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Posts Tagged ‘president obama’

Having had the opportunity to review President Obama’s newly released 2011 tax return for Bloomberg news this morning, one thing is immediately obvious: the President’s tax return stands in stark contrast to the 2010 return previously released by his Republican counterpart, Mitt Romney. One look at the candidates’ tax filings makes it clear why tax policy will likely play an integral role in the upcoming election, as the dramatic differences evident in the determination of each man’s tax liability are mirrored in their respective tax proposals. 

Based purely on their respective tax filings, President Obama will be sure to portray himself as the “every man” in the upcoming election, despite being among the top 1% of earners in America. To the contrary, Mitt Romney, through no fault of his own, is likely to be painted as the embodiment of a broken tax system. This difference in perception will be due to a number of factors evidenced in their respective tax returns:

Sources of Income

The overwhelming majority of President Obama’s taxable income in 2011 was of the ordinary variety — wages of $395,000, self-employment income from book sales of $441,000, and taxable interest of $11,000. The President had no investment income in the form of qualified dividends or long term capital gains during 2011. In fact, Obama does not appear to be invested in the stock market to any material degree. As a result, the President derives no benefit from the 15% preferential tax rate afforded to these classes of income by the Bush tax cuts.  

To the contrary, on his 2010 tax return, Mitt Romney reported no wages and relatively minimal self-employment income. Instead, of his $21,600,000 of adjusted gross income, $5,000,000 was in the form of qualified dividends and $12,500,000 was generated as long-term capital gains. Courtesy of the Bush tax cuts, all of this income was taxed at the preferential 15% tax rate.

Level of Transparency

President Obama owns no rental properties, holds no interests in partnerships, S corporations, or trusts, and he fully maximizes his retirement plan contributions.  Even the President’s itemized deductions give the appearance of relative “normalcy;” he has a mortgage on his home and  his real estate taxes are a “reasonable” $22,000.

In contrast to the President, sophistication and complexity permeate Romney’s return. He holds interests in multiple trusts and rental properties, and his return is littered with informational filings related to numerous offshore investments. He owns no mortgage on his home, but paid over $226,000 in real estate taxes during 2010.

Effective Tax Rate

Due to his combination of considerable ordinary income, the absence of qualified dividends and long-term capital gain, and a moderate amount of itemized deductions, the President’s effective tax rate in 2011 was 20.5%. This is a number many American’s are likely to find more palatable than the 13.9% paid by Mitt Romney in 2010, particularly in light of the fact that President Obama’s adjusted gross income was $789,000, compared to the $21,600,000 Romney reported.  

Industry-Specific Tax Breaks

Perhaps most egregious in the eyes of observers, a substantial portion of Romney’s income is subject to one of the more hotly debated tax breaks currently available in the Code: the 15% tax rate afforded “carried interest.” This break allows private equity fund managers such as Romney to pay tax on the allocable share of fund income they receive in exchange for management services at a rate of 15% if the allocable income is in the form of long-term capital gains or qualified dividends, despite the fact that compensation for services rendered is typically taxed at ordinary rates.

 To the contrary, President Obama receives no industry-specific breaks.

Reflections in Tax Policy

Perhaps more so than in any election in recent memory, the tax returns filed by President Obama and Mitt Romney provide a window into their tax policies.

President Obama has built his platform on what he calls “fairness.” It is time, he insists, for the wealthy to pay their share. To do so, he proposes changes that would impact his tax situation minimally, but would drastically change that of his opposition and many of the nation’s wealthy.  

The President has vowed to repeal the Bush tax cuts, which would increase the top rate on ordinary income from 35% to 39.6%. While this would increase the tax imposed on Obama’s wages and self-employment income, it alone would do little to effect those of Romney’s ilk who earn their income predominately from qualified dividends and long-term capital gains.

To that end, the President has proposed returning the tax rate on qualified dividends to the top ordinary rate of 39.6%, while the tax on long-term capital gains would increase from 15% to 25% for those with adjusted gross income in excess of $250,000. These changes, if implemented, would have virtually no impact on the President’s tax liability, courtesy of his lack of investment income.

Romney, on the other hand, would feel a significant pinch, as the tax on his $5,000,000 of qualified dividends would increase by 24.6%, with the tax on his long-term capital gains of $12,000,000 jumping by 10%.

The President’s war on the perceived inequities doesn’t end there, however. He proposes two more law changes that would ensure Romney and other wealthy taxpayers pay there “fair share.” First, Obama would put an end to the tax break on carried interest, meaning much of Romney’s long-term capital gains would be taxed as ordinary income, at a maximum rate of 39.6%. In addition, the President proposes to institute the much-discussed “Buffett Rule” — named after the billionaire business magnate who stirred the hornet’s nest by famously claiming that he paid a lower tax rate than his secretary — which would guarantee that taxpayers earning over $1,000,000 in AGI paid a minimum effective tax rate of 30%.

Given that President Obama’s adjusted gross income did not exceed $1,000,000 in 2011, the Buffett Rule would not affect his tax liability. For Mitt Romney, on the other hand, the Buffett Rule would more than double his effective tax rate and his resulting tax liability.

It is this difference in their current and potential tax liabilities that the President will play up in his ensuing campaign. In order to chip away at the deficit, the President will insist, the nation’s wealthy must no longer be able to take advantage of industry-specific tax breaks and preferential tax rates and start pulling their weight, in the name of both fiscal responsibility and social equitability.

In direct contrast, Mitt Romney has built his tax platform on an array of tax cuts that could easily be dismissed as self-serving, but in fact may well do more to stimulate the economy and reduce the deficit than the increases proposed by the President.

Romney proposes to cut the tax rates for all Americans, with the maximum tax rate on ordinary income dropping to 28%. This would result in a 7% reduction on the President’s wages, but would have little effect on Romney’s return, with its absence of wages and self-employment income.

Where Romney would benefit greatly, however, is his proposal to keep the tax rate on long-term capital gain and qualified dividends at 15%. While this would preserve the preferential tax rate applied to the overwhelming majority of his income, Romney does not hoard the benefits all for the super wealthy. Instead, he proposes that taxpayers earning less than $250,000 in AGI be able to earn interest, dividends, and long-term capital gains tax free, a law change that would certainly motivate the middle class to save and invest.

Romney would keep the current preference on “carried interest” in place and also attempt to repeal the estate tax, two policies that are likely to be perceived as his catering to the super wealthy. As the majority of Americans will never have to concern themselves with carried interest or be subject to the estate tax, they may well see this as Romney aiming to protect his fortune and those of his Republican constituents, further alienating him in the eyes of many.

It’s rare that the tax world takes over the front pages, but judging by the immediate and widespread reactions to the President’s release of his tax return this morning, it appears the tax policies of Obama and Romney have become the focal point of the upcoming election.

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Last week, in our reactions to President Obama’s proposal for corporate tax reform, we took special note of the president’s continued push towards a  “worldwide” international tax system; one  that greatly expands the reach of the U.S. in taxing non-U.S. sourced income earned by foreign subsidiaries.

Most notably, we highlighted just how dramatically the president’s proposal deviates from those posited by the leading Republican candidates, who favor the “territorial” systems adopted by much of the developed world.

But what do “worldwide” and “territorial” international systems really mean? How do they compare to our current system? And more importantly, how would they change the way the U.S. currently taxes the icnome earned by foreign subsidiaries of domestic corporations?

To illustrate, let’s take a simple fact pattern:

X Co. is a U.S. corporation. X Co. owns 100% of Foreign Co., a foreign corporation that generates no revenue from U.S. sources.

How is Foreign Co.’s income taxed by the U.S. under either:

1) The current “deferral” international tax system?

2) The “territorial” tax system proposed by Mitt Romney and Newt Gingrich?

3) A more expansive “worldwide” tax system as proposed by President Obama.

Current  “Deferral” Tax System

Under the current system, there is generally no U.S. tax imposed upon the earnings of Foreign Co. until the earnings are repatriated to the U.S through a distribution to X Co. At that point, X Co. will pay U.S. tax on the dividend received from Foreign Co., subject to any tax treaty between X Co. and Foreign Co.’s resident nation.

Upon receiving the dividend, X Co. is permitted to utilize a foreign tax credit to reduce the U.S. tax applied to the dividend, preventing the same income from being taxed twice: once when earned by Foreign Co. and a second time when distributed to X Co.

Pros:

  • The current “foreign tax credit” system ensures that even where Foreign Co. enjoys a lower tax rate in its home nation, tax will ultimately be imposed on the earnings of Foreign Co. at the U.S. corporate rate;
  • U.S. tax is not imposed upon income earned by F Co. until the earnings are repatriated to the U.S.

 Cons:

  •  An administrative nightmare;
  • Encourages X Co. to leave Foreign Co.’s profits offshore to avoid the imposition of U.S. taxes upon repatriation;
  • Gives birth to a wide variety of accounting tricks and sophisticated tax planning measures employed to minimize the U.S. tax burden, which ultimately reduce U.S. tax revenue.

Territorial Tax System

Under a territorial tax system, U.S tax would never be imposed on income earned by Foreign Co. from non-U.S. sources. The U.S. would simply allow Foreign Co.’s home country to tax its earnings. When Foreign Co.’s earnings are subsequently repatriated to X Co., the dividends would not be subject to U.S taxation.  

Pros:

  • Greatly reduces the complexity of international taxation;
  • Eases the administrative burden on multinational corporations;
  • By eliminating the U.S. tax on repatriated foreign earnings, U.S. companies will no longer have to pay to bring overseas income “home,” thus encouraging investment in the U.S.

Cons:

  • Encourages U.S. corporations to shift activities to jurisdictions with lower corporate tax rates, taking jobs and revenue along with them and eroding the U.S. tax base.
  • Transition concerns; What do you do with the foreign income that was previously earned but not yet repatriated to the U.S.?  

A More Expansive Worldwide Tax System

President Obama is proposing a sea change in the way the U.S. taxes international operations; one which embodies the opposite characteristics of the system proposed by his Republican counterparts. The president would eliminate the current laws that permit domestic corporations to defer U.S. tax on Foreign Co.’s earnings until they are repatriated by instituting a worldwide minimum tax. This tax would be imposed on Foreign Co.’s income when earned, regardless of whether it was U.S. sourced or when it is repatriated.

Pros:

  • More tax revenue for us!
  • Does not distort the decision of where to invest.
  • Eliminates incentive to game the system, since the U.S. will tax Foreign Co.’s earnings, wherever they may be.

 Cons:

  • Makes the existing administrative nightmare even worse;
  • I’m not sure if this is a pro or con, but it is the opposite system that much of the developed world is adopting, potentially putting us at a competitive disadvantage.
  • Is sure to be highly opposed by powerful corporations that have successfully shifted much of their earnings overseas under the current regime.

Which system is the best? It’s nearly impossible to say at this point, because under no scenario would the U.S. adopt a pure territorial or worldwide international tax system. Any territorial system would have to adopt elements of a worldwide system to curb abuses, and vice versa. As indicated above, there are advantages and disadvantages to each of the options, and ultimately, the devil will be in the details.

This much is clear, however; the chasm that exists between the proposals fronted by President Obama and the Republican candidates is material and meaningful, and stands to garner more attention as November nears.

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