Certain tax proposals President Barack Obama is seeking as part of his plan to help America “live within its means” would be especially damaging to a broad swath of financial advisory clients — and not just the super-rich ones.
A half-dozen proposals in the deficit reduction and jobs plans introduced by Mr. Obama in the last two weeks specifically target higher-income Americans. The first would allow the Bush tax cuts to end as of 2013 for couples making $250,000 and above, and singles earning $200,000 or more. Those taxpayers also would see their deductions for mortgages, charities and state taxes limited to 28%.
A more amorphous feature would reform the individual and corporate tax codes to ensure that those earning more than $1 million a year paid more income taxes, an idea dubbed the “Buffett Rule” after billionaire Warren E. Buffett said he should be asked to pay more. Investment fund managers also would pay more, because their income from partnerships invested in real estate, venture capital, private equity and hedge funds would be treated in a less favorable manner.
Implementing Mr. Obama's ideas could put high-net-worth individuals in the position of having to pay nearly half of their marginal income in federal taxes.
Under a scenario in which the Bush tax cuts disappear, the highest earners would face a tax rate of 39.6% for 2013. In that year, wealthy Americans also are slated to be hit with a 3% to 4% surcharge to pay for increased health care costs. Adding the impact of fewer deductions, the top rate will be about 45%, said Rob Lineberger, principal of Diversified Trust, a wealth management firm managing about $4.5 billion in assets.
While some clients will accept the increase as part of a broad program to address the deficit, he said others will be “chagrined” to have to pay the tax.
“Some clients will feel like they have worked very hard during their lifetime, and this is like a penalty tax for their success,” Mr. Lineberger said.
If some of the proposals come to fruition, high-net-worth individuals and families are going to want to accelerate income for 2012 to take advantage of the lower rates. They also should consider gifting strategies, he said.
Given the current political climate, advisers don't expect Mr. Obama's deficit reduction and jobs plans to go through as proposed, but many said they expect taxes to increase and they worry about the shape of the hikes.
Many advisers said the $250,000 income threshold and deduction limits are worth worrying about now.
“A $250,000 limit would be counterproductive,” said Benjamin Tobias, president of Tobias Financial Advisors Inc., which manages $175 million in assets. “Trying to say that a family that makes $250,000 is "very wealthy' is dangerous thinking.”
He supports a $1 million threshold.
“High-income earners have to have some kind of a reasonable minimum” amount of tax being paid, Mr. Tobias said.
Sen. Charles Schumer, D-N.Y., recently pointed out that $250,000 “might make you rich in Mississippi,” but not in his state, suggesting a cost-of-living scale could dictate the rate.
“On the surface, it makes sense to do that, but politically, I don't see how it could happen,” because every congressman would try to secure the cost differential for their citizens, said Kurt Laubinger of Potomac Wealth Management LLC, a fee-only firm focused on retirement planning. “I don't think it's practical.”
In fact, Mr. Laubinger blames politicians' voting in their own interests for the convoluted state of the country's tax code and an inability to hammer out policies to help the nation's economy.
“The tax code has become part of the legislative process that has gone to "what's in it for me?' decision making,” Mr. Laubinger said. “Someone is going to have to raise taxes, and you can't address the budget gap without going after the top 1% of earners, because they control most of the wealth.”
Many wealthy Americans are small-business owners and entrepreneurs for whom tax policy is a major consideration when deciding whether to hire, invest and expand. The prospect of tax code changes makes it difficult for companies to plan, advisers said.
EFFECT ON SMALL BUSINESSES
Mr. Obama has stressed that his proposals would reduce taxes for small businesses. His jobs-creating plan calls for cutting payroll taxes in half to 3.1% for the first $5 million in wages, eliminating 2012 payroll taxes on firms that hire new workers or increase wages, and continuing a 100% expensing deduction for 2012 on investments in new plants and equipment.
“A big part of business owners' and investors' being reluctant to hire and to invest is the temporary and targeted approach of tax policy,” said Hank Smith, chief investment officer of The Haverford Trust Co., a wealth management firm managing $6.5 billion in assets. “Having a temporary reduction in payroll taxes for one year doesn't do anything for planning; it retards planning.”
Even supporters of Mr. Obama's deficit reduction and jobs plans don't believe changes to the tax code stand much chance of passing during this session of Congress, which lasts through 2012. But the issues still will be paramount when the next Congress, and either Mr. Obama or a Republican president, are sworn into office in January 2013.
“In the long run, I think a lot of this is going to end up happening,” said Michael Linden, director of tax and budget policy for the Center for American Progress, a left-of-center think tank. “The country just doesn't collect enough tax revenue.”
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