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Sunday, January 20, 2008

A Middle Class Legacy of Rich Tax Cuts

It is said that “money is the No. 1 fighting word in America”; therefore, it shouldn’t come as any surprise that Americans wrote more letters to their congressional representatives about money in 1969 than about the Vietnam War. It came about after a popular upheaval, decrying how “155 individual taxpayers with incomes above $200,000 paid no federal income tax on their 1967 tax returns” (Burman et al. 2002). The 155 individual taxpayers cited by Joseph Barr, who was Secretary of the Treasury under Lyndon Johnson from 1968 to 1969, included 20 millionaires!

Thus the Tax Reform Act of 1969 was introduced, and, after 18 major legislative changes, the 10% add-on minimum income tax evolved into what is commonly known today as the Alternative Minimum Tax (AMT). AMT now encompasses a complex set of rules that assesses a minimum tax rate of either 26% or 28% on Alternative Minimum Taxable Income (AMTI) and tacks it on the regular tax owed, currently affecting individual taxpayers with an Adjusted Gross Income even lower than $50,000!

For more information, visit our website: http://www.gbctax.com/income_tax_services.asp
Comparatively, when the minimum tax was first introduced in 1969, the 10% additional tax was assessed on incomes exceeding $200,000, which by most calculations, equals more than $1.1 million in 2007 – after adjusting for inflation; therefore, AMT, though originally aimed at the very rich who, through various loopholes in the tax system, had been able to purchase their way into paying no federal income tax, has now become a major source of government revenue assessed primarily on middle-income households. While there has been a 160% increase in the minimum tax rate since 1969, income subject to the tax has decreased by 95% in value. It's what is popularly described as the "AMT mistake": the government's failure to adjust the minimum tax for inflation.

Analysts generally agree that a second and more important mistake behind the AMT’s recent expansion is related to President Bush’s 2001 and 2003 tax cuts, which, ironically, reduced regular income tax without changing the way AMT is calculated, thereby giving the top 1% income earners in the US the most benefit. In other words, by reducing regular tax rates, the 2001 and 2003 tax cuts effectively reduced the income tax paid by households whose regular tax rates are higher than AMT rates. More than 90% of households that reported Adjusted Gross Income (AGI) in excess of $500,000 evaded paying AMT because their regular tax rates are higher than AMT rates, and they are the primary beneficiaries of the 2001 and 2003 tax cuts. Contrastingly, over 90% of upper-middle and middle income households whose AMT is calculated after taking the AMT exemption ($44,350 for single filers, $66,250 MFJ or widowers, and $33,125 MFS), disallowing credits for dependents, medical expenses, state and local taxes, and and other itemized deductions, made up the deficit in the government’s tax revenue created by the reduction in the regular tax rate.

By the numbers, in 2004 (latest complete data on AMT available from the IRS post the 2001 and 2003 cuts), of 132,226,042 tax returns sampled, 3,096,300 were subject to AMT, divided by AGI as follows: 4,714 had no AGI (0.15%); 5,809 had AGIs under $25,000 (0.18%); 14,821 had AGIs between $25,000 and under $50,000 (0.47%); 244,461 had AGIs between $50,000 and under $100,000 (7.9%); 1,095,242 had AGIs between $100,000 and under $200,000 (35.4%); 1,529,159 had AGIs between $200,000 and under $500,000 (49.4%); 149,042 had AGIs between $500,000 and under $1 million (4.8%); and 53,052 had AGIs of $1 million and over (1.7%)!

Naturally, no discussion about tax can be totally devoid of politics. The so-called AMT mistake has been a big boon for the federal government’s coffers. Increases in the AMT rate notwithstanding, which until recently had popularly been viewed as an equalizing tax on the very rich, Republican and Democratic administrations alike have reaped billions in increased revenues without appearing to raise income taxes. However, under assumptions that existing tax credits, like the child credit, would remain in place, “by 2013, the AMT alone would actually raise more revenue than the regular tax alone.”

As in 1969, the United States was at war in 2007. Unlike 1969, there was relatively no outcry when congress failed to “fix” the AMT till the last minute, and, unlike 1969, money does not appear like the no. 1 fighting word in America, as there seems to be little repercussions over a tax that has outlived its intended purpose. If the federal government's intent had been to raise the income tax on middle-income households, then compounding the burden in complicated and costly rules does not constitute a sound economic policy; but the American people's relative complacency about the way AMT has apparently been exploited to effectively fund upper-income households' tax cuts points to uncharacteristic apathy towards the government's ineptitude, deep-rooted corruption, cynicism, or subservience to a combination of interests that embody these and other uncomplimentary traits.

Recent criticisms of the present tax system range from those who lament their smaller proportionate tax, in comparison to taxpayers earning substantially less, to those who think that they are paying too much tax, irrespective of comparative earnings. Ideas for fixing the US tax system range from implementing a complete overhaul of the present tax code to those who aim to abolish the income tax system.

Proposing an eleventh hour one-year fix that shields millions of Americans from an average $2,000 tax assessment, congress’ so-called “fix”, however, has not changed the trend established since 1969: increasing the AMT tax rate while decreasing the AGI subject to the tax. No longer the equalizing tax on the rich, this complex set of rules determining how to calculate AMT, requiring middle-income Americans to tabulate two calculations before totaling their tax liabilities, has now paid for the tax cut upper-income Americans have received since 2001. There are many proposals for fixing the AMT mistake and for relieving the federal government from its subsequent addiction to the revenue; but, unless the tax is either abolished or indexed to affect the taxpayers originally targeted by its introduction in the tax code, middle income taxpayers will continue to tote a disproportionate burden of a questionable political agenda.

To learn more visit our website:http://www.gbctax.com/income_tax_services.asp 

Friday, December 7, 2007

Retiring 401(k) Plan Fees

In all business transactions,
pay for performance.
Pity the Wall Street Banker! Earlier this month, I heard that their bonuses were expected to fall $200,000 on average, from $2 million. After all, by many accounts, this year’s equity market hasn’t performed as expected. But then I read about the latest record-setting Wall Street bonus payout.

Ask five economists about the source of this Wall Street bounty, and, all things being equal, they might give the same answer, all things being considered, each with 25 different qualifications, all things being possible.

One conclusion many economists might propose, all things being bright and beautiful, is that Wall Street bonuses are not necessarily tied to performance. (Duh?) In fact, some economists might find a correlation between the size of an average banker’s portfolio and the average payout. So without begrudging those hard working folks at Wall Street the trillions of pennies they scrape from the millions of average investors like me, here’s a rub: no matter how the financial market performs, Wall Street bankers seem assured of receiving record bonuses every year. Whereas recipients of Wall Street’s annual windfall have to worry about ways to double that income next year, the average mortgage-paying, life-loving, family-supporting, global-rationing guy like me is thinking – or should be thinking – about ways to accumulate enough in retirement assets to simply live comfortably during those looming forgetful years. A pretend-economist like me, therefore, might not be faulted for assuming that a major chunk of the average household’s wealth is tied to retirement savings like a 401(k).

In a November 5, 2007, article published on Bloomberg.com, (Time for Employers to Cut Cord to 401(k) Plans), John F. Wasik cites a troubling calculation from the US Government Accountability Office, stating “that paying an additional 1 percent in 401(k) fees will reduce your retirement fund total by 17 percent after 20 years and 30 percent over 30 years.” In other words, those pennies scraped by Wall Street bankers will make a substantial impact not only on those record-setting Wall Street bonuses but also, in reverse, on the average retirement savings account. Those fees cited by Wasik, however, are not limited to 401(k) plans; but, in the interest of limiting the number of words in my first entry on this blog to .1% of an average Wall Street bonus, I will focus on 401(k) plans.

If a household’s goal is to accumulate $1 million in retirement savings over the course of two married careers, something that is not only possible but also recommended for the average middle income household with two working parents, then 1% percent in 401(k) fees, according to US GAO quoted by Wasik, will shave off $170,000 over 20 years! $300,000 over 30 years! What’s more troubling, according to US GAO, 83% of 401(k) plan participants don’t even know how much in fees and expenses they are paying for their 401(k) plan, and many investment advisors are not helping the situation. In fact, short of full disclosure, some investment advisors have a conflict of interest vis-à-vis their investment recommendations.

Looking to the regulatory agencies hasn’t paid dividends either. While the US Securities and Exchange Commission has instituted rules for using “plain English” in writing disclosure documents in financial statements, facilitating the ordinary investors’ understanding of a company’s financial health, understanding the costs of a 401k or any other retirement plan, it seems, require the help of a consultant like Jeb Graham. Graham correctly distinguishes between hard dollar and soft dollar costs, and it is through the so-called soft dollar costs that an average contributor to an employee retirement account can lose up to 30% of 401(k) value over 30 years. It is not hard to accumulate 1% in hidden fees – fees that are not disclosed in prospectuses – and even though the issue has been identified, raising the ire of an increasingly untrusting public, the problem is compounded, in my experience, by plan providers who have lied to their customers about those fees.

In deference to Graham, pin-pointing soft dollar costs does not require a consultation. Stephen J. Lansing describes 401k costs in plain English. Though Lansing underestimates the basis points charged by plan providers, even Lansing’s calculation of soft dollar fees amount to more than 1%: finder fees starting at .25%, 12b-1 fees starting at .25%, and sub-transfer agent fees up to .65%.

But rather than cutting the “cord to 401(k) plans”, as Wasik suggests, employers should seek a plan that adopts Wasik’s recommendations, which are also summarized interrogatively by the 401k help center dot com:

· Give plan participants control
· Eliminate conflicts of interest
· Provide access to all investments
· Pay only hard dollar costs to plan providers (no finder, no commission, and no asset-based fees)
· And shop for the best value

And, most importantly in all business transactions: pay for performance.

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