Originally published on Forbes.com Dec 2nd, 2012
I have never gotten over the early eighties. There was this amazing phenomenon. Back then money earned interest. I mean it earned INTEREST. There was a period where prime was 20%. You could get more than 10% on money market accounts. It was somewhat illusory because of inflation, but it could feel real good when you were collecting it. When you were paying it, not so much. Back then how seriously would you have thought about accelerating income in anticipation of an 8 to 9 percent tax rate increase ? You might make a case for it, but it would be pretty marginal. My partner and mentor Bob Charron (One of the C’s in CCR. I wasn’t the R.) used to say “Pay no tax before its time.” The current low interest rate environment changes things a bit, but I still question whether it is enough of a swing to accelerate even though when you crunch the numbers it will come out that way. So who should be thinking about acceleration ?
Warren Buffett Maybe
The alternative to the rate increase being floated has me thinking pretty hard though – a cap on itemized deductions. What deductions ? How much of a cap ? Who knows ? Consider somebody like Warren Buffett who has millions of dollars in charity carryovers. The charitable contributions are of appreciated property so deduction is limited to 30% of adjusted gross income. Whether the cap is $18,000 or $50,000 is immaterial. It’s a rounding error. The only question will be whether charity is included or not. Buffett’s income is effectively 100% capital gains. Given his charity carryover, that gives him an effective marginal rate of 10.5% (70% of 15%).(Just to be clear. I am using adjusted gross income, not taxable income, as the denominator.) If the capital gains rate goes to 20%, his rate moves to 14%. If charity is eliminated his rate then moves to either 15% or 20%. Then there is the 3.8% tax on investment income. That could bring him to 23.8%. That creates as spread of 13.3%. So should Warren Buffett, putting aside that he says he would really like to pay more taxes, sell a boatload of Berkshire Hathaway in the last week of December. Probably not, since it might affect the price. Although he could simultaneously buy shares which he might sell in the future. Also there will never be any gains paid on the stock he holds when he dies. It would seem that if it does not distort the market he might want to sell the shares that will represent his walking around money for the next year or two.
The Waltons For Sure
The most dramatic example would be someone who lives off dividends and makes large cash gifts charity. Their marginal rate would currently be 7.5% (50% of 15%) assuming they live in Florida or some other state without an income tax. Suppose the compromise is that the 39.6% does not kick in till $500,000, itemized deductions are capped at $25,000 (including charity) and dividends go back to ordinary income. From 7.5% to 43.4%. That is impressive. When you throw in that federal taxes are not deductible, you need a very high discount rate to make accelerating unattractive. No wonder Walmart and several other companies are accelerating dividends according to this story. Even if you are not really charitable 15% to 43.4% is an impressive spread.
Who Else ?
It is tempting to wait to see the particulars of whatever deal is crafted, but there really will not be enough time to both plan and execute. Here are a couple of situations where spending some time studying the idea and inquiring as to feasibility might be time well spent in the next week.
Roth Conversion
I have never been that excited about Roth conversions. It always seemed like hitting your head against the wall because it feels so good when you stop. It could be a way to recognize a boat-load of income in 2012 that would create a tax privileged investment for the future. Roth conversions become a lot less exciting when you don’t have the money outside the Roth to pay the tax. Unlike most acceleration methods you can get a mulligan on it when it comes time to file your return.
Got An Old C Corp Kicking Around ?
It really amazes me that you still run into closely held C corporations with appreciated property. If there is not enough active business going on they cannot make an S election and wait out the built-in gain period, since they will be subject to the sting tax and bounced out of their S election after three years. If the corporation does not have earnings and profits, the sting tax does not apply. You get rid of earnings and profits with a dividend. If you have been procrastinating on getting on the road to avoiding double taxation, this might be an opportune time. There are some really ugly stories about people who never got around to it.
Will You Be Accelerating Payments ?
If the deduction cap is part of the deal that may be what you want to do. If charity is included you can make planned charitable contributions to a donor advised fund if you fear that a big donation might burn a hole in somebody’s pocket. You may want to pay real estate taxes and state income taxes in December. Don’t forget about the AMT, though.
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