What's My Rate? Challenges of Understanding 2013 Federal Taxes

While the American Taxpayer Relief Act of 2012 enacted January 2, 2013 brought permanency to the individual rate structure, the addition of two new taxes for 2013 and varying phase-out levels for certain rules, some high income individuals will be puzzled as to what their tax rate really is.  For example, while a single filer with over $400,000 of taxable income for 2013 reaches the top 39.6% bracket, if their next dollar of income is a capital gain or qualified dividend, it is taxed at 20%.  They would likely also be subject to the new Net Investment Income Tax so it would really be taxed at 23.8%.

For individuals subject to the new Additional Medicare Tax, they will have employment taxes reported on their income tax form. That will be something new for employees.  If they tax their total Form 1040 tax liability divided by their taxable income, they'll get a distorted number because a small portion of their total employment taxes would be included.

I've got more on this question of "what is my rate" in a short article from the AICPA Tax Insider - What's my rate?(12/12/13) - please take a look. What do you think?

C Corp Preference Even Before Possible Rate Reduction?

A Wall Street Journal article published this week - "Small Businesses Puzzle Over Tax Riddle," by Emily Maltby (2/20/13), states that some small business owners are considering converting to C corporation form now.  Today, the top C corp rate is 35% and the top individual tax rate is 39.6% (20% on capital gains; or really 23.8% on capital gains with the Medicare tax).

So, if your sole proprietorship, S corporation or partnership or LLC generates over $400,000 of income, the C corp rates look good. They look even better than the 35% top corporate tax rate because that doesn't kick in until the corporation has over $10 million of income. With $400,000 of income, the C corp is in the 34% bracket with the first $50,000 taxed at 15% and the next $25,000 taxed at 25%.

The WSJ article also refers to a recent WSJ/Vistage International poll of 848 small businesses where 35% said they would consider the C corp form if the corporate rates were reduced from the current top 35%.  Remember that Congressman Camp wants a 25% top rate and President Obama has called for 28% and even lower for advanced manufacturers.

But, there are downsides of the C corporate form, namely double-taxation of income. That is, when the corporation issues a dividend, the shareholder pays tax on that income (which was already taxed to the C corp when earned).

Policy considerations:

• Should all businesses be taxed similarly?
• Why have double taxation for C corporations? (an integrated tax system can be complicated to get to)
• Can/should Congress lower the corporate tax rate while leaving the top rate 39.6% for all other businesses?  While few businesses have income in excess of $400,000 for each individual owner, it is still the possibility of that higher rate that would leave a significant tax discrepancy.
• Is elimination of most tax preferences to get to a 25% corporate tax rate helpful to businesses and the economy?  Preferences that likely would go would be rapid depreciation, expensing research expenditures when incurred and the research tax credit.

What do you think?

Tax rate increases and relevance to revenues and the economy

A March 2012 article in Journal of Economic Literature, by economists Saez, Slemrod, and Giertz: "The Elasticity of Taxable Income," provides an analysis of the economic effect of changes in marginal tax rates. It's a detailed analysis of data across many years.  I'll note two of several statements I found interesting:

1. "A tax system with a narrow base and many deductions and avoidance opportunities is likely to generate high elasticities and hence large efficiency costs. In that context, broadening the tax base and eliminating avoidance opportunities such as to reduce the elasticity is likely to be more efficient and more equitable than altering tax rates within the old system." (pages 4 - 5)
2. "there is compelling evidence of substantial responses of upper income taxpayers to changes in tax rates, at least in the short run. However, in all cases, the response is either due to short-term retiming or income shifting. There is no compelling evidence to date of real responses of upper income taxpayers to changes in tax rates." (page 35)

The second statement and the evidence (and more) from these economists and others should be part of the discussion of tax reform as well as the effect of keeping or not keeping any of the 2001/2003 tax cuts that expire at the end of 2012.

Also, the above should not be too surprising in that revenue estimates of the effect of letting the tax cuts expire or of increasing marginal tax rates, show that revenue is generated rather than lost. For example, see a Joint Committee on Taxation analysis of the effect of increasing marginal rates for various categories of high income individuals that was proposed in H.R. 3200 (111th Congress) (it would impose a surcharge on such individuals).

For more on this topic including several references to other literature on the effect of tax rate changes on behavior and the economy as well as debunking various statements about tax increases or changes, see an April 2012 report by Chye-Ching Huang of the Center for Budget and Policy Priorities - "Recent Studies Find Raising Taxes on High-Income Households Would Not Harm the Economy Policy Should Be Included in Balanced Deficit-Reduction Effort."

What do you think?  Why do we sometimes hear that a tax rate increase, particularly one on capital gains (such as is produced when you sell your stock at a gain) will harm the economy or harm job growth?  Have you seen job creation tied to the current 15% tax rate on capital gains?  Will selling Apple stock at a gain create jobs?

Corporate Tax Under the Microscope

2007 was a year of examining our corporate income tax system and considering alternatives -- but only as a preliminary step to further discussions and debate.

The US combined federal and state corporate tax rate is one of the highest among industrialized countries due to reforms in those countries in the past several years. Many believe that lowering the federal income tax rate on corporations would help make U.S. companies more competitive in the global market. House Ways & Means Committee Chairman Charles Rangel included a corporate rate reduction in his "mother of all tax reform" bills (H.R. 3970) introduced in October 2007. That bill also included some base broadening to help pay for a lower tax rate.

But, there are many issues to consider:

1. Should the analysis only look at the statutory tax rates or the effective tax rate (tax as a percentage of income)? Many U.S. corporations have ETRs below the statutory rate.
2. Corporate tax revenues are already declining. What would be the effect on the budget and economy of lowering tax rates further?
3. Should a rate reduction be offset to make it revenue neutral? Some say no because the rate drop will lead to greater investment and revenue, others (including a recent report by the Congressional Research Service) say yes.
4. Unlike many other countries, a lot of business income in the U.S. is subject to the individual income tax rather than the corporate income tax because we have so many sole proprietorships and flow-through entities. Would corporate reform alone help businesses be more competitive?

For more information and a link to several studies and reports released in 2007, please see Corporate Tax Under the Microscope.