The year 2013 may snap a 12-year winning streak for wealthy Americans on taxes due on income, capital gains, dividends and money given to their heirs
The year 2013 may snap a 12-year winning streak for wealthy Americans on taxes due on income, capital gains, dividends and money given to their heirs.
The U.S. deficit, forecast by the nonpartisan Congressional Budget Office to reach a two-year cumulative total of $2.5 trillion next year, has prompted calls by some in President Barack Obama's administration, Congress and a bipartisan commission to limit tax breaks for home mortgage interest, charitable contributions, municipal bonds and retirement contributions.
“The deficit is an issue,” said Bill Fleming, managing director at PricewaterhouseCoopers LLP. Many wealthy taxpayers “have already decided in their minds that something is going to happen and they're going to pay higher taxes.”
Rates on income, capital gains and dividends will rise in 2013 because tax cuts extended last year are scheduled to expire at the end of next year, unless Congress acts. In 2013, top earners also face additional levies on unearned income and wages to help pay for health care reform.
Mr. Obama has proposed raising income tax rates to as much as 39.6%, from 35%, for couples making more than $250,000 annually or individuals earning at least $200,000. Capital gains and dividends would be taxed at a top rate of 20%, up from 15%.
The highest earners face an additional 3.8% tax on unearned income such as realized capital gains, plus a 0.9-percentage-point rise in the Medicare payroll tax on wages starting in 2013 as part of the health care bill passed in March 2010.
A majority of Americans favor increasing taxes on the wealthy, at least two polls this year found. A Quinnipiac University poll released May 4 showed that 69% of voters back raising taxes on households earning $250,000 a year or more, while a March Bloomberg poll reported the figure at 59%.
For a married couple with two children in Connecticut, which has the third-highest state and local tax burden in the United States, the increase in rates that Mr. Obama has proposed, along with levies from health care reform, means their tax bill would increase 12.5% to $142,160 in 2013, from $126,410 this year, according to an analysis that Mr. Fleming ran for Bloomberg News.
That is based on $485,000 in earnings, $2,000 in interest on investments, $3,000 in dividend income and $10,000 in long-term capital gains, and the following deductions: $20,000 in mortgage interest and charitable donations of $10,000, said Mr. Fleming, who works for PwC's private-company-services tax group.
UNDER PRESSURE
The scenario includes interest payments of 5% on a $400,000 mortgage, he said. If the mortgage deduction is eliminated, the family's tax bill will increase to $150,080 in 2013, a 19% hike from this year, according to the analysis.
States such as Connecticut and Illinois have raised taxes this year, according to the Tax Foundation, a nonpartisan research group. Hawaii and Oregon have the highest state income tax rates — as much as 11%.
The federal government must come up with ways to reduce deficits and the national debt or it might lose its AAA credit rating, Standard & Poor's said April 18. The budget situation is causing some lawmakers to call for cuts in spending and others to advocate for tax increases, said Mark Robyn, an economist for the Tax Foundation.
“Politically, you're probably going to see some combination of the two,” he said.
The biggest federal tax breaks for individuals include those for mortgage interest, charitable contributions, state and local taxes, incentives for retirement savings and the exclusion for employer-provided health care, said Clint Stretch, managing principal of tax policy at Deloitte Tax LLP.
Each of them would be “politically pretty toxic” to eliminate or reduce, he said.
Phasing out the mortgage interest deduction would increase federal revenue by $214.6 billion over the next 10 years, according to estimates from the Joint Committee on Taxation in a March report by the CBO. Curtailing deductions for charitable giving would raise an estimated $219 billion over the next decade, the CBO study said.
Other revenue-raising options include taxing interest earned on muni bonds and reducing the cap on all contributions to 401(k) retirement plans to $14,850 annually and to $4,500 for individual retirement accounts, according to the CBO report. That compares with a maximum of as much as $22,000 this year for individual contributions to 401(k)s and $6,000 for IRAs.
DEFICIT REPORT
The bipartisan deficit commission suggested overhauling tax rates in a separate report in December that would set a top tax rate of 28%, down from the current 35%. That plan also would tax capital gains and dividends as ordinary income and convert the mortgage interest and charitable-contribution deductions into limited credits.
“Individuals have a real problem,” Mr. Stretch said of the varying proposals.
“It's sort of like going through a tunnel when you're driving: You turn up your lights and you keep up your speed. You've got to pay attention to it. You've got to see where risks and opportunities are, but the worst thing you could probably do is to be paralyzed, to stop planning.”
A reduction in tax breaks or increase in rates means that taxpayers will have less money to spend in the economy, and it may discourage investing, said Bloomberg tax analyst Matthew Caminiti.
Investments are the main asset of the wealthy, while for the middle class, it is their home, said Edward Wolff, a professor of economics at New York University. The top 10% of wealth holders in 2007, the latest year for which data are available, owned 81% of stocks, he said.
“The preferential tax treatment of capital gains and dividends in the tax code definitely mainly benefits the rich,” Mr. Wolff said.
Congress also may take a “close look” at the tax benefits of muni debt as soon as next year, said George Friedlander, chief muni strategist for Citigroup Inc.
“If they actually get around to doing a bona fide cut in future spending, then state and local finance will be on the table next year,” he said.
Muni bonds generally are exempt from federal taxes, as well as state and local levies, for residents in most states where they are issued.
For high earners and retirees seeking tax-free income, any changes to the tax benefits of muni bonds would be “impactful,” said Christopher Johnson, director of the wealth advisory group for Barclays Wealth.
Proposals to cap tax incentives that encourage Americans to save for retirement are “shortsighted,” Robert Reynolds, chief executive of Putnam Investments, said in a statement. He urged the Massachusetts congressional delegation to oppose any such policy shift.
“Those most severely hurt if savings incentives were cut would be low- and moderate-income workers who need help in saving for their futures,” Mr. Reynolds said.
Limiting retirement benefits also may change strategies used by the wealthy, said Mr. Johnson, whose clients typically have at least $10 million in investible assets. Many high-net-worth individuals use accounts such as Roth IRAs to pass wealth down to their children, he said.
If such opportunities are removed, there will be a re-balancing toward whatever areas remain opportunistic, Mr. Johnson said.
“It's going to be difficult to anticipate in advance what those will be,” he said.
MAKE A GIFT
The uncertainty means that wealthy families should consider taking advantage of favorable gift taxes that are scheduled to expire at the end of next year, said Linda Beerman, chief fiduciary officer of Atlantic Trust Private Wealth Management.
Under the tax cut compromise passed in December, individuals generally may transfer up to $5 million during their lifetime without paying tax. That threshold will revert to $1 million in 2013 unless Congress acts.
“Move that $5 million now to your children or grandchildren to lock that in, if you're afraid that will go away,” Ms. Beerman said.
That way, the appreciation on those assets is out of an estate, she said.
The debate around taxes and deficit reduction will continue into the 2012 election because lawmakers can't agree, Mr. Stretch said.
“Over the last decade, this country has failed to live within our budget,” Senate Finance Committee Chairman Max Baucus, D-Mont., said in a May 3 budget-hearing statement. “It is time to craft deficit reduction legislation that will stabilize debt held by the public by 2014 or 2015.”
During a May 16 speech, House Budget Committee Chairman Paul Ryan, R-Wis., said that cutting spending and reforming government programs will be necessary to reduce the U.S. debt.
“The government cannot close its enormous fiscal gap simply by taxing the rich,” he said.
It is unpatriotic for the rich to oppose higher taxes, because the distribution of wealth in America has become so skewed, said Jerry Rockefeller, 81, a retiree in Brandon, Fla.
“The country is calling on the wealthy to kick in and help,” as when everyone “stepped up” during World War II, said Mr. Rockefeller, who used to run a consulting business for publishing firms.
“The middle class can't do it. They've been kicked dry,” Mr. Rockefeller said.
