The Rich Are Very Different. So Are Their Taxes.

Author F. Scott Fitzgerald, chronicler of America's moneyed class, once famously said the rich are very different from you and me. Fitzgerald's jazz age compatriot Ernest Hemingway reportedly responded "yes, they have more money"! So how different do you think their tax returns look from ours?

Last week, the IRS released their annual report on the top 400 incomes in the entire country. This year's report covered 1992 through 2008 and offers a fascinating peek into the wallets of America's highest earners.

What does it take to join the club? For 2008, you had to make $109,736,000 — up from "just" $24,421,000 in 1992. 2008's top 400 reported an average adjusted gross income of $270.5 million. That amount represented 1.31% of all personal income, up from 0.52% in 1992.

How do the top 400 make their money? Just 8.18% of it came from salaries and wages. 6.78% came from taxable interest; 9.23% came from taxable dividends; and 19.92% came from partnership and S corporation net income. By far the biggest portion — 56.71%, or $155,748,000 per taxpayer — came from capital gains, taxed at just 15%. In fact, the top 400 reported 10.49% of the entire country's capital gains! This suggests that the top 400 consist largely of business and real estate owners cashing out at the end of a successful career, or of hedge fund superstars whose income consists largely of "carried interest" taxed as long-term gains.

On average, the top 400 are a generous group. 394 of them reported charitable contributions, with the average contribution weighing in at $22,688,000. The top 400 as a whole claimed 5.17% of the nation's total charitable deductions, up from 1.03% in 1992. (Of course, "on average" whitewashes a lot of exceptions. You have to wonder about the six world-class misers who made nine-figure incomes without reporting a dime in charitable contributions! Were they just born with hearts two sizes too small?)

The top 400 averaged $227,362,000 in taxable income and paid $48,983,000 in tax. That represents 1.90% of the nation's total income tax bill — nearly double the 1.04% the top 400 paid in 1992. But their average tax rate was just 18.11% — down from 26.38% in 1992. Why do they pay such a dramatically lower rate now than in 1992? The main explanation is capital gains, which have grown to represent an ever-larger share of the top 400's total income. Taxing more of their income at preferential rates (then 20%, now 15%) actually brings the overall rate down.

3,672 taxpayers have appeared in the top 400 list since the IRS started tracking them in 1992. 2,676 of them have appeared just once, 439 have appeared twice, and 171 have appeared three times. The data reveals a changing group over time, rather than a fixed group of taxpayers.

But — four lucky winners have appeared in the top 400 for all 17 years. The IRS knows who they are. But they're not telling. So who do you think they are are? Bill Gates? Warren Buffet? Oprah Winfrey?

Washington Finally Gets Something Right

Every great once in awhile, the legislators who make up the United States Congress set aside short-term politics to craft truly historic legislation that improves the lives of Americans for generations to come.

Other times, the party in power takes advantage of sheer numbers to jam controversial legislation down the minority's throat like a French farmer force-feeding a flock of geese to make foie gras.

We'll let you decide which of those two was the case when Washington gave us the "Patient Protection and Affordable Care Act," otherwise known as Obamacare. Congress passed the 2,500+ page act last March, and the rest of us have been trying to figure out what it means ever since. (As former House Speaker Nancy Pelosi famously said, "we have to pass the bill so that you can find out what is in it, away from the fog of the controversy.")

But one provision drew immediate howls from small businesses across the country. Specifically, the healthcare reform law mandated that all businesses, tax-exempt organizations, and federal, state, and local governments file a Form 1099 at the end of the year for any business they spend more than $600 with. (We're talking 26 million sole proprietorships, 4 million S corporations, 2 million C corporations, 3 million partnerships, 2 million farms, a million charities, and 100,000 government entities.) The goal was to help pay for healthcare reform by making it harder for businesses to underreport their income. The problem, unfortunately, is that it did so with the bureaucratic equivalent of using a howitzer to kill a fly.

Let's say Joe the Plumber is just trying to make an honest buck in a tough economy. Now he's got to collect taxpayer identification numbers and file 1099s with every gas station, plumbing supply shop, equipment rental store, and quick-lube shop he patronizes during the year. Oh, and he'll also have to track the 1099s he gets from all his business clients! Congratulations, Washington — you've just taken a guy with a pickup truck and a pipe wrench and turned him into a rolling tax whistleblower!

Congress ratcheted up the pain in September with the Small Business Jobs Act, extending the 1099 requirement to landlords filing Schedule E. Let's say you rent out your vacation home a few weeks each season to help cover expenses. Now you get to track down ID numbers and file forms with your plumber, your cleaning crew, your cable company, your insurance company, and even the kid who cuts the grass when you're not around to do it yourself. Doesn't that sound like fun?

House Republicans drew a bullseye on the 1099 requirements before they even took office this year. President Obama agreed and called for repeal in this year's State of the Union Address. So on April 15, appropriately enough, Congress and the President granted everyone's wish. Of course, nothing is ever easy in Washington. Last month's law pays for the 1099 repeal by increasing "clawback" provisions that penalize taxpayers who claim more insurance subsidies than they're actually entitled to under the original bill. (Don't feel confused, the folks who passed the new law don't understand exactly how it works either.)

Here's the bottom line. Nobody really wanted to deal with the hassle. Even the IRS National Taxpayer Advocate Nina Olson testified before Congress that the rule's burden may turn out to exceed its benefits. Washington listened, and made life just a little easier for those of us who work and pay taxes in the real world.

What do you think? Now that the 1099 requirement is history, what would you say is the next thing Washington should do to make tax time easier?

Royal Wedding Notes

Hi!-

Last week's royal wedding between England's Prince William and Catherine "Waitie Katie" Middleton, now Duchess of Cambridge, drew millions of viewers across the globe, including 22.8 million here. The wedding offered a dose of royal pageantry for every little girl who grew up idolizing Disney princesses. And it offered a rare peek inside the fabled life of the world's most glamorous royals.

England's economy is struggling just like ours, so the royal family took pains not to burden the Exchequer (that would be "taxpayers" to us Yanks) with an expensive wedding. While the total cost has been estimated at $30 million, the royals themselves paid for everything but security for the event. (This doubtless came as a great relief to the parents of the bride.)

While the Queen enjoyed a great reason to show off last week, she's not actually as wealthy as most people imagine. Forbes magazine ranks her personal net worth at "just" $450 million, 12th among the world's royals. That's because she doesn't really own Buckingham Palace, Windsor Castle, the Crown Jewels, or the Royal Collection. They're held in trust and can never be sold. The "Crown Estate," which dates back to 1066, generates income of about £110 million/year. However, the Queen turns that income over to the government in exchange for about £40 million in "Head of State" expenses.

The Queen's own assets consist mainly of Balmoral Castle in Scotland, Sandringham House near Norfolk, smaller jewelry and art collections, and one of the world's great stamp collections (built up by her father and grandfather). She also makes about £12.5 million/year from her holdings as Duchess of Lancaster. Since 1992, she's voluntarily paid tax on her income, at regular rates up to 50%. (A spokeswoman for Buckingham Palace told London's Telegraph earlier this week that "the Queen's personal wealth has always been vastly exaggerated." But let's make no mistake here, folks - it's still good to be the Queen!)

Here on our side of "the pond," we treat our President to many of the same privileges as England's royals enjoy. The White House isn't quite as grand as the Queen's digs (just 55,000 square feet versus 830,000 for Buckingham Palace). There aren't any Crown Jewels to speak of, although the First Lady could probably borrow something nice from Tiffany's. And the President tools around town an armored Cadillac, as opposed to the Queen's custom Bentley.

But here in America, our President is more open about his income. Last month, the Obamas posted their Form 1040 on the White House website. For 2010, they reported $1,728,096 in adjusted gross income, mainly from book sales. They claimed $373,289 in deductions, including $245,075 in charitable gifts. And they paid $453,770 in actual tax. Those numbers already sound big to most Americans. But the real money won't come in until Obama leaves office. Former President Clinton reported $109 million in income between 2000 and 2007, and former President George W. Bush makes $150,000 for a single speech (plus first-class airfare or private jet transportation for a party of four).

What do you think? Should the Queen post her tax returns online for all the world to see? Should the Obamas be jealous that the Queen has a bigger house? Should the Queen share some of her jewels with her former colonists? American taxpayers might not mind a little bit of royal trappings - but they sure don't want to pay the bill!

Looking into the Crystal Ball

Back in 1971, a British band called Ten Years After scored their biggest hit with their idealistic anthem, "I'd Love to Change The World." While that song is arguably a reaction against the radical protests of its time, it includes a line that on its face appears written to give today's tea-partiers heartburn:

"Tax the rich, feed the poor,
Till there are no rich no more."

Today in Washington, politicians are buzzing with talk about how spiraling deficits may choke our economy. House Budget Committee Chair Paul Ryan has offered a proposal to cut $4 trillion in spending by privatizing Medicare and turning Medicaid into a block grant program. President Obama has countered with his own $4 trillion proposal to match deep spending cuts with tax increases.

While no one is seriously proposing to tax the rich until "there are no rich no more," the lyric begs an interesting question. Just how much would we have to "tax the rich" to claw our way out of this budget mess?

The answer, it turns out, may be more than they can afford to pay. A recent study by the Washington-based Heritage Foundation found that if Obama wants to keep his promise not to raise taxes on families making under $250,000, the top tax rate - currently 35% - would have to rise to 142% . You don't have to be a math major to know that's just not possible. Even the accounting geniuses who ran Enron would be hard-pressed to make those numbers work!

A similar study by the Washington-based Tax Foundation reports that for 2008, the top 1% of taxpayers (those earning $380,354 or more) reported $1.685 trillion in adjusted gross income and paid taxes of $392 billion. If we raised taxes on those earners to 100%, the extra $1.3 trillion in revenue would nearly close this year's deficit. But how long would that work? How much income would you bother making if it all went to taxes? "Till there are no rich no more," indeed!

The lesson here is that we can't just count on "the rich" to bail the rest of the country out. We probably can't even count on income taxes to do the job all by themselves. If lawmakers want to tax their way even partially out of this hole, they're going to have to target the middle class. Why? Well, for the same reason Jesse James robbed banks - because that's where the money is!

We talk a lot in these emails about the importance of planning . Some clients mistakenly believe they don't make enough to have to worry about planning their taxes. The sad reality is that as politicians accepts the inevitability of tax increases, tax planning will become more important, for every one. So don't wait until it's too late! We're here with the help you need - and we're here for your friends, family, and colleagues too.

Tax Credits for Bad Hairstyles?
The 2012 presidential campaign is already well underway, with pollsters crawling through Iowa like corn-flea beetles infesting a crop of the state's finest grain. Surprisingly, developer Donald Trump leads the Republican field in some of those polls, ahead of even "mainstream" candidates like former Massachusetts Governor Mitt Romney.
Trump has flirted with running twice before. And all the way way back in 1999, he announced a radical plan that he claimed would pay off the national debt, give the middle class a tax cut, and even keep Social Security afloat. That sort of grandiose talk is nothing new for Trump — but how would he actually deliver?
Trump floated his plan shortly after he formed an exploratory committee to run for the Reform Party's nomination. Specifically, he proposed hitting individuals and trusts worth more than $10 million with a onetime "net worth" tax of 14.25% of amounts above that threshold.
"No one has put forward a plan to make this country entirely debt free as we enter the next millenium," Trump said in a written statement. "The plan I am proposing today does not involve smoke and mirrors, phony numbers, financial gimmicks, or the usual economic chicanery you usually find in DisneylandonthePotomac," he claimed. "By my calculations, 1 percent of Americans, who control 90 percent of the wealth in this country, would be affected by my plan," he asserted. "The other 99 percent of the people would get deep reductions in their federal income taxes," he said.
Eliminating the national debt would have saved $200 billion per year in interest costs at that time. Trump proposed earmarking half of those savings for middle-class tax relief and half for Social Security. He also proposed eliminating the estate tax. "Personally, this plan would cost me hundreds of millions of dollars, but in all honesty, its worth it," he said. "It is a win-win for the American people, an idea no conventional politician would have the guts to put forward," he bragged.
And how would the IRS actually collect that sort of tax? Well, for starters, they'd have to create a new form to collect net-worth information. It would probably look like the current estate tax return, a deceptively simple three-page form requesting valuations on all real estate, securities, insurance proceeds, and other property owned at death. That sounds easy enough at first — but assets like real estate are a lot harder to value than income. Who's to say what Trump's own properties are worth in this market, for example? What about privately-held businesses, art collections, and other illiquid assets? High-net-worth individuals will have plenty of reason to understate them or hide them entirely!
It's worth mentioning that while the income tax audit rate is just 1%, the estate tax audit rate (which involves valuation questions just like Trump's proposal raises), is a staggering 24%. And right now there are fewer than two hundred estate tax auditors for the entire country!
Trump's 12-year-old proposal has as much chance of becoming law as his hair does of making the cover of GQ magazine. If anything, it may come back to bite him as he courts a more conservative audience in 2012. But we can promise you we'll keep a sharp eye out on the candidates' tax proposals, to better help you evaluate who you want to support. And what do you think of Trump's big idea?

Worth Fighting For

One hundred and fifty years ago this week, Confederate soldiers fired on South Carolina's Fort Sumter. That shot touched off a Civil War that would eventually claim over 600,000 American lives and haunt the nation's memory. The war's legacy lives on in obvious ways, such as a history of racial conflict. But it lives on in more subtle ways as well "? for example, would you believe the taxes you pay are also a Civil War legacy? Up until the Civil War, the government raised nearly all its revenue from excise taxes and tariffs. In 1860, when our population was just 31.4 million, the U.S. raised $56.1 million in excise taxes and $8.5 million from business and other revenue. (The deficit back then was $13.4 million, and total public debt just $64.8 million!) But the Civil War challenged the Treasury like no other crisis before it. Congress passed the first "emergency" income tax on July 1, 1862. The rate was 3% on incomes above $600 (roughly $13,000 in today's dollars) and 5% on incomes above $10,000 (roughly $212,000 in today's dollars). The Commissioner of Internal Revenue supervised monthly collections from various sources, including transportation companies, bond interest income, auction sales, and sales of slaughtered cows, pigs, and sheep. There were also complicated excise taxes on hotels, eating houses, theatres, and circuses, as well as licenses for bankers, auctioneers, pawnbrokers, doctors, lawyers, and jugglers. ("Every person who performs by sleight of hand shall be regarded as a juggler under this act.") Congress passed the first tax hike in 1864, with rates going up to 5% for incomes between $600 and $10,000 and 10% for incomes above $10,000. Taxpayers filed Form 24, "Detailed Statement of Income, Gains, and Profit," with their local assessor. Business owners got many of the same deductions they get today. But landlords reporting income from land and buildings got just one deduction, and that was for repairing fences! There was even a "kiddie tax" on minors' incomes over $600. Filing late cost an extra 25%. Filing a false return meant the local assessor did your taxes for you, with a 100% penalty and no appeal. Ouch! David Wells was appointed chairman of the U.S. Revenue Commission in 1865. He described the tax system as being "akin to that recommended to the traditionary Irishman on his visit to Donnybrook Fair, 'whenever you see a head, hit it.'" Wells added that Congress was guided by a similar principle: "whenever you find an article, a product, a trade, a profession, or a source of income, tax it!" Sound familiar? Congress finally killed the "emergency" income tax in 1872, and it remained dead until until World War I. The rest, as they say, is history. Once again our nation is at war, and once again our lawmakers are struggling with how to finance it. And just as the Civil War led to a new form of income tax, today's lawmakers are contemplating new national sales taxes, value-added tax, and even carbon taxes. Regardless of what they choose, we'll "respond in kind" in the war to keep your taxes as low as possible!

Qaddafi Cuts Your Taxes, But . . .

The uprisings in the Middle East are nothing short of historic — the Islamic world's equivalent of the Berlin Wall crumbling before our eyes. While countries like Tunisia, Egypt, Libya, Bahrain, and Yemen may not be ready for our style of democracy, their citizens are enjoying the hope, and promise, and even a first taste of the freedoms our own forefathers shed blood to secure for us.

But can you believe that the uprisings in the Middle East — especially the conflict in Libya — may actually work to cut your tax bill?

Libya produces just 2% of the world's oil, and most of it goes to Europe. But Libya is one of the primary sources of "light sweet crude," and worldwide production is near full capacity. So the rebellion against Qadaffi has sent prices surging nearly 30% — way out of proportion to Libya's actual impact on the world's oil supply. Prices are super-sensitive to the news, and twitch with each new development. On March 20, for example, prices jumped $2/barrel after western forces began enforcing a "no-fly zone." The very next day, they fell $3/barrel in just 15 minutes after Libya's foreign minister declared a cease fire. And of course, oil prices drive gas prices here in America — an extra dollar per barrel means an extra 2.4 cents for every gallon.

Why does this matter? Well, higher gas prices, in turn, affect your taxes — depending on how you handle them. You have two choices for deducting car and truck expenses:

•You can take a standard mileage rate the IRS issues for all vehicles. Right now that allowance is 51 cents/mile for business, 19 cents/mile for medical or moving purposes, and 14 cents/mile for charitable purposes. It was announced on last December 3, when the average price of gas was around $3.00.

•Alternatively, you can deduct your actual expenses for operating your vehicle. Those expenses include the actual price you pay for gas, which now averages $3.60 nationwide. (The "actual expense" method also lets you deduct more if you drive a big honking SUV than if you drive a fuel-efficient compact or hybrid — something the standard rate doesn't allow.)
Bottom line: Qaddafi balks at giving up his "throne." Oil prices shoot up. You pay more to fill up your family truckster. But you get to deduct more. So you pay less tax!

Uh oh . . . what's wrong with this picture?

Well, there's a reason you get to deduct more, and that's of course because you pay more. If you're in the 25% tax bracket, a $3.00 gallon of deductible gas costs $2.25 after tax. A $3.60 deductible gallon costs $2.70. Who cares about saving 15 cents more in tax if it means paying 45 cents more per gallon? Paying less tax isn't always a good thing if it's because you're making less!

It's easy to applaud Libya's movement towards democracy. It's harder when we realize how much that movement costs us at the pump. How high do you think gas prices will go? Do you think they'll go higher than they did in the aftermath of Hurrican Katrina?