Presidential Debates and Income Taxation - What is Fair and What is Strategic?

No matter how you slice and dice it, it is difficult to swallow when you see Warren Buffett's or Mitt Romney's taxes. You may think, how did they get their tax rates down to 15%? The challenge for many of us is not the tax rates, but the totality of taxes or the level of income we receive. As I have taken tax law classes, MBA courses, and a tax preparation course, as well as taught on the subject of taxes, I know the analysis of progressive tax rates can be deceiving. If you buy and sell something for a long-term capital gain, you can receive a low rate of 15%. If you receive dividends, you may be able to capture a low rate of 15%. If you can find bonds that pay tax free, you may also receive similarly low rates on passive income. If you use a tax deferred vehicle, you can also defer taxes until withdrawal - examples include 401Ks, IRAs, annuities and such. Also, don't forget that you can avoid state income tax if you live in one of these 7 wonderful states: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. 41 states impose income taxes. New Hampshire and Tennessee apply it only to income from interest and dividends. Some states actually limit the taxes on certain governmental retirees or military retirees income. Various states exclude Social Security benefits from state income taxes. 27 states and the District of Columbia have income taxes but provide a full exclusion for Social Security benefits: Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin. All states are prohibited from taxing benefits of U.S. military retirees if they exempt the pensions of state and local government retirees. Various other retirement exemptions apply to the value of property or the type of income. For example, all citizens of some states may have a tax exemption for the first $50,000 of their property's value. Numerous states allow special tax benefits to military retirees. Some states that - with conditions - do not tax retired military pay include: Alabama, Alaska, Florida, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, , Ohio, Pennsylvania, South Dakota, Tennessee, Texas, Washington, Wisconsin and Wyoming. Mississippi, Missouri, Kentucky, Oregon, and North Carolina also have specific conditions that apply. Many states still have an estate tax that is added on top of the federal estate tax. The following states impose an estate tax: Connecticut, Delaware, District of Columbia, Hawaii, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Ohio, Oregon, Rhode Island, Vermont, and Washington. So, the question of the day is: how do the super-rich avoid the taxes that most of us pay? While they may pay some of "working class" taxes, they avoid doing so on most of their income. An example would be, how can Warren Buffett or Mitt Romney avoid self-employment taxes? Well, the law allows business owners to pay self employment on income, but most of the other income may be treated as pass-through, long-term gains or unconsidered self-employment taxes such as interest, dividends, or sale of assets. In the end, the middle class and upper middle class is getting hit with the bulk of the "nickel and dime" taxes in this country. Think about the taxes on income, automobiles, gasoline, utilities, electricity, water, phone, flight, cellular, internet cable, luxury, alcohol, tobacco, and so forth. The TOTALITY of these TAXES may put the the average taxpayer in a 50% tax bracket, with a $60,000-100,0000 paid per year. Remember, the W-2 employee is the least likely to have the ability to deduct business-related expenses as per our tax codes. In the end, high paid wage-earners such as doctors, lawyers, government employees, pilots, and CPAs probably pay the highest tax rates on earned income. In contrast, Buffett - who has invested billions for his clients and himself - owes no taxes on typical investments until he sells them. So there you go, viola! No taxes paid on long-term holdings until you sell. With that being said, if Buffett owns a company, that company or its employees will pay taxes on all money that comes in and goes out. In theory, corporate welfare is a myth in the sense that even if a company pays zero taxes at the corporate rate, its employees all paid taxes. Tax breaks should be everyone, as I remember reading in Russell Simmons' recent success book. He claimed that he felt like he should have paid more taxes after the sale of a company. The current capital gains rate allowed him to only pay a low rate of 15-20% tax on the sale of the large company. He claims to have had an 'ah-ha' moment and paid all of his employees who helped build the company an extra bonus as a result of the tax relief. In my humble opinion, this was the original intent of the lower tax rates to begin with. Everybody should can benefit. You can theorize that lower long-term rates and lower dividend rates allow communities to benefit from more local income and for retirees to survive on their pensions or investments. Overall, when taxes are too high, investment is reduced. This is probably why people like Buffett are long-term holders. They are trying to avoid the punishment for having sales that are too large. It could be the case that Romney just has good tax advisors and that there really is no need to pay more than the law requires, as per numerous US Supreme Court cases. We all remember John Edwards. He saved $600,000 in taxes by forming an S corporation. Edwards earned $26.9 million as a lawyer in 1995, and he minimized Medicare taxes by creating his own

. Edwards paid himself a salary of $360,000 each year for four years and then he had the S corporation pay him the rest of the income in dividends. Salary was subject to Medicare taxation at a rate of 2.9%; however, dividends escape Medicare taxation. There is no wage base for Medicare, while all wages or salaries are subject to the full tax. Social Security does have a wage base, which means wages above the limit are exempt from the Social Security tax. In contrast, President Obama may have a different and much higher tax rate. Most of his income comes from his book sales and from his employment. Book royalties and large government wages are generally taxed at a much higher rate. If you remember, most NBA and NFL stars will attempt to maintain residence in a low income tax state like Texas or Florida; however, the state income tax authorities may show up to tax any players who visit their "higher tax" state to play a game. Some players may earn 1 million dollars per game and 8% of that income is nothing to balk at. Historically, there has been so much wealth created in the last 30 years, it has been amazing. To watch Google and now Facebook go public is truly fantastic. I remember back in the 1980s, when people would complain that all of the property or wealth was controlled. However, as new property and wealth is created from thin air, it proves that creativity always trumps materialistic scarcity theory. In closing, I also remember in the 1970s when somebody showed me a list of the Forbes 400 wealthiest people in the U.S. I distinctly recall that the bulk of the people on the list inherited the money or started out wealthy. But in the last 20 years, you now see that the bulk of the wealthiest are self-made. The one thing that changed during this time was the reduction in long-term capital gains rates. Are taxes good or bad? Everyone knows that those who benefit from society must chip in, and that everyone must have some skin in the game. However, at the other extreme is the idea that extremely high taxation is pure economic slavery. Everyone is against slavery on any level. The major question that looms is how to know what is fair. And with that, I will conclude that to the government and politicians are the servants of the customers, "We the People."

George Mentz - All Rights Reserved 2012