The federal government has committed more than $11 trillion to bailouts to “help” the U.S. economy. The good news is that only $3 trillion of it has been spent so far. Of course, somebody has to pay for this — primarily, high-income taxpayers.
Let’s examine facts about the taxes for high income Americans and corporations, and see how much of this burden will really fall on doctors and similar-earning taxpayers.
According to the Internal Revenue Service, more than 140 million tax returns were filed in 2009. Of these taxpayers, 70 million people pay more than 97 percent of the total income tax in the United States. That means the bailouts will cost each of those 70 million taxpayers an average of $157,143.
According to the Tax Foundation (www.taxfoundation.org), a Washington think tank, the tax burden of the top 1 percent of earners exceeds that of the bottom 95 percent of earners. As a physician, you can expect to be in the top 1 percent if your adjusted gross income is over $410,000, or in the top 5 percent if your income exceeds $160,000, according to most recent statistics from the IRS.
If tax changes that benefit the wealthy are not enacted, the top 5 percent of taxpayers, or 1.4 million people, will be expected to pay for 60.63 percent of this bailout in taxes — or an average of $952,757 per taxpayer. The numbers don’t lie.
Don’t rely on corporations to help
In 2009, Exxon Mobil Corp. reported $45 billion in profits and boasted that it had zero U.S. income-tax liability. During the same time period, General Electric Co. filed more than 7,000 tax returns in various jurisdictions. GE’s total U.S. tax bill: $0! This was on a global profit of $10.8 billion.
Did the financial collapse and need for bailouts hurt the incomes of chief executive officers of top financial institutions? Citigroup Inc.’s CEO, John Havens, received total compensation of $11,276,454 in 2009. His company had to rely on $5 billion of bailout funds.
It is not conspiracy theory to say that the government and Big Business work together. The numbers are abundantly clear.
For the wealthy, taxes aren’t fair, either
According to the Tax Foundation, the “average” adjusted gross income of a member of the top 0.1 percent of taxpayers is $7.4 million. If you are looking for a goal, you should note that it only takes an income of $2,155,365 (the low end of the top 0.1 percent of earners) to claim a seat within this group.
Compare this to the rest of the top 1 percent of taxpayers. This group has AGI over $410,000, but less than $2.155 million.
Consider the next troubling statistic: The rest of the top 1 percent pay 22.56 percent as an average income-tax rate, while the top 0.1 percent pay a lower average tax rate of 21.46 percent. The group with income between $410,000 and $2.1 million pays more tax as a percentage of income than the group with “average” income of $7.4 million.
How can that be? Higher-income taxpayers receive better financial advice and more careful tax, retirement and investment planning.
Where might tax increases come?
There has already been passage of legislation with a Medicare surtax of 3.8 percent on all investment income for taxpayers who earn more than $250,000. The cost of this tax increase is going to vary, based on the amount of your investment income. If you consider that the long-term capital gains tax on investments is only 15 percent — for now — this surtax represents an increase in tax of 25.3 percent.
There may also soon be a tax-rate increase on capital gains and dividends that could be as high as 33 percent of the existing tax rate (raising the tax from 15 percent to 20 percent). These two taxes combined could represent an increase in taxes on investments of more than 58 percent.
The dollar impact of this increase will depend on the value of your appreciated assets and income-producing assets (such as real estate, equipment, etc.). For many doctors who utilize smart asset-protection strategies, and separate assets from the operating practice, this tax increase may hurt a little.
The Medicare tax on investments mentioned above is in addition to the Medicare tax rate hike from 2.9 percent to 3.8 percent. This increase is on all earnings above $250,000, for joint filers.
Right now, the Social Security tax stands at 12.4 percent for self-employed individuals, but it only applies to the first $106,800 of income. What would happen if Congress successfully legislates away all benefits of S corporations, and every dollar of income is subject to Medicare’s new 3.8 percent tax? What happens if the law changes so that Social Security is no longer limited to the first $106,800, and it picks up again on all income over $250,000?
For doctors making $500,000 to $1 million per year, these hypothetical changes could represent up to $110,000 of additional taxes. The Medicare payment increase alone for a $1 million earner who currently takes half of his or her income in salary and half in S distribution could be as high as $23,500 per year.
Another possible tax increase that’s been discussed is to raise the highest marginal income tax rate back up to 39.6 percent, from the current 35 percent. (This would apply to income of approximately $400,000). For a doctor earning $600,000, this could cost another $9,200 a year.
Finally, the estate-tax repeal that was enacted under former President George W. Bush is going to “sunset” on Dec. 31, 2010. This means if you don’t die this year and lawmakers don’t extend or make the repeal permanent before it expires, all those big, nasty estate taxes — up to roughly 55 percent — are back on the table.
Now, assuming you are not interested in dying this year to avoid estate taxes, or to save the time and aggravation of doing income-tax planning, here are some strategies to prepare for the potential for higher taxes in the coming years:
Pay as much tax as you can right now
Yes, you read that correctly.
What’s crucial is to get as much money as humanly possible out of taxable environments and into tax-free environments. This is necessary because it’s extremely likely tax rates are going to have to increase substantially to pay for the bailouts, healthcare reform and other federal programs that are on the agenda.
Here are some examples of ways to accomplish this goal:
Retirement Accounts. If you have the liquid cash available to pay the income tax, convert all of your individual retirement accounts to Roth IRAs in 2010.
Real Estate. If you have property with capital gains — especially those that are the result of a number of 1031 tax-free exchanges — sell it and pay the taxes now.
Equity Investments. If you have appreciated stock of public or private companies, explore ways to sell so you can trigger capital gains taxes in 2010.
Life Insurance. Increase the amount of money you invest into tax-free vehicles, such as cash value life insurance. Under the current tax regime, the benefits of tax-savings outweigh the costs of the insurance. In a higher-tax environment, the benefits will only be enhanced.
Pay no more tax than absolutely necessary
On items you’ll eventually be taxed on, no matter what, you want to pay the tax now while rates are still relatively low. But on future income, you need to be smart and maximize tax deductions any place you can.
If Congress passes the bill to eliminate all benefits of S-Corps, savvy doctors will take advantage of all the benefits C-Corporations offer. These include:
Tax Break on Health Insurance. Health-insurance expenses are 100 percent tax deductible. Right now, individuals can’t deduct health-related expenses until the costs exceed 7.5 percent of adjusted gross income. One bill under consideration right now would raise this threshold to 10 percent of AGI, unless the individual is eligible to take a self-employed health-insurance deduction. For a doctor earning $600,000, the first $45,000 to $60,000 of health expenses are not deductible individually, but are 100 percent deductible through a C corporation.
Long-Term Care Insurance. Long-term care insurance is treated like health insurance. While you are in your peak earning years, you can pay these premiums for a limited time — for example, over 10 years — and be eligible for a full income-tax deduction while doing so. So benefits are tax-free if and when you and your spouse need them. The deductible amounts for long-term care insurance are very low for individuals.
Life Insurance. There are ways for a C corporation to tax-efficiently purchase life insurance. If you can get a partial deduction for putting money into a vehicle that grows tax free, allows you access to the funds in the policy tax free, and provides some protection for your family, why wouldn’t you do it?
Tax Deductions. There are tax-saving strategies that exist that allow successful doctors to take annual deductions that can be in the hundreds of thousands of dollars or more under the umbrella of a C corporation.
The best offense is a good defense
Not knowing exactly where the tax increases will fall is no excuse for inactivity. In all likelihood, tax rates are going to increase for high earners. By the time tax increases go into effect, it may be too late to act. And if, by some chance, tax rates go down, at least you’ll have invested the time to lower the overall rate of tax you will ultimately have to pay, so there will still be some benefit.
Oh, and the answer to the title question? A quadrillion. At the rate the national deficit is ballooning, many taxpayers may learn the answer to that question the hard way.