Wallace: Just words when it comes to taxes, taxes, taxes

Randel Wallace
Wednesday, Apr 4, 2012

Election year, taxes. Taxes, election year. This is when politicians and candidates make bold proposals to modify and simplify our complex tax code. Candidates talk about “flat taxes,” “9/9/9 taxes,” “middle incomers paying too much tax” and “tax breaks for the wealthy that pay a lower percentage than the other classes…taxes." Wait…the last one I get asked about a lot, and we’ll get back to it in a minute. The others?

9/9/9? Mmm, no comment.

Flat tax? What fun would that be? No more incentives? No more planning or “strategery?” Not to mention, what about me and my colleagues? Although simple, it doesn’t incentivize us. How many people bought Priuses, new windows and HVAC systems? Energy credits fueled an entire industry for good reason. Those credits made us conscious of our ability to improve our environment.

The decision to make capital purchases for businesses is highly influenced by bonus depreciation. We analyze the benefits of those purchases with our clients every year. If the ability to get accelerated deductions was removed, yearend trade would plummet.

The other problem with a flat tax is the debate about who should pay more would only grow. Let’s say the flat tax is set to 20 percent. Currently if you earn $100K, married with two children and itemized deductions of $16,500, your income tax after child tax credits is $7,459, or 8 percent. Not bad at all. Twenty percent flat tax…your tax is now $20,000. Even if the flat tax was 15 percent...well you do the math.

Now, same situation, but you earn $200K and your itemized deductions are now $24,000. Currently your income tax would be $33,206, 17 percent. A flat tax of 20 percent adds almost $7,000 to your taxes.

The tax rates only go up from there to a max of 35 percent. Now if politicians and celebrities who like to make the papers, think the wealthiest Americans don’t pay their fair share, how does a flat tax make sense? Their percentage decreases.
Keep in mind, in those scenarios, the family making $100K was effectively paying 8 percent as middle class and the $200K family was effectively paying 17 percent as upper middle class. So for the “middle incomers pay too much tax” debate, it generally isn’t arguable.

Now if there is a tax that middle to upper middle incomers pay too much of, it would be our social taxes. Social Security, Medicare and unemployment for those who are employers can create an even larger effective rate. Let’s assume the family that made $100K did so as business owners who employed 10 people and those 10 people cumulatively earned $350K. The owner has now paid almost $30K in Social Security, Medicare and unemployment, or 9 percent on the employee’s earnings. And if the $100K the owner earned is subject to self-employment tax, add another $13,300, or 13.3 percent. Now, that would reduce the income tax by $612, but even so, the total tax the owner has now paid is $20,147, but the majority is our social tax, 13 percent, not income tax, 8 percent.

Maybe reforming our income tax isn’t where the focus should be?

Tax breaks for the wealthy that pay a lower percentage than the other classes…taxes. I.e. the Warren Buffett Rule. Does Warren Buffett pay taxes at a lower rate than his secretary? Well if so, good for him and his accountants. All they have done is taken advantage of the tax code as it is currently written. That is what we are hired for. He has decided to accept his pay as dividends and capital gains, which are taxed at a maximum of 15 percent. Ethical? Not my call. Legal? Maybe.

I am not an expert on Mr. Buffett, his secretary or their respectful earnings, but if he wanted to pay more taxes, well that would be easy. That’s where I have a problem with his soapbox political comment. He took advantage of a popular tax strategy. Just don’t pretend there weren’t options. A portion of what he earns could arguably be taxed at ordinary rates as earned income (along with self-employment taxes). Despite the current political climate, as Treasury Secretary, Tim Geithner should have the IRS inquire how Mr. Buffett’s income is classed. (That stirs the political blood and I am not here to do that).

For me, until we start including social taxes and Earned Income Credit, the words of politicians, celebrities and investors of how we should change income taxes sound like they always have, just words.
n 

Randel Wallace is a CPA at Progressive Business Services in Cookeville. He can be reached at (931) 372-1711 or at www.randelwallaceCPA.com.