Often it is assumed that if you have a good CPA who does your taxes, you are paying the least amount of taxes that you legally can. What I always stress is that there is a huge difference between doing a tax return and doing proactive tax reduction strategies.
Proactive tax reduction strategies for successful individuals is not about “pushing the envelope,” but rather, understanding the fundamentals and working with that.
So President Obama must be paying the least amount of taxes possible, as he has access to such talented people, right? Wrong. Even without a thorough analysis, we see there are some huge ways to reduce what the Obamas are paying in taxes. Before we start, here are a few key points that we need to know in reviewing his returns.
• 2011 Total Income: $844,585
• 2011 Taxable Income: $496,376 (taxable income after deductions)
• Tax Paid: $156,094
- Alternate Minimum Tax: he paid $12,491 in additional taxes due to the AMT, which reduces or eliminates his ability to deduct certain things that are generally tax-deductible. This is included in the $156,094
• Average Federal Tax Rate: 20.5%
• Marginal Tax Rate (35% federal + 5% Illinois tax) = 40%
- 2013 Marginal Tax rates with repeal of the Bush tax cuts
• 39.6% federal + 5% Illinois= 44.6%
• “Obamacare” Income Surcharge
- Earned income: 44.6% + .9%= 45.6% (earned income above $200,000 for single and $250,000 for families)
- Investment: 44.6% + 3.8% = 48.4% (Investment income additional tax above $200,000 on single & $250,000 for families of AGI)
The marginal tax rate is the rate that they get taxed on at every additional dollar of income that he earns. In 2013, if his wages increase, he loses 45.6% of every additional dollar of income earned. If his investment income increases, he loses 48.4% of every investment dollar (excluding capital gains which would be 28.8% (20% federal, 3.8% surcharge, 5% Illinois)).
So how can we help this family legally reduce the amount of income taxes payable, so that they can enjoy themselves more and save for their future? This analysis focuses only on the 2011 income; however, all things being equal, in 2013, they can expect to pay substantially more in taxes. Here are a few things that I see.
1. Taxable Interest: The Obamas received $10,694 in taxable interest (US Treasurys), which tells me that probably have around $2 million in taxable-interest-bearing investments. Taxable interest in 2011 gets taxed at his marginal tax rate of 35%, so this interest cost him $3,742 in taxes. US Treasury bonds are exempt from state taxes but not federal. Why not municipal bonds, Mr. President? That gives you tax-free income on both a state and federal level— while helping our communities!
2. Qualified Dividend Income & Capital Gains: None! Stock dividends which are considered “Qualified” dividends offer a nice dividend rate that gets taxed at capital gains rates (currently 15%) vs. taxable income interest that is taxed at more than 2x the rate (35%). The S&P 500 currently have a dividend rate around 2%, which is similar to what 10-year Treasurys pay, but we have upside market potential as well. I am not sure of his stock exposure based on his returns, but dividend-paying stocks are an excellent option if he is in the stock market.
3. Retirement Plans: I did see that I think Michelle did a $49,000 SEP contribution on her self-employed income. They should review alternative plan designs to see if a defined benefit plan (pension) would work out better. A defined benefit plan could potentially double her deduction and this is a viable option, as long as she sees that the income is stable for at least a few years.
4. Alternative Minimum Tax: it is possible, especially if you are self-employed, to plan around the AMT. This can be done by not taking income in the year and accelerating expenses. This cost him over $12,000 in 2011. We should at least see if this is an option.
5. Refund: they received a $24,515 refund. Why would you ever give the federal government a $24K, zero-percent-interest loan. Do some proactive planning and control your money!
6. Charity: the Obamas gave over $172,138 in charitable contributions in 2011, all in cash. I applauded their efforts but cash is probably the worst thing that you can give to charity, as it is so inefficient. So this is how it worked for them:
a. Taxable Income in a 40% marginal tax bracket. They needed to earn $286,896 in income, to end up with $172,138 after taxes, to make the contribution that gets you back $68,855. Not very efficient. Few better ideas.
i. Why not have your fees go directly to non-profit groups instead of taking it as taxable income. While it will not show up on a tax return as income or a deduction, it accomplishes the same thing in a more tax-efficient manner.
ii. Why not use appreciated securities to donate, where you do not have to pay the capital gains on the securities. This can save you up to 20% or more (in 2013) depending on the gains.
iii. Either they can give much more for the same cost to them or they can give the same amount as they were, only making it cost them less.
7. Capital Loss Carry-Forward: they have $119,527 in loss carry forwards, meaning that this can be used to offset future gains up to $119,527 or they can deduct $3,000 against ordinary income. Good news! As long as they live 40 years and have no gains, they will outlive the deduction!
So I am seeing some substantial ideas here that can be as much as $100,000 in tax savings annually. This is really important to you, Mr. Obama, mainly because this is not a one-time deal only. These tax strategies can be used to benefit you and your family every year. This will allow you to give more to your family, to the community, or if you like, you can give it back to the government as a symbolic representation of your ideology!
Our job is not to break tax laws, but rather make sure that we use everything within our power to pay the least amount of money possible for our clients. If you waited to see your CPA after the year end, I am fairly confident that you also paid more in taxes then you needed to, as the “game” was over and their ability to be proactive was eliminated. Remember, everyone has to pay their fair share in taxes, but nobody said that you gotta leave a tip!
Jerry Lynch is president of JFL Consulting and has more than 25 years in insurance and financial planning. He has been a regular guest on CNBC, WABC and does regular articles for the Star Ledger. He can be reached at firstname.lastname@example.org.
Jerry Lynch is a representative of Comprehensive Capital Management, Inc., an SEC registered investment adviser through which such representative provides investment advisory services, with principal offices at 2001 Route 46, Suite 506, Parsippany, NJ 07054 (Phone 800-637-3211). Jerry Lynch may also provide commission based securities sales through Comprehensive Asset Management and Servicing, Inc., an SEC registered and FINRA member broker-dealer, with principal offices also located at 2001 Route 46, Suite 506, Parsippany, NJ 07054 (Phone 800-637-3211). JFL Consulting is a trade name, it is not a registered investment adviser. All questions should be directed to Ron Rollins, Chief Compliance Officer.