excess of $1,000,000 to guarantee the individual pays tax at the desired effective rate. Any such calculation would likely have to take into account the myriad of exclusions, above-the-line deductions, itemized deductions, and tax credits taxpayers are currently entitled to, generating an exponential increase in administrative headaches, late nights, and billable hours for tax advisors.

Are there any other individuals proposals I should know about?

The President’s proposal includes a plan to limit the tax benefit of itemized deductions for individuals with taxable income in excess of $200,000 ($250,000 MFJ) to 28 percent (as opposed to a current maximum benefit of 35 percent). While this proposal doesn’t appear to be integrated with the “Buffet Rule,” it would surely have to work in lockstep with any alternative alternative minimum tax. As mentioned, however, this rule targets individuals with taxable income in excess of $250,000, while the Buffet Rule is meant for wealthy individuals of the $1,000,000 variety.

What else makes the plan so complicated?

Let’s rehash what we’ve already discussed. If all the President’s proposals become law, we could potentially have three independent computations of tax going on in 2013 and beyond:

1. Taxable income < $200,000 ($250,000 if MFJ): Would still have a top rate of 35 percent, and it appears, would still be entitled to the 15 percent tax rate on long-term capital gains and qualified dividends.

 2. Taxable income > $200,000 but less than $1,000,000: Would fall into the “first tier” of wealthy taxpayers. These individuals would likely see their top rate revert to the old 39.6 percent, with the preferential rates on long-term capital gains or qualified dividends either being eliminated entirely or moved to a 20-25 percent rate. These individuals would also be subject to the additional 0.9 percent Medicare tax on wages and self employment income and the additional 3.8 percent Medicare tax on unearned income already enacted into law. Finally, these individuals would also be subject to the 28 percent cap on their itemized deductions. Good luck preparing/reviewing that tax return.

 3. Taxable income > $1,000,000: Will have to contend with all of the items discussed in #2 above, but will also have to wrestle with a separate computation to reach the goals of the “Buffet Rule.” Again, this sounds like a lot of moving parts that will challenge tax software and practitioners alike.

Are there any tax changes for corporations in the plan?

Right now, the President is showing an inclination to reduce corporate tax rates as long as certain loopholes are closed. No specific tax rates have been discussed, but it’s clear the President is prepared to provide some incentive for US corporations to remain onshore rather than seeking out greener pastures overseas.  

[1] In response to the President’s proposal, O’Reilly said that an increased tax rate on the wealthy amounts to a “tax on achievement.” “And when you tax achievement,” O’Reilly added, “some of the achievers will pack it.” This statement is both stupid and unfounded, particularly in light of two facts:

 1. O’Reilly made his vast, inexplicable fortune at a time when the top tax rate was 39.6 percent under President Clinton. As such, he’s no stranger to the proposed rate, and did he “pack it in” during the Clinton regime? No, he opted instead to slap a stupid logo on every piece of crappy merchandise imaginable and sell it on his website, giving the world meaningful products such as the “patriot coffee mug” and the “patriot hat.”

2.  Effective tax rates have been as high as 90 percent in this country, and it’s safe to say that the majority of achievers, even when faced with the prospect of turning the majority of their hard-earned income over to the government, didn’t simply shrug their collective shoulders, pull the plug on their life’s work, and take a job flipping burgers.

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