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Posts Tagged ‘Bush tax cuts’

Is It Bad to Pay Income Taxes?

I’ve been in the tax business for over 20 years.  Having dealt with scores of clients, I’ve talked with all kinds of people and dealt with a myriad of situations.  Although people may accept the requirement and necessity to pay taxes, there is a general disdain for paying taxes and filing tax returns.

I often hear people bemoaning the amount of taxes that need to be paid.  You may have heard someone say that they don’t want to make more money, because they’ll have to pay more taxes.  My response to that statement is rather blunt… that is stupid.  Sorry, if I’ve offended you, but let me explain why I was so brash in my comment. 

As I tell my clients there are worse things in the world than paying taxes.  Income taxes are assessed on income.  Thus, there is a general premise that you must earn income to require the assessment of taxes.  If you don’t pay taxes, it means you aren’t making money. Think about this… if you paid any taxes in 2008, you probably paid more taxes than Ford, General Motors, Chrysler and many of the big U.S. banks combined.  All of those companies lost billions of dollars in 2008.  As they were fighting for their survival, paying income taxes was not the most important concern of the executives, employees and shareholders.

With the extension of the Bush tax cuts, the top federal rate is 35%.  Add in state, local and Social Security taxes, and your top marginal tax rate could be 50-55%.   Even if your rate is 50%, you get to keep 50% of what you make.  Thus, for every extra dollar you make, you have 50 cents to spend.  As long as the tax rate is less than 100%, you will still come out ahead if you make more money and pay taxes. 

Many years ago, one of my wealthy clients told me that he was privileged to pay $1 million in taxes each year.  At the time, he was making over $2 million.  Although he lost over one-third of his income to taxes, he still had more than $1 million to spend.  Would you prefer make $50,000 a year and pay no tax or be in his situation?

Granted, you would probably like to pay less in taxes, as would my client who paid the $1 million, but that is a different discussion. 

The simple fact is that our government raises part of its revenue by levying an income tax.  You may not like the amount of tax that you pay, but there are worse things than paying taxes.  Furthermore, the more that you more you make, the more you pay, and as a result the more you pay, the more you have to spend.

Thus, I am of the opinion that paying income taxes is a good thing.

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Fiscal Austerity: Easier Said than Done

Although there is still a lot of political posturing and wrangling to be done, it appears that a deal has been made regarding the extension of the Bush tax cuts.  Like most Washington deals, it’s a compromise where all sides get to claim victory. 

Here is a quick summary of the major points of the plan:

  • 2-year extension of all current tax rates
  • Reinstatement of the Estate Tax for estates in excess of $5 million
  • Extension of unemployment  benefits for an additional 13 months
  • Reduction in the employee’s portion of Social Security taxes of 2% for one year
  • Extension of several expiring tax provisions

The price-tag of this bill: $800 billion – all of which will be funded by additional U.S. debt.

There are arguments to be made for the economic and social benefits of each of the provisions.  However, while the machinations may be different, there is still an overriding principle to consider… Congress continues to spend money it doesn’t have.  While many people oppose various elements of the agreed framework, all of the politicians and economists I have heard comment on this matter support deficit-spending of some sort. 

The sluggish economy, the rapid expansion of government spending and national debt were hot issues during the recent 2010 elections. Candidates made promises of fiscal restraint and austerity.  There was a lot of drum-beating and chest-thumping over the debt and deficit and many promises to reign in government spending. 

It’s interesting how quickly Washington returns to business as usual, or remains oblivious to the wishes of the voters.  Granted, many of the new elected officials have yet to take office, but the recent tax legislation is a clear example of the challenge that lies ahead.  However, the stark reality is that fiscal austerity measures are easier said than done.  As this article in The Economist points out, President Obama and Congress have punted on fiscal austerity once again. 

The progress of the lame-duck session of Congress is a good indication that we should not expect to see a dramatic shift in the way Washington works or spends money.  Political posturing continues to take precedence over what’s best for the country. Furthermore, when faced with the choice between making tough financial decisions and pandering to certain constituencies, fiscal responsibility loses every time.

Whether anyone wants to admit it or not, hard decisions will eventually be required.  You only need to look to the recent events in Greece, Ireland, Spain and Portugal to realize that sooner or later a nation must put its fiscal house in order.  As these countries and their citizens have discovered, it won’t be pleasant, but you can’t continue to spend more than you take in forever.

Fiscal Austerity is easier said than done.  It’s also easier if it’s tackled sooner than later.  At this point, I’m not sure we can count on either.

The Price of Political Posturing

The second week of the 111th Congress’ lame-duck session is nearly over.  With less than three weeks to go before the session adjourns for the holidays, Congress has still not acted on two important matters – passing the 2011 budget and an extension of lower tax rates.

Congress needs to pass the 13 Appropriations Bills that make up the federal budget.  It doesn’t need to act to extend the tax rates, but the potential economic and political ramifications of increasing taxes on all Americans has dominated the attention of Congress.

The mid-term elections have been over for more than a month, and the lame-duck session started three weeks ago, yet little progress has been made.  Extending the tax rates for the highest taxpayers is the stumbling block.

Generally speaking, President Obama and many Democrats support an extension of the lower rates for everyone except for the individuals making in excess of $200,000 a year and couples making more than $250,000.  The Republicans advocate an extension of the tax rates for everyone.  Given the makeup of the Senate, the Democrats need at least 2 Republican Senators to vote with them, but it’s doubtful that this will happen.  Most people believe a compromise bill will pass providing for a temporary extension of the rates for everyone.

Despite this general expectation, the House passed a bill yesterday raising the rates on the higher income taxpayers.  The Senate could take up the bill later today or tomorrow.  No one expects the bill to pass.  Therefore, these votes are largely symbolic.  In essence, both parties are pandering to their supporters.  It’s great political posturing, but bad for the overall welfare of the country.

Payroll companies have expressed concerns regarding their ability to properly prepare paychecks at the beginning of 2011.  It’s also anticipated that the tax legislation will include the extension of certain provisions that affect 2010 tax returns.  Therefore, the Commissioner of the IRS, Douglas Shulman, announced earlier this week that the IRS may not be able to program its computers in time to process returns for the changes that are likely to happen.

These are practical concerns with real money implications for the government, individuals and business.  Despite these apprehensions, Congress continues to plod along as if time doesn’t matter.  They are clearly more interested in political posturing and scoring political points, than actually coming up with a solution.  Is it any wonder that Congress has such abysmal approval ratings?

If your first paychecks of 2011 are messed up, or your 2010 tax refund is delayed because the IRS can’t properly process your 2010 tax return, you’ll know why.  Congressional leaders believed meaningless, symbolic votes were worth the price of delay.

Taxing Rich People: Who Are They?

The debate in Washington rages over whether or not to extend the Bush tax cuts.  Essentially, the debate has come down to whether or not to extend lower tax rates to those individuals in the highest marginal tax bracket. 

President Obama wants the tax rates to increase for individuals making more than $200,000 and couples making over $250,000.  It’s an interesting choice of words.  Presently, tax brackets are determined by taxable income, which is your adjusted gross income less deductions (e.g., mortgage interest and charitable deductions).  By referring to income, is he referring to taxable income or adjusted gross income?

Aside from that question, the debate is centered around taxing the “rich” people.  Some opponents have argued that targeting the wealthy is a form of class warfare.  However, it’s widely understood that we have a progressive tax system, and the more you make, the more you pay.

If you’re going to tax the rich, it’s good to understand who they are.  Being rich is a relative term.  One person’s idea of being rich is quite different than another.  For my grandparents, $100,000 was a fortune, but some people will spend more on a car.  Being rich can also vary dramatically depending upon where you reside.  Making $200,000 a year in west Texas is vastly different than making $200,000 living in Manhattan.

If you consider that one-third of the world lives on less than $2 per day, every American is rich.  In short, most people don’t feel rich. Thus, when we advocate taxing the rich, we’re typically thinking of someone else.

In the debate about extending the Bush tax cuts, a viewpoint of who is rich is an important consideration. President Obama argues that those affected can afford to pay more, and the increased taxes won’t affect their spending.  The proponents of extending the lower rates believe that the government will be taking money away from business owners and entrepreneurs who may invest those dollars into business ventures that will help stimulate the economy.

When thinking of rich people, A-list celebrities and names like Gates, Buffet and Rockefeller often come to mind. You imagine people who live in mansions, travel, shop and generally life a life of leisure. In the world of the rich and famous, paying extra taxes has little impact on their lifestyle.  While these people exist, they are by far the minority of the “rich” people who will be affected by the pending tax increase.

A large majority of the people who are in the highest tax brackets are people who own businesses.  If you look at the IRS statistics, S Corporations and partnerships comprise the majority of all business tax returns filed.  S Corporations and partnerships do not pay taxes at the entity level.  The taxes are paid by their owners.  Thus, the income of the business is included in the owners’ returns, but income doesn’t necessarily equate to cash in the owners’ pocket.  It’s common for the business to retain money for working capital and expansion.

This is the crux of the issue.  The more money the business pays in taxes, the less that is available for economic growth.  An increased tax burden probably won’t put the company out of business, but it might keep the business from hiring additional employees or purchasing new equipment.  Since the government is attempting to spur economic growth and reduce unemployment, whatever hinders business growth is counterproductive to this goal.

Assume a person makes $1 million a year and pays an additional 5% of taxes, which is $50,000.  If the person has the $1 million in cash for their lifestyle, the extra $50,000 of taxes paid probably won’t make a huge difference in their spending.  However, if the $1 million of income is the profit from a business, the extra $50,000 of taxes could be the equivalent of another full-time employee. 

In the debate over extending the Bush tax cuts, I think it’s important to know who is going to be affected by the tax changes.  I believe Congress has a bias in their understanding.  If you look at the background of the members of Congress, very few are business owners or entrepreneurs.  Therefore, I think they have a distorted view of the impact that increased tax rates have on behavior.  Based upon their characterization of wealthy people, it seems most of them think wealthy people have trust funds and large investment portfolios, rather than entrepreneurs running a business.

If it’s all about lifestyle, then the additional taxes probably won’t have much of an effect, but if it’s money associated with operating a business, extra taxes may mean slower expansion and few employees hired.

Who are the rich people?  Hopefully it’s you.

Lame Duck Session and Bad Tax Policy

The 111th Congress resumes session today.  With the recent mid-term elections over and a significant shift of power coming in January, this session has been dubbed a lame duck session.  A lame duck isn’t supposed to accomplish much, yet Congress has a lot of unfinished business and little time.

Two of the biggest issues Congress needs to tackle are the 2011 budget and taxes.

The U.S. Government started a new fiscal year on October 1, 2010, yet none of the 13 appropriation bills that govern federal spending have passed both houses of Congress.  To keep the government from shutting down, Congress passed a continuing resolution that allows federal agencies to continue spending based on the 2010 budget.

The other major issue that has dominated the political discourse for months is the scheduled elimination of lower tax rates, otherwise referred to as the “Bush tax cuts.”  The biggest point of contention is whether or not the lower tax rates should be extended to high income taxpayers (i.e., individuals earning over $200,000 and couples earning over $250,000). 

I will explore the arguments of maintaining the Bush tax cuts in subsequent articles.  Today’s topic is the political process and poor tax policy that is likely to result.

When the current tax rates were enacted in 2001 and 2003, they were scheduled to sunset at the end of 2010.  Thus, if Congress does nothing, tax rates and brackets will revert back to the rules that were in place at the end of 2000. It will literally take an act of Congress to extend the current rates beyond December 31, 2010. 

You may have your opinion of whether or not this is good for the country or the economy.  Irrespective of that issue, it’s bad tax policy to wait until the last minute to make a decision.

Congress has known for at least 7 years that the current rules would expire, but they have not acted.  In my mind, it’s a travesty that we are 46 days away from a new year and no one knows what the rules will be.   That may not seem like a big deal, but it is very challenging for business owners, managers and entrepreneurs, who are planning months or years in advance.  Many of my clients have been asking me for months what tax rules will change in 2011.  All I could tell them was that no one knows, and with six weeks to go, we still don’t know. 

With so much to do in a matter of a few days, I question the veracity of the decisions Congress will be making.  Will they be casting votes for what’s best for the country and the economy, or will their votes be primarily based upon politics and the desire to get out of town quickly?  Granted, these issues are always part of the process, but deferring these major issues to the lame duck session has created more pressure than was necessary.

Tax policy and the 2011 budget affect every person in the nation.  To postpone these major decisions and deal with them in a lame duck session is an indictment of political leaders from all political parties and persuasions. 

Over the past year there has been a lot of frustration with the political process.  Politicians will argue the process is not important, but that’s not true.  The Founding Fathers created a process that was designed to generate good legislation for the nation.  A poor process results in poor legislation.  Additionally, the process is a reflection of the culture of Washington.  Passing major legislation that affects every American in a lame duck session, is an indication that the legislative process is not functioning well, which will result in poor financial decisions and bad tax policy.

The Economic Impact of Tax Uncertainty

Congress has adjourned session for the 2010 midterm elections.  Facing an anti-incumbency mood and a lingering recession, you can understand the urgency for Congress to get out of Washington. 

Unfortunately, they left town without addressing some important issues.  The U.S. government starts a new fiscal year today.  There are 13 different appropriation bills that determine how the government is going to spend money in the coming year.  None of them have been enacted into law.

Additionally, there is the matter of what is going to happen to tax rates on January 1, 2011.  The tax rates that were implemented in 2001 (i.e., the Bush tax cuts) will expire on December 31, 2010.  If Congress does nothing, taxes rates will revert to the 2000 levels, resulting in a tax increase for all taxpayers.

You may have opinions about whether the current tax structure should be extended, allowed to expire or some combination thereof.  There are lots of political and economic issues, ideas and opinions of what is best.  Aside from these issues, one this is clear, uncertainty is not helping people.

My clients continually ask what is going to happen, and all that I can say is that no one knows.  It’s impossible to predict what will happen, if anything, in the lame duck session.  Based on my experience, one thing is clear; the continued ambiguity is not good.  A natural human response to uncertainty is to delay action, while you try to gain clarity and minimize risks.

This certainly applies to business decisions.  It’s hard to commit to aggressive expansion or major capital expenditures, if you don’t know what the future holds, and waiting is probably not beneficial for the overall economy.  As a tax advisor, I’m advising people to delay certain decisions and actions.  From a tax perspective, postpone your decision if you can, which is what a lot of people are doing. 

There is always uncertainty in life, business and taxes.  However, Congress has created a level of unnecessary angst.  This situation wasn’t suddenly sprung on them.  They have known for 10 years that the Bush tax cuts would expire, yet they continued to defer action.

President Obama and the Members of Congress lament the slow pace of economic recovery, but do they recognize that some of their actions are not contributing to a recovery?  To the extent that their inaction on tax policy creates uncertainty, which slows economic growth, they have no one to blame but themselves.

The lame duck session won’t start until November 15th.  Thanksgiving is just 10 days later, which will mean another recess.  In all probability, Congress won’t resolve the tax question until December, less than 30 days before the end of the year; not much time to plan and prepare for the coming year.

Payroll administrators are concerned with their ability to update software in time for the changes that will need to be implemented by January 1.  Do you assume that rates will go up and start programming for those changes?  If the law changes in December will you have time to re-program everything for the new law?  Do you invest time and resources planning for something that may not happen?

Elections are important and Members of Congress should have time to campaign.  However, they should also be responsible enough to complete their work in a timely manner. Not all decisions are easy or popular, but that’s what they are elected to do.  Their inaction on the appropriation and tax bills may be good for their political careers, but it’s bad for taxpayers, the economy and the country.