Doing real serious planning for the contingency of President Sanders enacting his program in the first 100 days is probably a little silly. Still, I find it irresistible to think about what tax practice would be like in Bernie Land. Probably comes from reading too much alternate history – Harry Turtledove, S.M Stirling to name a couple. So think about a Sliders episode in which you find yourself in an America where Bernie won in 2008 and managed to get his plan enacted in 2011. In case you are not familiar with Sliders, here is the trailer for the pilot.
I’ll leave it for others to imagine what it will be like in doctors offices and hospitals. I’m focused on tax practice. For youngsters like Joe Kristan and Tony Nitti, it might seem that we have entered a brave new world or more likely a dystopian nightmare, but for older folks like me and somebody, like Robert Flach, the Wandering Tax Pro, there will be an eerie familiarity.
The Butcher, The Baker And The Candlestick Maker
For folks making less than $250,000, things might not be very different, maybe even a little simpler. They are mostly not affected by the limit on the tax benefit of itemized deduction and don’t have to worry about the alternative minimum tax anymore. So people making in the high five or low six figures who live in high tax states, pay heavy property taxes or have a whole passel of kids might find that their federal income tax is somewhat lower. They will have to pay 2.2% for health care and will have 0.2% withheld to fund paid family leave.
Employers will be paying 6.2% for health care, which gets a little interesting. An employer already providing health care benefits to the bulk of employees might come out ahead. I also have to wonder what will happen with workman’s comp and various forms of liability insurance. When someone is hurt on the job, workman’s comp is about more than the medical bills, but they are a big part of it. Regardless, you have to wonder if the 6.2% and possibly the $15 per hour minimum wage is going to make for more independent contractors.
For the self-employed the 8.4% (I assume the employer share will be paid by the self-employed) for health care and 15.3% for self-employment tax from dollar one will be much more significant than the income tax. Chances are they are not behind unless they were sneaking by without health insurance. Over $118,500, the SE rate drops to 2.9% as in our world.
Bernie has said that he is all for the middle class and if we define the middle class as people earning in the low six figures, his system delivers. Including payroll taxes, they face a lower marginal rate than those in the high five figures and continue to get full benefit of their itemized deductions.
Doctors, Lawyers and Indian Chiefs
Well maybe Indian chiefs not so much, what with tribal sovereignty and all that, but we’re talking here about people making from $250,000 to $2,000,000. I know there are plenty of doctors and lawyers who make less than that and plenty of people from other endeavors who get into that character. Even some CPAs make it there, but outside the Big 4, it is more the ones that are good at playing golf and sipping single malt scotch, than the ones who are good at tax research and getting returns out.
Regardless, those are the type of people who have made up the bulk of my clients over my career, so I’m thinking about how they are faring in Bernie Land. He is getting more in income tax from them, but not really that much more. For a married couple, our system calls for 33% on amounts over $231,450, 35% over $413,350 the top bracket of 39.6% kicks in at $466,950. In Bernie Land, it is 37% for $250,000 to $500,000 and 43% from $500,000 to $2,000,000.
In addition, the benefit of itemized deductions is limited to 28%, but there is no phase-out of personal exemptions, carve-back of itemized deductions or alternative minimum tax. For people living in high tax states, it might not be that much of a difference. The people who it will really hurt are those who are the most charitable.
So income taxes are higher, but really not that much higher. What is really hurting these people is the health care tax and FICA being switched back on at $250,000. Self-employed or business owners, which many among the service professionals will be, will, by my rough computation be facing a marginal rate of about 57% which will tip over 60% when they cross over $500,000 (I’m assuming half FICA and the 6.2% employer health care are deductible for income tax purposes).
It happens that there is a technique currently available that might allow many people to beat most of that. I discuss it in one of my all time most popular posts – S Corporation SE Avoidance Still A Solid Strategy. If you run your business as an S corporation and cap your salary at $250,000, you beat the lions share of the FICA and health care tax. Of course, maybe they’ll catch onto that. And be sure not to run for President, if you do that, Newt Gingrich caught a lot of grief about using that technique.
Rich Man – Back To The Early Eighties?
In Bernie Land, a 48% rate kicks in over $2,000,000 and 52% over $10,000,000. I think the latter is a sop to Bernie’s promise that somebody would be over 50%. This is a better deal than we had in 1983 when the 50% rate kicked in at $109,600 (the equivalent of about $260,000). What is not like the eighties is that there is no favorable rate for long-term capital gains. Also, legitimate tax shelters were pretty well killed by the Tax Reform Act of 1986. You can be sure that there will be people out selling shelters in this environment. It will be interesting to see how many of them work.
What is most intriguing though is that the top corporate rate remains at 35%. And this is the really odd thing about the plan. Bernie has been talking about taking on the billionaires, but this plan is not really touching some of them at least while they are alive. Warren Buffet and Mark Zuckerberg take low salaries. Of course, they have to pay full rate when they liquidate their low basis stock and Warren can feel virtuous about now paying an income tax rate greater than his secretary, but the great growth in the net worth of the likes of Bill Gates, Warren Buffett, Mark Zuckerberg and the Koch brothers comes from unrealized appreciation. If Bernie really wanted to go after them, he would need a wealth tax.
It strikes me that the people hit hardest by Bernie’s plan would be those with very high income who don’t want to live relatively modest lifestyles. People in that category will be going back to C corporations, which is what brings up the eerie familiarity. Of course, some of the lifestyle will be buried in the C corporation – the jet, the corporate retreat – stuff like that. That gets nerve-wracking, because when those type of corporate deductions are disallowed, there is also a deemed dividend, so they end up being taxed at over 80%. Ouch! But people who live relatively modestly will be able to accumulate and reinvest inside their C corporations. They will need a hefty second to die policy in an irrevocable life insurance trust to pay the estate taxes though.
Take Me Out To The Ball Game
The likely shift to C corporations can best be illustrated when you consider how much you have to earn to go to a Red Sox game. If you can plausibly run it as an entertainment cost through a C corporation, it is 50% deductible. Let’s ignore state income taxes to keep things simple. We want box seats near third base when the Yankees are in town. You and your best business buddy take turns paying for the tickets which, for the two of you, cost $360. Throw in parking a couple of beers and pre and post game stuff. Let’s call it $500. Your C corp has to earn $606 to pay for that. For your S corp, if you are making over $2 million, it would be $658. If you and your best baseball buddy are just people earning really big salaries you have to earn over a thousand bucks to see the game. A thousand bucks for your night at Fenway! Holy _____. What if the Yankees win? You’ll want to go shoot yourself.
About That Capital Gain Thing
My evidence is of course anecdotal, but one thing I have noted over the years is that many people with healthy incomes do not have much in the way of investable assets outside their retirement plans. Many of those that do in Bernie Land will assiduously seek to shelter their investment returns. I’m thinking annuities and life insurance might get a tremendous boost, particularly with all that income that might be accumulating inside C corporations.
How about an irrevocable trust borrowing from your C corporation to buy a second to die life insurance policy with you using annual exclusion gifts to pay the interest?
Maybe Bernie Is Not All That Radical
Some of the Republican tax plans seem to want to send us to a libertarian brave new world. It actually might not be so bad. I really don’t know. Sometimes I’m reminded some lines from the Chad Mitchell Trio song Barry’s Boys
“We’re the bright young men who want to go back to 1910” “Social without security” and perhaps most oddly “A government like Grand Mama’s”. You might say that Bernie’s millennial boys and girls are also looking for a Government like grand mama’s and are also looking to go back 50 years and reboot.
Late in 2010, Alexander Cockburn wrote:
The prime constant factor in American politics across the past six decades has been a counterattack by the rich against the social reforms of the 1930s.
It is really sad that we don’t have Cockburn, who died in 2012, to comment on the whole Feeling the Bern phenomenon. In a 2009 column Cockburn referred to Sanders as the US Senate’s “parlour populist”. When Sanders has two words and those two words are not “Koch brothers” or Pope Francis, they are “middle class”, which certainly, by sixties standards, indicates that he is hardly being radical.
I Still Think Bernie Land Is Like The Early Eighties
I had a bit of a twitter exchange with another elderly CPA who was offended by my comparing Sander’s plan to the regime we had in the early eighties. He had a point because there were favorable capital gains rate and it was pretty easy to find legitimate tax shelters that would defer ordinary income and convert it to capital gains.
His point was a good one, but not that good. My early career was built around low-income housing projects which involved a not for profit sponsor, a HUD or MHFA mortgage, rent subsidies, 50 to 300 single mothers or senior citizens and 15 dentists who thought they were getting free real estate because the two for one write-off meant they were paying for their partnership interests with money they would have paid in taxes. They were supposed to take their tax savings and invest them in tax-exempt bonds, although they mostly forgot to do that.
Regardless, many people did not have that much in the way of capital gains and most were afraid of the shelters, probably with good reason, so for that type of person the Sanders tax regime will be a lot like the early eighties, which were actually alright times for the middle class, whoever they are.
In Case You Think I Am Evil
Some of my commentary on how high-income people might deal with a Sanders style tax system has made people think I’m altogether wicked. My defense is a statement by Learned Hand, which became something of a mantra for my industry in the eighties.
Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.
The reason I got into this line of work is because you have to do something to feed your family, but I also think poor guidance in high school may have been a factor.