More On Tax Planningfrom The Advisor's Professional Library
- IRAs: In General Individual Retirement Accounts are highly popular tools for contributing funds that grow on a tax deferred basis. Depending on the type of IRA, the accumulation can be tax free.
- Cafeteria Plans The income tax treatment of cafeteria plans is key to their popularity. Learn how to maximize the tax benefits of these “flexible benefit plans”.
A central focus of President Barack Obama’s State of the Union address Tuesday night was economic fairness, and requiring the wealthiest of Americans to pay more in taxes, but tax specialists and wealth managers say hiking taxes for the rich will do nothing to fix the tax code–which they say is a mess.
Obama’s proposal to cut $3.6 trillion from the deficit over the next decade through a measure called the Buffett rule, named for billionaire investor Warren Buffett, which increases taxes on wealthy Americans who earn $1 million or more per taxable year, is merely “good tax politics, not good tax policy,” says Christopher Bergin, president of Tax Analysts.
The fundamental problem with the tax code, Bergin says, is that “our tax system right now picks winners and losers.” The wages that average workers pay and are reported on their W-2s are taxed “differently” than the money Buffett and Mitt Romney, the current GOP presidential candidate, make, which is “not by working but by moving money around.” The way the law is written, Buffett and Romney “get a better tax rate than the rest of us.”
As Obama said during his speech on Tuesday, “Tax reform should follow the Buffett rule. If you make more than $1 million a year, you should not pay less than 30% in taxes.… Washington should stop subsidizing millionaires. In fact, if you’re earning a million dollars a year, you shouldn’t get special tax subsidies or deductions.” On the other hand, he said, “if you make under $250,000 a year, like 98% of American families, your taxes shouldn’t go up. You’re the ones struggling with rising costs and stagnant wages. You’re the ones who need relief.”
But “sticking it to the rich” will not fix the income tax code, “which is extremely problematic,” Bergin says. The tax system as it stands now “benefits the rich, and the poor–however you want to categorize them–lower income people do not pay federal income taxes. Some of them get refundable earned income tax credits for some of the payroll taxes they pay.” But it is the middle income folks–those generally earning $100,000 to $500,000 per year, Bergin says, that “really get hit; and are paying more of an effective [tax] rate than Romney.”
Obama also said he wants to let the Bush tax cuts expire. “When it comes to the deficit, we’ve already agreed to more than $2 trillion in cuts and savings. But we need to do more, and that means making choices,” Obama said. “Right now, we’re poised to spend nearly $1 trillion more on what was supposed to be a temporary tax break for the wealthiest 2% of Americans. Right now, because of loopholes and shelters in the tax code, a quarter of all millionaires pay lower tax rates than millions of middle-class households. Right now, Warren Buffett pays a lower tax rate than his secretary.”
Asked Obama: “Do we want to keep these tax cuts for the wealthiest Americans? Or do we want to keep our investments in everything else–like education and medical research; a strong military and care for our veterans? Because if we’re serious about paying down our debt, we can’t do both.”
Obama went on to say that America needs “to change our tax code so that people like me, and an awful lot of members of Congress, pay our fair share of taxes.”
But Bergin doubts Congress will make any headway in reforming the tax code this year. Sen. Max Baucus, D-Mont., chairman of the Senate Finance Committee, and “his colleagues have to deal with things that are timed to blow up this year or have already blown up last year; there is no opportunity for tax reform this year.”
Lawmakers must grapple this year with the Alternative Minimum Tax, as the patch instituted last year has expired, as well as the estate tax. Bergin says he’s been hearing from wealth managers “who don’t know how to advise their clients” because the estate tax rules revert back to 2001 rates at the end of 2012.
Then there’s the payroll tax cut, which was extended for two-months before Congress’ holiday recess and that expires on Feb. 29. The Temporary Payroll Tax Cut Continuation Act of 2011 extends the two-percentage-point payroll tax cut for employees, continuing the reduction of the Social Security tax withholding rate from 6.2% to 4.2%.
Obama urged Congress during his speech to pass the payroll tax cut “without delay.” He said Congress’ “most immediate priority is stopping a tax hike on 160 million working Americans while the recovery is still fragile.”
Bergin says there’s a danger for Social Security if Congress continues to “extend” the payroll tax cut as opposed to a long-term solution. “If [Congress] keeps extending this payroll tax cut there’s a threat to Social Security that no one is talking about, of it not becoming a separate system but just another budget item” for Congress.