High profile billionaire, Warren Buffett, has been quite vocal in arguing that the rich should be taxed more. He sat down with Tom Brokaw back in 2007 on the NBC Nightly News discussing this very matter and, later, on August 14, 2011, The New York Times published an op-ed headlined “Stop Coddling the Super-Rich” written by none other. It was this editorial that ignited a focus on the tax treatment of millionaires. In it, Buffet speaks of his staff paying more in taxes, as a percentage of income, than he does. According to his calculations, his 2010 tax rate was 17.40% while his staff’s average was 36%.
To add to the momentum, when Mitt Romney, presidential candidate, recently released his income tax returns to the general public, they revealed a tax rate of 13.90%, far less than his $21.70 million income would suggest.
How can this be? Certain investment income, including long-term capital gains and qualified dividends, is subject to a maximum tax rate of 15 percent. In the extreme case, if all of a taxpayer’s income is derived from these sources, their overall tax rate could be 0 or 15%, depending on the amount of income.
As a result, the President’s latest tax proposal is affectionately coined the Buffett Rule. The proposal would require those with income in excess of $1 million pay at least 30 percent in taxes. Rather than raising the tax rates on long-term capital gains and qualified dividends, the proposal would create a new 30 percent alternative minimum tax (AMT) for the high earners.
So, here we have two very successful individuals who are taxed, almost exclusively, at the 15% rate. Are they the exception or the rule for America’s highest earners? According to 2009 data released by the Internal Revenue Service’s Individual Returns Analysis Section, those with income in excess of $1 million are paying, on average, 24.40%. That is actually up from 23.30% in 2008 and with the exception of those making $500,000 – $1,000,000, there is not another income level paying, on average, over 20%. Further, of the 140.50 million tax returns filed for 2009, the average tax rate was 11.40%.
So, what do all of these numbers mean? Generally, the more you make, the more you pay. On a lot of levels, Buffett and Romney are the exception rather than the rule. It is the nature of their business rather than the massive income of their business that allows for favorable tax treatment. What can we learn from this?
From a planning standpoint, because we’re in an environment of hyper-gridlock, don’t expect to see the President’s proposal passed into law. However, if Congress does not change the law, the expiration of the Bush-era tax cuts will boost the maximum tax rate on such investment income to 25 percent in 2013. What tomorrow brings is anybody’s guess. For now, taking advantage of the current rates may make good sense, whether you make $1 million a year or not.