Wednesday, January 2, 2013

First World Problems: Calculating Taxes Just Got Harder for the 2%

I'm going to coin a new phrase today: the "cash-flow-but-not-asset rich". These are people like the mystery professor who lives in Chicago, earns $455,000 per year, and yet feel like they're not saving as much money as they should, because they feel they "have" to live in a big house in an popular metropolis, send their kids to private school, drive a Lexus and replace it every four years instead of a Subaru and replace it every eight, etc. They're saving appropriately for retirement, but there's not that much money left at the end of each month. Theirs is a world of problems so far beyond first world problems it's hard to express.

The CFBNARs are largely big winners from the fiscal cliff deal. Had Barack Obama gotten his way, these folks would have seen their taxes go up from 35% to 39.6% starting at $125,000 for individuals and $250,000 in income for married couples. Instead those thresholds will be set at $450,000 for married couples and $400,000 (note: this revives the "marriage penalty" which will surely be resolved by setting the married couple threshold at $800,000 rather than the individual threshold at $225,000 when the time comes). However, not everything is coming up roses for the CFBNARs. Negotiators revived the Personal Exemption phase out starting at $250,000 and the Pease limit at $300,000.

The Personal Exemption Phaseout is mostly straightforward. The first $3,800 of adjusted gross income is exempt from taxation. Starting at $250,000, that amount will decline until it reaches zero, so that high earners will owe another $1,330 in taxes.

The Pease limit, however, is a total clusterfuck. Most high income households have lots of deductions -- high property taxes, business expenses of various stripes, mortgage interest, possibly some investment interest, etc. The Pease limit starts shrinking your deductible based on how much you earn above $300,000. For every $1.00 of income you earn above that threshold, your deductions are reduced by $0.03 ... but it only applies to certain deductions -- non-business interest, charitable giving, and state & local taxes, mostly. You can't just take the bottom line of your Schedule A and calculate the impact of the Pease limit. On top of everything else, the Pease limit doesn't apply to the Alternative Minimum Tax. It's a mess, and for people like me who wish the tax system were simpler so that America didn't spend a significant chunk of GDP (somewhere between 1% and 3%, depending on who you believe) on tax preparation, it's an abomination. Everyone should find the needless complexity of this system offensive. If we simply capped deductions at a percentage of AGI, without making specific allowances for this or that, we'd be much better off.

The good news here is that the IRS and Congress are fairly responsive to the plaintive cries of the CFBNARs--not quite as responsive as they are to the financial sector, but still fairly responsive--so perhaps this will change.
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