Political Rhetoric vs Facts
I think it’s quite fair to say that this year’s election is more fit for reality television than the oval office; however, no matter your party or distaste for either candidate, one of them will be the President of the United States in January 2017. I have been asked on numerous occasions, who I think will win or what I think will happen if so-and-so wins. At this point, it’s mostly speculation. Our media—which includes financial journalism—is consumed with peddling a continuous stream of fear and disillusionment; so it’s no doubt that there will be quite a bit of fear mongering on both sides for the days ahead.
My goal in writing this piece is not to be political, but dare I say, objective, when it comes to some of the policy positions being presented by our 2 candidates. Before I begin this discussion, I want each of you to know that Presidents are not kings. While we have seen some unsavory methods used by the current administration to circumvent Congress, almost all major policy changes that impact taxes, healthcare, the military, and entitlement programs must go through Congress. I hope that you will keep this in mind—for a candidate’s proposals during election season and the actual legislation they sign can often be quite different (as if you didn’t know this already).
Now, let’s talk TAXES.
I have spent several hours over the last 2 weeks going through each candidate’s website and searching online for published tax policy positions for both Clinton and Trump. I look at tax policy because I genuinely believe that we are way overdue for income tax overhaul in this country, and it’s something that directly impacts almost 100% of our clients in some way. As you might expect from the 2 respective parties, Clinton is staying with the “rich must pay their fair share” stance, which is a staple of the Democrats, while Trump is proposing an across the board tax cut.
If you’ve watched the debates (if you can call them debates), Clinton repeatedly tells the listeners that Trump’s plan will give significant tax breaks to the top 1% in our country, and she presents it in such a way that he’s simply trying to feather the nest of the elites. The truth is that it’s hard to create any type of tax cut in this country that doesn’t disproportionately help the super wealthy. Here’s an oversimplified example for educational purposes only:
If your tax bill for 2015 was $5000 to the Federal government, and you received a 2% reduction in that figure next year, you would owe $4900.
If Mr. Rich owed $500,000 to the Federal government, and he received the same 2% reduction, he would owe $490,000.
Mr. Rich received the same proportionate decrease as you did, but the media headline would read:
“Rich people get 100 times more tax relief than the middle class.”
It sounds so terrible, but it’s really just math. I had a conversation with one of my friends the other day, and I reminded him that our government raises revenue in 2 primary ways: they borrow it or they get it from taxes. Since we continue to spend more than we raise, we are forced to finance the shortfall by going deeper and deeper into debt. If we all agree that we cannot continue to go deeper into debt, what option does that leave Washington but to raise taxes?
In addition to reducing the federal rates, Trump also proposes a significant increase in the standard deduction for joint filers from $12,600 to $30,000 and eliminating all personal exemptions. Before you cry foul because of the loss of exemptions for children, he proposes an above-the-line deduction for childcare expenses up to the state average for the age of the child. Since I have 2 small children and pay a significant sum for childcare each month, I’m completely biased in favor of this proposal (full disclosure). Where Trump’s plan could face resistance, however, is that in its current form, he proposes that the head of household status be repealed. This could create some undue hardship for single parent homes. My belief would be that, if elected, this would be reformed in the final bill.
Of course, there are other nuances to his tax plan, but for the sake of time, I won’t discuss them in this piece. Next up, we have Hillary Clinton’s proposals when it comes to taxes. There are some significant differences between her and Trump, starting with the additional taxes she wants to add. For ultra high income earners, who have over 5 million in income each year, she wants to add a 4% surcharge onto their taxes. Moreover, she wants households with incomes between 1 million and 2 million to have a minimum rate of 30%. Lastly, she wants to limit deductions and exclusions (except for charitable contributions). But, in my view, the biggest shift in her tax policy is the treatment of capital gains. Right now, the maximum long-term capital gains rate in our country is 23.8% (this is the 20% rate with the additional 3.8% tax from Obamacare which kicks in for households with adjusted gross incomes in excess of $250k.)
Clinton proposes a schedule for capital gains instead of the current system we have now which defines any property held for more than 12 months to be long-term capital gain/loss property. Property held less than 12 months is considered short-term capital gain/loss property, and it is taxed just like ordinary income. For Clinton’s plan, she proposes that property be held for at least 2 years before it can be considered long-term capital gain property. This essentially doubles the holding period. Next, the schedule doesn’t simply revert to one lower rate. Instead, in declines over 4 year period so that property must be held for 6+ years to qualify for the lowest capital gain tax rate.
Here’s where it gets very interesting—and where I believe a stealth tax is being proposed by the Clinton plan:
Second, Clinton would limit the exemption of a decedent’s unrealized capital gains when assets are transferred at death. Under current law, when a person inherits an asset, the basis or deemed purchase price of the asset is reset to its current market value—so the decedent’s unrealized capital gain on the asset is never taxed. For example, if an asset purchased for $10 is worth $100 when the owner dies and the heir subsequently sells it for $150, the capital gain tax applies only to the $50 increase in value after the inheritance. The $90 gain accrued by the decedent is never subject to tax. Clinton would end this so-called “step-up” in basis—the transfer at death would be considered a realization event and the estate would pay tax on the unrealized gain ($90 in the example) accrued during the decedent’s lifetime. The proposal would exempt a moderate amount of capital gainsas well as most gains on owner-occupied housing and some small business gains.*
*This paragraph is copied verbatim from the language used in policy analysis on the Tax Policy Center’s website.
So, consider the potential implications of this new tax law. Not only could families lose the “step-up” in basis, but the estate could be forced to pay taxes on the gains realized. Moreover, consider the schedule being proposed. If the property had been held for only a couple of years, an estate or its beneficiaries could be forced into paying even higher taxes. Now… you may be thinking that this doesn’t apply to regular folks. Consider this potential scenario:
Mom and Pop purchase their dream home down at the beach, and they got a steal for the property at $400,000. They don’t make any improvements to the property other than personalizing it a little. After a period of 3 years, Mom and Pop get into a horrible car accident and pass away, leaving their assets to their 2 kids. Because the area where the beach house has been booming, the new value of the home is $475,000. This $75,000 would now be considered realized gain, and the estate would have to pay the tax!
In a stark contrast, Trump’s plan calls for an elimination of the federal estate, gift, and generation-skipping transfer taxes. In a similar vein to Clinton’s plan, he does advocate for taxing capital gains at death—with an exemption of 5 million for singles and 10 million for married couples.
As you can imagine, there are many, many additional proposals to the tax plans. I have just highlighted some of the areas that I personally find most impactful and interesting to my own life and the lives of many of our clients. Before I go, let’s explore a very basic example of how these various plans would play out for a retired couple.
Let’s take Mom and Pop again—both 67 years young. They’ve just retired down to the beach. Their life is relatively simple: no mortgage or debts of any kind and no extravagant lifestyle. Mom and Pop have the following:
850,000 in Pop’s IRA account
25,000 in Checking earning .01% interest
22,000/year Pop’s Social Security
18,000/year Mom’s Social Security
15,000/year Mom Pension
18,000/year Pop Pension
80,000 in a CD paying 1.5% annual interest (non qualified)
Their income breaks down as follows:
1200/year –interest income (CD)
40/000/year — in social security but only 34,000/year —taxable
15,000/year — Mom’s pension
18,000/year — Pop Pension
28,000/year — IRA withdrawal for lifestyle wants/desires
Total Adjusted Gross Income for the year = $96,200
Under the Clinton plan:
($12,600) standard deduction
($2500) standard deduction for both being age 65+
($8100) personal exemption
$73,000 Adjusted Gross Income (still in the 15% tax bracket)
Under the Trump plan
($30,000) standard deduction
$66,200 Adjusted Gross Income (this would put them in the 12% bracket)
Again, this is an oversimplified example, and every single tax scenario is unique. To illustrate my point, each individual state has its own state income tax system that plays a role in your overall tax picture. Different counties and cities may have their own schedule of municipal taxes that must be paid. My goal here is to simply show how the two federal income tax plans can be very different for normal, everyday people…not just the millionaires as is often discussed. It’s unlikely that either plan will survive in its current form because both of them have significant flaws. Trump’s plan does simplify the tax code, but it is possible that there is too much reliance on economic growth to make up for revenue shortfalls. Clinton’s plan is just more taxes, plain and simple…but it’s more taxes for everyone in its current form.
There are many other issues that will be discussed in the upcoming weeks…hopefully, some of them will actually have some substance. The issue of taxes, however, is one that I find very relevant for this year’s election and the years ahead. Hopefully, you will evaluate your own situation when it comes to taxes, investments, and estate planning and consider making sure your plan is adaptable enough to weather whatever lies ahead. If you don’t think it is, or if you’d like another opinion, please don’t hesitate to reach out to our team.
Vertex Capital Advisors, LLC. does not offer legal or tax advice. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. The information presented does not constitute financial, legal or tax advice and should be used for informational purposes only. Since individual circumstances vary, you should consult your legal, tax, or financial advisors for specific information.