Some of the president's tax plans likely will give nightmares to the clients of financial advisers.
President Obama's State of the Union message last Tuesday included proposals aimed at the dream of a “simpler, fairer tax code.” But some of his plans likely will give nightmares to the clients of financial advisers.
No one could argue that the country doesn't need a simpler tax code, both for individuals and corporations, but Mr. Obama's proposals barely nibbled at the edge of the individual tax code and didn't mention corporate taxes at all.
The major item for wealthy individuals centered on capital gains and the proposal to eliminate the stepped-up basis for valuing property bequeathed at death.
Today, when property is transferred to an heir upon the death of the owner, its value is “stepped up” to its current market value so no capital gains tax is owed. Under Mr. Obama's proposal, that transfer would be treated as a realization event, like an ordinary sale, which means the value would not be stepped up. The heir or heirs would owe capital gains tax on the difference between the purchase price and the value at the date of death or sale.
Another part of the plan would increase the top capital gains rate to 28% from the current 20% for couples with incomes over $500,000.
This proposal, while raising more revenue for the federal government, does nothing to simplify the tax code but rather increases the planning burden for high-income individuals.
Mr. Obama also proposed raising the tax on dividend income for high income earners to 28%. Given that dividends are taxed already at the corporate level, this is a retrograde step and should be resisted.
The other major proposal likely to affect advisers' clients would prohibit additional contributions and additional benefits in tax-preferred retirement plans and IRAs once balances reach about $3.4 million.
According to a fact sheet published by the administration, this cap would provide an annual income of $210,000 in retirement. That implies the investor can earn a return of 6.17% a year, assuming the principal is not touched. Many investors would love to lock in a return of 6.17% a year, so perhaps the administration could tell advisers where they see that return coming from.
The president's message also included a proposed tax on large financial institutions, supposedly designed to encourage them to shrink, or split into smaller parts. However, the large institutions almost certainly will resist, and the tax is sure to be passed on to their clients.
In the event that any of these proposals gain traction in Congress, which seems unlikely given the Republican control of both houses, financial planners and advisers will have to decide, based on their own clientele, whether or not to campaign against them, or at least let their representatives in Washington know how they feel about the plans.
MORE COMPROMISE
Broadly speaking, raising taxes is troubling. While Mr. Obama's intentions may be noble, his choice of a way forward could have provided a little more room to work with Republicans. Indeed, the GOP didn't waste any time slamming each and every proposal the president laid out.
Still, the president should be applauded for his proposals to consolidate and simplify various education and child care tax benefits.
And to his credit, Mr. Obama attempts to protect middle-class couples. Under the proposal, inherited capital gains of up to $200,000 per couple ($100,000 per individual) could be transferred free of tax. In addition to the basic $200,000 exemption, couples would have an exemption of up to $500,000 for personal residences ($250,000 per individual).
However, the best thing he could have done for the middle class and the economy as a whole would be to commit to working with the Republicans to simplify both individual and corporate tax codes in a revenue-neutral way. Simplifying the codes would save individuals and companies billions of dollars currently spent in compiling and filing those taxes.
According to the Tax Foundation, the complexity of the tax codes means compliance cost individuals and companies $457 billion in 2014, or 20.7% of the revenues collected.
What a waste.
