The other day, a reporter asked a politician how to collect more money with lower taxes. Of course, there is a very simple answer to this childish riddle. With 95% of the worlds population outside of the United States, there must be economic development in the USA to bring companies, jobs, and capital into your jurisdiction. Whether you are President Obama, Paul Ryan, Joe Biden, or Mitt Romney, there are eternal truths about tax policy that can make or break a government budget, businesses, and families. Just like states compete for new business, so should the United States. With the USA corporate tax rates being the highest in the world, this reduces the number of businesses and people doing business within the US jurisdiction.

As the old sage says, “60% of nothing is still nothing”. So, if you raise taxes, less people participate. Even with higher rates, you get less. But with competitive rates, you always get more. Examples are Walmart, Target, Amazon or other. Water always flows to where there is the least friction, and the same holds true for businesses.

In todays global marketplace, there are businesses from around the world running to special jurisdictions to establish headquarters or offices within these economic hubs of freedom. Thus, money and tax dollars flow freely where the fees are fair, reasonable and are for mutual benefit of the business and society.

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

President Obama signed a debt-limit compromise bill last Monday—the very day the administration predicted the U.S. would default—averting the financial Armageddon.

Crisis was averted, but where are we a week later?

The agreement allows the debt limit to be increased by a total of $2.4 trillion; but the limit will increase by only $400 billion immediately. President Obama has the power to request a $500 billion increase—although Congress can veto any such increase by a 2/3 majority. The remaining $1.2 to $1.5 trillion is accessible only if matching spending cuts are made.

The agreement also includes $900 billion in cuts, to be made over the next 10 years.

The President’s signature on the bill last Monday was only stage one in a two part process: Congress and the President are going to have to agree on another $1.5 trillion in deficit reduction by the end of the year.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the debt talks in Advisor’s Journal, see Democrats Call Debt Limit Unconstitutional (CC 11-134), Debt Limit Standoff Boils Over (CC 11-115) and Storm Clouds over U.S. Debt (CC 11-85).

Why is this Topic Important to Wealth Managers? Clients will often ask for your “take” on the annual federal budget.   It is important to show the client a command of the the facts and figures before addressing the political perspective of spending and revenue.  Any producer can “mime” someone else’s perspective.  Distinguish yourself with a command of the underlying numbers.  Thus, this week Advanced Market Intelligence presents the facts and figures of the proposed federal budget for fiscal year 2012. 

The new 2012 Federal Budget was released today by the President.  Below is a summary of the inflows and outflows concerning next year’s proposed budget (in billions of dollars).

Outlays:

Appropriated (“discretionary”) programs:   Security $ 884/Non-security 456; Subtotal—appropriated programs: 1,340

Mandatory programs: Social Security $ 761, Medicare 485, Medicaid 269, Troubled Asset Relief Program (TARP) 13, Other mandatory programs 612; Subtotal, mandatory programs 2,140, Net interest 242, Disaster costs 8

Total outlays 3,819

Receipts:

Individual income taxes $ 1,141, Corporation income taxes 329

Social insurance and retirement receipts: Social Security payroll taxes 659,Medicare payroll taxes 201, Unemployment insurance 57, Other retirement 8, Excise taxes 103, Estate and gift taxes 14, Customs duties 30, Deposits of earnings, Federal Reserve System 66,Other miscellaneous receipts 20

Total receipts 2,627

2012 Deficit $ 1,101

Here are some noted observations of the current budget: 

• By 2020 individual income taxes will more than double from their 2012 levels of 1,141 to 2,439 billion. 
• The Proposed corporate tax rates increased from 2011 to 2012 to over 60% from 198 billion to over 329 billion (the budget notes that The President is calling on the Congress to work with the Administration on corporate tax reform that would simplify the system, eliminate these special interest loopholes, level the playing field, and use the savings to lower the corporate tax rate for the first time in 25 years—and do so without adding a dime to our deficit.)
• By 2020 the annual interest owed will balloon to over $729 billion, or an increase of over 300% from the 242 billion 2012 levels. 
• The cost of Medicaid will more than double by 2020 as compared to 2012 levels. 
• The estimated deficit for 2020 is 735, which means the overall national debt by year end 2020 is estimated to be over 21.5 trillion dollars. 

The Department of Defense and Department of Homeland Security together make up the largest spending area in the budget.  Here’s a list of some of the highlights the security spending provides for. 

• The allocated amount reflects the continued investment in national security priorities such as cybersecurity, satellites, and nuclear security.
• Maintains ready forces and continues efforts to rebalance military forces to focus on both today’s wars as well as potential future conflicts.
• Enhances the Administration’s commitment to maintaining a reliable nuclear deterrent by increasing investments in the nuclear weapons complex and in weapon delivery technologies, and to nonproliferation by preventing the spread of nuclear materials around the world.
• Refocuses funding for border surveillance on technologies that have proven to work, allowing for a tailored approach in different border regions instead of the previous one-size-fits-all approach.
• Safeguards the Nation’s transportation systems with an $82 million increase to support deployment of up to 1,275 Advanced Imaging Technology screening machines at airport checkpoints, with robust, built-in privacy safeguards.

Tomorrow’s blogticle will continue with discussion on the national budget. 

We invite your opinions and comments by posting them below, or by calling the Panel of Experts

In a tax plan full of surprises, President Obama’s unexpected proposal to give workers a one-year, 2 percent Social Security tax holiday is perhaps the most surprising part.   But Social Security experts caution workers not to party just yet because the holiday could destabilize Social Security.   And, although a 2 percent paycheck bump is better than nothing, it is not the tremendous boon to workers it is being presented as.  The Social Security tax holiday would essentially offset the loss of the Making Work Pay tax credit, which expires at the end of 2010 and is not renewed by the tax cut bill.  The Making Work Pay tax credit gives taxpayers making at least $5,000 and no more than $75,000 annually a refundable $400 tax credit.

Opponents also characterize the proposed tax holiday as an attempt to shift retirement savings from the Social Security Administration to Wall Street.  Undoubtedly, many taxpayers will, smartly, divert the 2 percent tax break into their 401(k)s and IRAs, but a majority of taxpayers are likely to spend the money, barely noticing the tiny bump in their paychecks.  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the debate over the expiring Bush tax cuts in Advisor’s Journal, see Obama Tax Agreement Faces Stiff Resistance in Congress (CC 10-112) and What Lies Beyond the Sunsetting 2010 Tax Provisions (CC 10-88).