In the Loophole

Don't tax the rich. Jesus, don't tax the rich. They're making the economy go, they're investing, they're job-creating. So goes the refrain of Republicans, lobbyists, and other supporters of the Bush tax cuts for the wealthy, which will terminate automatically at the end of the year if Congress doesn't bestir itself. When the cuts expire, people making more than $250,000 -- about the top 3 percent of earners in the country -- can expect to pay a 3 percent tax increase, with their marginal tax rate rising from 33 percent to 36 percent. If they make more than $374,000, they will pay 4.5 percent more to the government and go from paying 35 percent of income over that line to paying 39.5 percent.

What's a wealthy person to do -- other than complain about socialism, that is? According to folks that rich people pay to keep their taxes low, the wealthy are already looking for ways to avoid the impact of higher income taxes. Given the modesty of these increases -- we forget that even the highest projected rates will still be lower than Reagan-era income taxes -- it's worth asking if the impact on the wealthy is overstated. According to the Internal Revenue Service, some 13,142 taxpayers with incomes of more than $200,000 reported owing no income tax at all in 2007, the most recent year with data. That same year, nearly two-thirds of high-income taxpayers reduced their taxable income by 20 percent or more, and four-fifths paid an effective tax rate of less than 25 percent.

As the debate over extending or ending the Bush tax cuts ramps up, we'll hear more and more about soaking the rich and class warfare and extortionate tax rates. But these claims don't really hold water. According to economists Emmanuel Saez and Thomas Piketty, the actual tax burden on the wealthy is the lowest it's ever been. The tax rate has been plunging for years; in 1995, the effective tax rate for the wealthy was 41 percent, a levy no one has dared suggest matching today. Put it this way: Bill Gates paid higher taxes when Microsoft took off than Steve Jobs does on his I-everything empire. No matter what happens with the Bush tax cuts, that won't change.

The wealthy have two key advantages when it comes to taxes. First, they can afford to hire experts to navigate the incredibly complex tax code for them. Second, the rich don't make their money like you and I do. "High-income earners are going to be looking at a variety of strategies ... to reduce the overall effective tax rate," says Fran Muracca, an attorney who runs a tax practice at Jones Day, a major law firm.

Simply put, the wealthy have more say than the rest of us do over when and how they get paid and thus, when and how they get taxed. If the rich have bonuses coming, they can try to bump them up to this year to ensure they're tucked safely in the bank before the Bush tax cuts expire. If they have expenses this year, they'll wait to pay, so they can deduct them next year. If they have stock or other capital gains, they'll sell now to take advantage of lower rates. "They are accelerating income, deductions they will be postponing to next year, that's what every client is doing," says John Waldron, CEO of Waldron Wealth Management.

Some are predicting more extreme strategies in the face of tax increases: Doctors, attorneys, entertainers, and other professionals who currently file for the income tax as partnerships can form what are called C-corporations to shelter their income, since the corporate tax rate will be lower than the income-tax rate. Wealthy couples might also "go Galt" by having one earner retire or even by moving to a lower-taxed state.

Yet for all this successful avoidance, the prospect of a tax increase creates a lot of concern among conservatives -- and not just because some poor financier won't be able to afford a new helicopter or a media mogul might have to mortgage his house in the Hamptons. Turns out, it's the economy, stupid! Taxing the wealthy is actually quite popular, which is why those who oppose the return to pre-Bush tax rates don't talk much about rich people. They prefer to issue warnings about how small businesses are going to suffer, sending our fragile economy spiraling into a double-dip recession. They won't call it trickle-down economics, and we won't be talking about how people with four times the median income should face a tiny tax increase -- we'll be talking about how many low-income earners the wealthy can hire to take care of their estates.

"The top 3 percent are responsible for 25 percent of consumption, and when you realize that our [gross domestic product] is about 70 percent personal consumption, do you really want to impose a big tax increase on the group?" says Ken Kies, a tax lobbyist who is working to prevent the increase. Kies has been at the center of tax-the-rich controversies before: During his tenure as chief of staff of the nonpartisan Joint Committee on Taxation, he came under criticism for his close relationship with the lawyer for an eccentric Yugoslavian-American billionaire who fled the country to escape his tax debt. "This notion that raising taxes is not going to affect anything, it's not true," Kies argues.

Can't wealthy folks just keep massaging their filings to avoid tax trouble?

"The wealth managers will tell you, yeah, we'll reposition, rebalance, [but] the reality is that increases from 35 to 39.6 is not enough of a reason to do a rebalancing of your portfolio," Kies says, before suggesting that it is enough of a reason for small businesses to stop hiring workers.

Studies, such as those from the Center on Budget and Policy Priorities, suggest that relatively few small employers will be affected by the cuts. Shockingly, the accountants to the rich and famous aren't buying it. "The Center for Budget or whatever it is, a bunch of horse shit, says Obama's plan would result in a tax reduction for 97 percent of tax payers -- half of them already don't pay any income tax at all!" Kies replies. "The real issue is that [the top] 3 percent represents over 50 percent of small-business income generated."

If they produce half of all small-business income, they probably aren't mom-and-pop shops or start-ups with the next big idea. But that doesn't matter, Kies says. Highly paid accountants, lawyers, and investment advisers all hire people, too, and they won't be hiring if the tax cuts go through.

Of course, the industry of protecting the rich from those tax increases seems to be better than ever. "I'm a small-business owner," says Waldron, whose firm controls about $2 billion in assets. "I'm hiring right now."

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