Beginning early in his re-election campaign, President Obama began voicing his belief that our broken tax system and mounting deficit could be fixed — in part, at least — by asking the nation’s wealthiest taxpayer’s to pay their “fair share” of federal income tax. By eliminating preferences, deductions, and exclusions that primarily benefit the rich, the president argued that we could successfully employ a balanced approach toward deficit reduction. Part of the savings would come from spending cuts, while the other part would be generated by additional tax revenue garnered from America’s wealthiest 2 percent, i.e., those earning more than $250,000 annually.
The president’s proposal created quite a stir among country club types, begging the natural question: How much tax must a wealthy individual pay before they’ve paid their “fair share?”
Well, now that the president has issued his 2014 budget proposal, with a little basic math, we can get our answer. And it ain’t pretty.
But before we get to that, let’s recap the recent legislative changes and proposals engineered toward reaching the president’s goal.
In 2012, taxpayers were still enjoying life under the so-called “Bush tax cuts.” The maximum individual rate on ordinary income was only 35 percent, the top rate on long-term capital gains and qualified dividends only 15 percent, and an employee’s share of Social Security taxes was temporarily reduced from 6.2 percent to 4.2 percent.
In the absence of congressional action, these favorable parameters were set to expire on Jan. 1, 2013. Rather than allow all the cuts to expire as scheduled and send America over the “fiscal cliff,” however, Republicans and Democrats reached an agreement to extend the cuts — except for the 2 percent payroll tax reduction — for 98 percent of Americans. For the wealthiest 2 percent of taxpayers, however, things changed drastically:
• Ordinary income in excess of $450,000 (if married, $400,000 if single) will now be taxed at 39.6 percent, rather than 35 percent.
• Taxpayers in that 39.6-percent bracket will pay tax on long-term capital gains and qualified dividends at a maximum rate of 20 percent, rather than 15 percent.
• Once a taxpayer’s adjusted gross income exceeds $300,000 (if married, $250,000 if single), he will begin to lose a portion of his itemized deductions and personal exemptions (the return of the PEASE and PEP limitations).
Also, independent of the fiscal cliff negotiations, two tax increases taking aim at wealthy taxpayers took effect on Jan. 1, 2013 under the president’s signature “Obamacare” legislation. Specifically, these provisions will:
• Subject a taxpayer’s earned income (wages and self-employment income) in excess of $250,000 (if married, $200,000 if single), to an additional 0.9 percent payroll tax.
• Tax the “net investment income” of taxpayers with adjusted gross income in excess of those same thresholds at an additional 3.8 percent.
But as the recently issued FY 2014 budget proposal indicates, the president does not believe the rich have paid their fair share just yet. Rather, in his budget, President Obama plans to raise an additional $1 trillion in tax revenue over the next 10 years, again asking the wealthiest taxpayers to contribute the bulk of the cash. As a reminder, the budget proposal includes the following tax increases:
• The benefit of certain deductions and exclusions would be capped at a 28 percent tax rate for those in marginal tax brackets in excess of the 28 percent bracket. Under the president’s plan, taxpayers in the 33 percent, 35 percent and 39.6 percent bracket would only receive a tax benefit equal to 28 percent of a claimed deduction. To illustrate, a taxpayer in the 39.6 percent bracket who makes a $1,000 charitable contribution would only experience a reduction in tax of $280.
• The controversial “Buffett Rule” would be added to the law, requiring that all taxpayers with adjusted gross income in excess of $1 million pay tax at an effective rate of at least 30 percent. This required alternative computation would put an end to the anomalous results experienced by the likes of billionaire Warren Buffett, who by virtue of the preferential 20 percent maximum tax rate afforded long-term capital gains and qualified dividends, pays effective tax rates in the low teens on tens or hundreds of millions of taxable income.
• The balance in a taxpayer’s tax-deferred retirement account will be limited to an amount sufficient to finance an annuity of not more than $205,000 per year in retirement, or approximately $3 million for someone retiring in 2013.
• The treatment of carried interest, which permits private equity fund managers to be compensated for services but taxed at the preferential 20 percent maximum rate afforded long-term capital gains and qualified dividends, would be changed. Carried interest would now be taxed as ordinary income at a maximum rate of 39.6 percent.
So assuming these provisions were enacted — a long shot, to say the least — it appears that President Obama will be satisfied that the rich have finally paid their “fair share.” But just how much is that?
Well, by culling distributional analysis performed by the trusty Tax Policy Center and applying some basic math, we can actually quantify the additional tax dollars the wealthiest 2 percent will pay in 2015 after considering the impact of the fiscal cliff deal, Obamacare, and the president’s budget proposal when compared to what those same taxpayers would have paid under 2012 law, i.e., the Bush tax cuts. And it looks like this:
Cash income/ tax increase from fiscal cliff and Obamacare/ tax increase from budget proposal /total
$200,000-$500,000/ $3,872/ $1,895/ $5,767
$500,000-$1,000,000/ $6,689/ $7,559/ $14,248
>$1,000,000/ $122,560/ $73,401/ $195,961
So there you have it. If you earn between $500,000 and $1,000,000 annually, apparently your “fair share” is the equivalent of the sticker price of a sleek and stylish 2014 Ford Fiesta. And if you’re pulling in more than $1 million annually, you’ll have paid your fair share once you’ve parted with the median purchase price of a three-bedroom home in lovely Sacramento.
Tony J. Nitti, CPA, MST, can be reached at email@example.com.