An article recently appeared in the Wall Street Journal titled “The Conservative Case for a Wealth Tax.” The proposal is to have a fair exemption, say, $3M, and any amount above this would be taxed each year at 3%. The author, Ronald McKinnon offers an example showing that a couple with $5M would be taxed $60K. I imagine many will think this is hardly enough, those hedge fund managers who make million each year can afford to pay more than this. Perhaps, but in the spirit of “Unintended Consequences” I’d suggest that this tax will hurt some people unfairly.

Take a couple who has made a decent income, $150K-$200K, and after selling their home, decides to take their retirement fund, and rent. They have exactly $4M. They don’t trust the stock market to go back to annual returns of 8-10%, and therefore they only withdraw $120K per year. (Remember, this is a retired couple, whatever their profession, let’s just agree they lived well beneath their means to save this money. They paid their taxes, but invested for the long term, much of it pretax.) The seemingly ‘fair’ 3% is $30K of the excess $1M they have. And it’s 25% of their annual budget. If the entire $120K withdrawal is a 401(k) or pretax IRA distribution, they are already planning to pay about $17K in tax, living off the $103K net. This tax would leave them with $73K.

At $5M, the numbers look even worse for this couple. Planning to withdraw $150K gross, and pay closer to $25K in tax, for a net $125K. Now take off $60K for the wealth tax, and they are left with $65K. Uh, right, they socked away an extra million dollars, but this wealth tax leaves them with a lower annual income. “But Joe, the wealth tax can come off the top, not from the withdrawals.” Agreed. but in the 25% bracket, it would take an extra $80,000 withdrawal to net the $60,000 for the $5M couple. They went from a pretty conservative 3% withdrawal target to $230K, a 4.6% rate. Something about this doesn’t seem right. Yet, when you paint a different picture, the 30 year old Wall Street Exec who has already built a $10M retirement account, the tax doesn’t seem so bad.

When it comes to the tax code, it’s very difficult to have a tax that doesn’t hurt those who are not the intended target. It’s easy to make judgments about who has really earned their money. I for one think there are hundreds of bankers involved in the Mortgage Collapse who deserve long jail sentences. The same folk at S&P who decided when you take enough C rated paper and put together, you can get AAA investments are the ones who pulled Uncle Sam’s AAA rating. These are the people who made us all poorer, along with our children who will inherit the national debt. Why these people are still on the streets (I mean employed and not serving time) I don’t know.

What do you think of the wealth tax? Have you seen any articles on it yet?

written by JOE \\ tags: occupy, Taxes, wealth

Flat Tax. Is it good or bad? Are we ready for it? Is it even possible that such a radical change in the current structure can be voted through?

When Steve Forbes ran for office he was an advocate of a flat tax. A 17% flat tax if I recall correctly. Now, Mr. Cain’s 9-9-9 plan takes the flat tax a step further, a very low 9% income tax along with a 9% sales tax.

At first blush, it looks like most of those who currently pay no federal tax at all will see an increase, but Cain points out that this covers the payroll tax as well, so even if you have no federal tax, you are paying 7.65% for social security and medicare. I think the idea of a tax like this might be appealing, after all, the simplicity alone is elegant, but the transition would be a tough hurdle.

What becomes of those who converted their IRAs to Roth IRAs to avoid higher future taxes? They paid 15,25, even 33%, and now would find that their rate is now 9%. Obama and others are currently on a “tax the rich” crusade, looking to bump their marginal rates further and remove their favorable cap gains rates. Cain’s plan has no cap gain at all.  I can only wonder what the reaction would be from Main Street if the fat cats managed to keep their income treated at capital gains and reduced their tax burden even further. I know, this can be legislated, and treated as ordinary income. Still, it goes counter to the concept of the Buffet plan, that the fairest tax system is a progressive one and higher earners should pay a higher rate.

The interesting thing to me is that Cain has calculated that compliance, enforcement, and collection of taxes cost the US $430 billion per year more than his plan would. Sounds like the IRS would have to plan a large downsizing if this plan goes through. On the other hand it would sure make planning easier, removing all the variables that change every year, that patches, fixes, extensions, et cetera. Unintended consequences aside (and you know there will be some big ones) I’d like to see if Cain’s plan gains any traction.

What do you think? Would a 9% flat tax appeal to you? No itemizing, no deductions at all?

written by JOE \\ tags: cain, flat tax, irs, tax

Each year the IRS updates some key numbers. Most are a product of the prior year’s inflation, all are near and dear to anyone having any interest in the tax process. Let’s look at what recently hit the wire from my friends at the IRS. (If I’ve not already made it clear, my use of the word friends is not sarcastic. The folk at the IRS do not create the tax code, they just enforce it. It’s congress that’s responsible for the tax regulations, as crazy as they appear.) Now, for the new numbers:

• A personal exemption is now $3,800, up $100 from 2011
• The standard deduction is now $5,950 for singles, $11,900 for married filing joint. Up $150/$300 respectively.
• Tax bracket thresholds have been adjusted, so, for instance, the 15% bracket for married filing joint now ends at $70,700 up from $69,000.
• The gift tax exclusion remains at $13,000 but the estate tax amount has increased to $5,120,000.

For greater details on 2012 tax brackets I recommend taking a peek at Revenue Procedure 2011-52. When these numbers appear at Fairmark.com, I’ll update here to advise.

That’s just the tax side, on the retirement side we have some changes as well:

• Participant in 401(k), 403(b), 457 plans, and the Government TSP is increased to $17,000 from $16,500
• No change in the catch-up contribution of $5,500 for those 50 or older.
• For those covered by a retirement plan at work, the IRA deductibility is phased out over the range of $58,000 – $68,000 for singles or $92,000 – $112,000 for married filing joint.
• The Roth IRA phase-out occurs from $110,000 – $125,000 for single and $173,000 – $183,000 for married filing joint.

written by JOE \\ tags: exemptions, rates, Taxes

My second year writing for the TurboTax Blog has finished, and I’m happy to say they have signed me on to begin a third. I’ll be taking a summer/fall three month vacation from the guest posting and back in November with another look at some great tax related topics.

My last two posts were published just over a week ago, and are good reading.

First, a look at Tax Withholdings and Your W-4. If in April you got (or owed) more than $1000, this article will help you understand how to adjust the money withheld each paycheck. I know a big refund feels good, but it also means you lent Uncle Sam money interest free.

And my last post of the season, The IRS Increases Standard Mileage Rates to 55.5 Cents Per Mile. In a rare mid-year move, the IRS updates the standard rates for those who take a tax write-off for miles driven, whether for business, medical, moving, or charity. Check out the full article and let my friends and TurboTax know Joe sent you!

written by JOE \\ tags: irs mileage, w4, withholdings

“Use it or lose it” is a provision of the Flexible Spending Account (FSA). The FSA is an account that permits you to use pretax dollars to pay for unreimbursed medical expenses. This can include copays for doctor visits, dental procedures, eye care, and prescribed medicine to name a few. With many employers allowing you to put as much as $5000 into the account over the course of the year, the tax savings can be substantial, $1250 if you are in the 25% bracket. Worth the bit of effort to request the funds be withheld and then fill out the paperwork for reimbursement. But as I started this article, stating that whatever you don’t spend by year end, you lose, many people avoid the FSA for just that reason. Trying to plan this type of spending isn’t easy.

Now, our friends in the Senate (when they are trying to get a bill I like passed, they are ‘friends,’ and I am their fair-weather friend) have introduced the Medical Flexible Spending Account Improvement Act, S. 1404 which would allow plan participants to withdraw their unused money at year end and pay the tax on it.

I like the idea of getting rid of the “lose it” part of the FSA, but the text of this bill leaves me a bit concerned. When an employee leaves, either voluntarily or is fired, and he had spent more from his FSA than he deposited, he is not liable to pay back the difference. My understanding was that the employers weren’t seeing a windfall from leftover money as their were those who spent more than they deposited before leaving. Note, you tell your employer in October/November how much you want to put in during the upcoming year, and are eligible for the entire annual amount as soon as you incur the medical bills regardless of how little you deposited by then.

Unless the bill addresses this feature of reimbursing before collecting, I can see a crazy “unintended consequence” brewing. Employers who decide to lower the FSA limits even lower than the upcoming $2500 limit congress has authorized.

How will this impact you? Do you have access to an FSA, and take advantage of it? Will this bill help you use it more than you did before?

written by JOE \\ tags: FSA, medical, Taxes

With all the talk of the deficit and the need to raise taxes today seemed a good day to visit the Laffer Curve. Named after Arthur Laffer, a member of Reagan’s Economic Advisory Board from 1981 – 1989, the curve describes the potential change in tax revenue as the rate itself changes.

This graph, clipped from the image drawn on a napkin (you can click the image to see the full sized one, including Mr. Laffer’s signing it “To Don Rumsfeld.”) illustrates a centuries-old concept. At a zero tax rate, revenue will be zero. This of course stands to reason. But, at a 100% tax rate, why would anyone work? So again, the tax revenue generated is also zero. So what’s left is two concepts, first, that there’s a rate that provides maximum tax revenue raised. Second, that if we are operating at the wrong point on the curve, at a rate higher than the maximum revenue rate, to raise revenue from there, the rate must actually be lowered, not raised.

The concept is intriguing, yet pretty simple. The question, however, is can we ever know where we are on the curve? Of course, as a thought experiment, not every individual may have the same shaped curve, so it’s the aggregate that needs to be optimized. This all goes to the point that as our government tries to get spending under control (they’re doing that, right?) they had best be very careful when tinkering with out tax rates.

written by JOE \\ tags: laffer, marginal rates, Taxes