Starting in 2013, federal and state taxes hikes are set to hit many of the nations hardest working families and retirees. If you have a company or appreciated asset that you are planning to sell, you may want to do it before the end of the year. Beginning in 2013, the cost and taxes on selling any tangible asset or your business may go up by a whopping 60 percent.

The established tax rates on long-term gains and qualified dividends will expire on December 31, 2012. Starting 2013, the federal tax rate on long-term gains will go up to 20% (or up to 10% if a taxpayer is in the fifteen percent tax bracket). In addition to this tax hike, the state income tax is added to the 20 percent. Thus, if you live in New York for instance, your federal and state combined tax to sell an asset for a profit would be about 28% if you add the 8 percent New York state income tax. But wait, there is more. Beginning in 2013, you will also be hit with another new tax on long-term capital gains and dividends where you get whacked with an additional 3.8% “Medicare contribution tax.

Also starting in 2013, the distinction between ordinary and qualified dividends will disappear, and all dividends will be subject to the ordinary tax rates. Thus, the maximum rate on dividends is scheduled to increase from 15 % to max out at 39.6% as the Bush Taxpayer Relief Act provisions expire. Thus, taxes on fixed income dividend assets will go over 100%. I would only assume that these new taxes may hurt the share price and demand for dividend yielding stocks.
To sum it up, if you have worked for 30 years in New York to build a company and you sell your small business for $500 thousand dollars, your federal taxes will go up on that retirement sale from about 15% to a whopping 23.8 percent in federal taxes plus state tax. And yes, you then would owe on top of that another 7 or 8 percent to the state of New York to bring you up to well over $150,000 dollars or 30% percent of your retirement being gobbled up by the state and federal governments.

To make a comparison, there may be some folks in a (state with no income tax) such as: Texas or Florida right now who have recently established residency. By the end of the 2012 year, they can sell their stock or company in a long-term capital gain transaction with the tax rate at a flat rate of 15% or only $75,000 dollars. This is 100% less than what the New Yorker or Californian might pay in 2013. “Viva el la Estado de Texas y la Florida” …..

From a philosophical standpoint, the less federal tax on capital gains, the more money that goes into a local economy where the seller resides. In the end, high capital gains rates tend to freeze up assets, constrict the sale of property, and the middle class generally end up waiting till they die to sell a company so as to avoid the capital gains taxes. Overall, if a taxpaying citizen does not receive a reasonable majority of the proceeds from the sale of a business or property, they will not sell or spend or circulate the money in local communities. Further, if people don’t sell things, taxes are not generated.

This whole capital gains tax debate brings me back to a vivid but real experience. I remember as a teenager reading the list of the Forbes 400 richest people in the world. The list in the 70′s was primarily people who inherited money, businesses, assets, or trusts. This list made me believe that being rich may be just luck and inheriting a 2nd or 3rd generational business. However, after the tax rates were lowered in the 80′s, the list changed quickly over the next few years to be comprised mostly of hard working folks who were “self-made”. Thus, my personal belief in the possibility for all Americans to become prosperous changed. The moral of the story is that lower tax rates helps create new wealth and new abundance. In sum, the incentives for hard work are directly correlated to the potential rewards, and everyone benefits from creativity and inventions in the form of cures, technology, and even tax receipts. And of course, higher taxes reduces global investing into new American ventures that may grow the economy.

For instance, even if you read the self-help book, Super Rich, by the famous music mogul Russell Simmons, you will see that even Mr. Simmons claimed to have used the favorable capital-gains rates to sprinkle around the vast proceeds from the sale of one of his businesses and share some of his good fortune with his workers who loyally invested their energy into his company over the years. I personally commend Mr. Simmons for rewarding his people for their contributions.

In the end, we must continue to think of ways to incentivize the hardest working and provide reasonable benefits for those who contribute with great creativity and effort.
Some Ideas for our Readers to Avoid Undue Tax:
1. Subchapter S Corporations may be more useful going forward to mitigate self-employment taxes or other taxes. However, dividend rates are going up if nothing is done by the administration.
2. The Purchase of ETFs, Funds or Stocks that do not produce interest or dividends may be a better investment for long term growth. iShares S&P 500 Growth Index Fund (NYSE: IVW) and WisdomTree LargeCap Growth Fund (NYSE: ROI) Read more: http://www.benzinga.com/analyst-ratings/analyst-color/12/02/2320350/growth-etfs-for-all-seasons#ixzz20LhXdkeF
3. Use of Tax Deferred Variable or Fixed Annuities or Self Directed 401Ks or IRAs may also become even more popular.
4. Read my previous article on Estate Tax Adjustments in 2013 and learn to prepare for those tax hikes and changes.
5. Consider donating appreciated assets to charity rather than cash to avoid undue taxes.

Dr. George Mentz is a world recognized wealth management commentator and professor who has authored several revolutionary books. Prof. Mentz, an international attorney, has been a keynote speaker globally in Asia, Arabia, USA, Mexico, Switzerland, and in the West Indies. Mentz can be contacted for speaking engagements at www.gmentz.com  or www.managementconsultant.us  To become a Chartered Wealth Manager please contact the AAFM

*No tax investment or legal advice provided herein. Please consult with a licensed professional in your jurisdiction before making any important financial or legal decision.

http://www.irs.gov/taxtopics/tc409.html

http://www.benzinga.com/personal-finance/financial-advisors/12/06/2691411/new-tax-rates-and-adjustments-for-2012-income-and-

http://www.smartmoney.com/taxes/income/what-obamacare-may-mean-for-taxes-1335896160486/

http://www.thestreet.com/story/11598139/1/time-to-avoid-2013-capital-gains-hike-is-now.html

http://businesscertification.org

Presidential Politics and Income Tax Theory – The Super Rich & Tax Havens in the USA ? – By G. Mentz, JD, MBA

No matter how you slice and dice it, it is difficult to swallow when you see Warren Buffet’s taxes or Mitt Romney’s taxes. You may think, how did they get their income tax rates down to 15%? The challenge for many of us is not the tax rates, but the totality of taxes we pay or the type of income we receive or earn. As I have taught on the subject of tax and wealth management and also been a Wall Street Firm Wealth Management Advisor, the analysis of progressive tax rates can be deceiving and tricky.

If you buy and sell something for a long term capital gain, you can receive a low rate of 15%. If you receive dividends, you may be able to capture a low rate of 15%. If you can find bonds that pay tax free, you may also receive a low rates on passive income. If you use a tax deferred vehicle, you can also defer taxes till withdrawal, Examples are 401K, IRA, annuities and such.

Don’t forget that you can avoid state income tax if you reside in one of the 7 wonderful states such as: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. 41 states impose income taxes. New Hampshire and Tennessee apply it only to income from interest and dividends.

Some states actually limit the taxes on certain types of retirement income. Various states exclude Social Security benefits from state income taxes. 27 states & The District of Columbia who have income taxes provide a full exclusion for Social Security benefits — Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin.

States are also prohibited from taxing benefits of U.S. military retirees if they exempt the pensions of state and local government retirees. Various other retirement exemptions apply to the value of property or the type of income. For example, all citizens of some states may have a exemption of the first 50 thousand dollars of property value.

Numerous states allow special tax benefits to military retirees. Some states, with conditions, which do not tax retired military pay are: Alabama, Alaska, Florida, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, , Ohio, Pennsylvania, South Dakota, Tennessee, Texas, Washington, Wisconsin and Wyoming. Mississippi, Missouri, Kentucky, Oregon, and North Carolina have conditions that apply.
Many states still have an estate tax on top of the federal estate tax: States that impose an estate tax are: Connecticut, Delaware, District of Columbia, Hawaii, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Ohio, Oregon, Rhode Island, Vermont, and Washington.

The question of the day is how do the super-rich avoid the taxes that most of us pay? While the super wealthy may pay some of the “working class” W-2 style taxes, they avoid it on most of their income.

An example would be, how can Warren Buffet or Mitt Romney avoid self employment taxes? Well, the law allows business owners to pay self employment taxes on income, but most of the other income may be treated as pass-through, long term gains or non considered self-employment taxable such as interest, dividends, or sale of assets.

In the end, the middle class and upper middle class is getting hit with the bulk of the “nickel and dime” taxes in this country. Think about the taxes on: State income, state automobile taxes, school district taxes, gasoline taxes, utilities, electricity, water, phone, flight and transport fees, cellular, internet cable, luxury, alcohol, tobacco, and a myriad of other taxes and fees. The TOTALITY of these TAXES may put the average middle income taxpaying family in a 50% tax bracket if they earn a combined 60-100 thousand dollar per year.

Remember, the W-2 employee is the least likely to have the ability to deduct business related expenses as per our tax codes. In the end, high paid wage-earners who are employees such as: doctors, lawyers, government employees, pilots, and CPAs probably pay the highest tax rates on earned income.

In contrast, Mr. Buffet who has invested billions for his clients and himself owes no taxes on typical investments until he sells them. Viola, no taxes paid on long term holdings until you capture income from the sale. With that being said, if Buffet owns a company, that company or its employees will pay taxes on all money that comes in and goes out. In theory, corporate welfare is a myth in that even if a company pays -0- taxes at the corporate rate, the 500,000 employees all paid taxes and hopefully kept their jobs.

Tax breaks are for everyone, and I remember reading one of Russell Simmons’ recent success books. He claimed that he felt like he could have paid more taxes after the sale of a company. The capital gains rate allowed him to pay a low rate of 15-20% tax on the sale of the large company. He claims to have had an ah-ha moment and paid all of his employees who helped build the company an extra bonus as a result of the tax relief. In my humble opinion, this is the original intent of the lower tax rates “to begin with” where everybody involved can benefit.

You can theorize that lower long-term rates and lower dividend rates allow communities to benefit from more local income and for retirees to survive on their pensions or investments. Overall, when taxes are too high, investment is reduced because the reward is mitigated. This is probably why people like Buffett were long term holders is that the punishment for a sale was too large.

So, Mitt Romney may just have good quality tax advisors, and there is NO need for any taxpayer to pay more than the law requires as per the US Supreme Court cases. We all remember VP candidate John Edwards. He saved $600,000 in taxes by forming an S corporation. Edwards earned $26.9 million as a lawyer in 1995, and he minimized Medicare taxes by creating his own S corporation. Edwards paid himself a salary of $360,000 each year for four years and then he had the S corporation pay him the rest of the income in dividends. Salary was subject to Medicare taxation at a rate of 2.9%; however, dividends escape Medicare taxation. There is no wage base for Medicare, all wages or salaries are subject to the full tax. Social Security does have a wage base, which means wages above the limit are exempt from the Social Security tax.

In contrast, President Obama may have a different and much higher tax rate. Most of his income comes from his book sales and from his government employment. Book royalties and high government wages are generally taxed at a much higher rate.

If you remember, most NBA and NFL stars will attempt to maintain residence in a low income tax state like Texas or Florida; however, the state income tax authorities may show up to tax any players who visit their “higher tax” state to play a game. You must figure that some players may earn 1 million dollars per game and 8% of that income is nothing to balk at.

Historically, there has been so much wealth created in the last 30 years, it has been amazing. To watch Google and now Facebook go public is truly fantastic. I remember back in the 80s where people would complain that all of the property or wealth was controlled with no more to be had. However, when new property and wealth is created from thin air, it proves that creativity always trumps materialistic scarcity theory. And yes, most of the new wealth from Facebook will take residence in a lower tax jurisdiction before selling their stock. Let’s face it, 6-9 percent state tax on a large sale of stock with a low basis is a lot of money.

In closing, I recall in the late 70s somebody showed me a list the Forbes 400 wealthiest people in the USA. I distinctly recall that the bulk of the list of names inherited the money or started with wealth. In the recent 20 years, we now see that the bulk of the wealthiest are self-made. With that being said, the one thing that changed during this time was the reduction in long-term capital gains rates.

Are taxes good or bad? Everyone knows that those who benefit from society must chip in and everyone must have some skin in the game. However, the other extreme is that “100% taxation is pure economic slavery”. Thus, everyone is against slavery on any level. The major question that looms is : what is fair? And that, I will leave that to the government & politicians who are the servants of the customers, “We The People”.

**Financial, Legal or Tax Advise is not intended to be offered in any way. The Academic Exception is Claimed in this Article. If you need tax advice, legal counsel or financial advice, please see a licensed professional in your jurisdiction.
George Mentz, JD, MBA – All Rights Reserved 2012

Authors:  Professor William H. Byrnes & Benjamin S. Terner

Why is this Topic Important to Wealth Managers? This study was based on the insightful comments posted by one of our readers.  We encourage you to continue posting comments, as areas of interest to yourself may very well be similar to that of others.  Thank you and we look forward to hearing from you.

The reader was interested in further analysis on capital gains rates and the consequences the rates have on the production from the national economy.  The reader’s states, “If you want to spur the economy then the Bush tax cuts need to remain for all. Not just the middle class. Business owners who hire people and happen to make $250,000 plus need to be included.”  His contention is “that you will see the largest percentage increase in GDP in the past 50 years when you look at what the Reagan tax cuts did.”  A worthy study followed the proposition of this intriguing question.

Here’s what we found:

The first decrease in capital gains rates occurred in 1978 under Jimmy Carter. The tax cut decreased capital gains rates, which at the time, the top rate, from “about 39%” to 28%. [1] In 1978 the increase in GDP over the previous year was 5.6 percent.[2]

In 1979 the increase in GDP over the prior year was 3.1% and by 1980 the change became a decrease of .03%. However, one report notes, that the 12 month’s leading up to the enactment of the legislation, ”GDP grew by 5.8%. But after the 1978 capital gains tax cut was approved…GDP dropped by 1% over the next year and a half. [3] Carter remained President until 1981.

Reagan took office in 1981 and the tax cuts, including capital gains rates quickly followed suit. “The 1981 cut in the top regular tax rate on unearned income reduced the maximum capital gains rate even further, this time to only 20%–its lowest level since the Hoover administration.” [4] The temporary effects of this were again negative.   “Over the 12 preceding months, the economy had grown by 3.5%, but in the 12 subsequent months the GDP fell by 2.8%.” [5]

In 1981 through 1988 (Reagan left office in 1989) the increase (or decrease) in GDP was as follows; 1981: 2.5%, 1982: -1.9%, 1983: 4.5%, 1984: 7.2%, 1985: 4.1%, 1986: 3.5%, 1987: 3.2%, 1988: 4.1%.[6]

Total growth of GDP over Reagan’s term of 8 years was 27.2%, and the average annual growth in GDP was 3.4%.  Total growth in GDP in the prior 8 years to Reagan’s term was 23.4%, with an annual average of  2.95%, and the 8 years following his term total GDP growth was only 21.9%, with an annual average of a mere 2.74%

Interestingly enough, “[a]fter capital gains taxes were increased in the 1976 Tax Reform Act, for example, the economy’s growth rate jumped from 3.9% in the preceding year to 5.2% over the next two years. Likewise, following enactment of the 1986 Tax Reform Act, the growth rate rose from 2.2% in the previous year to 3.8% over the next two years.”

Going back 50 years (from 2009) the GDP mean is 3.704%, the median being 3.56%.  The 8 years President George W. Bush spent in office, showed a dismal total GDP growth of 16.7%, averaging 2.09% over this time period.  President Clinton’s numbers show better than average results.  The total GDP growth during his presidency was 31%, with an average annual growth of 3.875%.

Regarding a capital gains tax increase, Dr. J.D. Foster of the Heritage Foundation, argues that “A higher tax rate means a higher cost of capital, which means less capital employed, which means less output and less income. In turn, less income earned means less tax revenue from the federal government’s many sources. While the directions are not in doubt, the magnitudes are very much in dispute.”[7] Dr. Foster points out that the U.S. Office of Management and Budget’s own analysis of an increase of the capital gains rate contemplates the scenario that the increase will lead to a decline in the real GDP growth rate of a mere one-hundredth of a percentage point yet the result will be a one-year bump up of additional tax revenues.  For six of the next nine years, from 2012 until 2020, the tax increase will lead to a loss of tax revenues, until the final net-result in 2020 that the slightest mitigation to economic growth has wiped out any anticipated tax revenues.

Conclusion:

Although, Reagan’s administration saw higher growth in total, and annually, on average, than  that of the previous and post 8 years of his term, his administration’s numbers are still below the 50 year trend, as well as the terms of some other Presidents, notwithstanding the unsupportive data on the short term effects of the tax cuts.  However, there is a lack of conclusive evidence, therefore, to determine that a decrease in capital gains tax rates will have the short or long term affect of increasing total GDP.  Yet, neither will an increase in the rate increase tax revenues.

We look forward to your comments about this data, be they supportive or corrective, or alternative interpretations.

For a detailed analysis regarding the tax treatment of capital gains, see Tax Facts Q 815. How is an individual taxed on capital gains and losses?

For the table of tax rates applicable to capital gains from 2002 until 2012, see Main Library Section 54. Income Taxes— Inflation Adjustments H—Capital Gains Tax Rates.

Next week’s blogticles will discuss how trusts are commonly used in estate planning structures.

Again, we invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Citizens for Tax Justice Report. “Capital Gains”.  http://www.ctj.org/hid_ent/part-2/part2-2.htm.  Last Accessed 9/14/2010.

[2] U.S. Department of Commerce-Bureau of Economic Analysis.  “National Income and Product Accounts Table”.  [Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product
[Percent] Today is: 9/14/2010].  http://www.bea.gov/national/nipaweb/SelectTable.aspLast Revised on August 27, 2010.  Last accessed 9/14/2010.

[3] Citizens for Tax Justice Report citing U.S. Department of Commerce.  Compiled 1992.  http://www.ctj.org/hid_ent/part-2/part2-2.htm.  Last Accessed 9/14/2010.

[4] Citizens for Tax Justice Report

[5] Id. citing U.S. Department of Commerce.

[6] U.S. Department of Commerce-Bureau of Economic Analysis.  Table 1.1.1.

[7] J.D. Foster, Ph.D., Obama’s Capital Gains Tax Hike Unlikely To Increase Revenues, March 24, 2010. http://www.heritage.org/Research/Reports/2010/03/Obamas-Capital-Gains-Tax-Hike-Unlikely-to-Increase-Revenues. Last Accessed 9/14/2010.