A bonanza of new and extended tax benefits could make it as easy as ever for the rich to stay that way.
Under legislation approved by the U.S. Senate on Wednesday, Dec. 15, and now moving on to the House, savvy wealthy Americans would be able to capitalize on an environment in which their tax rates on income and investments remain at historic lows. Also, new rules would make it possible to pass on fortunes to heirs with less fuss and lower taxes than all but a brief period of the past 80 years. It's a far cry from the 70 percent bite the federal government took out of the largest incomes and estates as recently as 1980.
"The climate we'll have after this legislation is extremely favorable for wealthy families," says Jeffrey Cooper, a professor at Quinnipiac University School of Law and a former estate planner who has studied the history of U.S. tax law.
The good news for the rich starts with income tax rates, which for top income groups would remain 35 percent , a rate enacted by former President George W. Bush in 2003. Except for a period from 1988 to 1992, the top tax rate has never been this low since 1931.
"Top rates are incredibly low from a historical perspective," says Indiana University law professor Ajay Mehrotra. The most surprising thing, he says, is that rates have remained at this level even as the U.S. has been fighting two wars, in Afghanistan and Iraq. Historically, income taxes on the wealthy have spiked during wartime: The first income tax was initiated during the Civil War and then later repealed. The top rate on income hit 77 percent in 1918, during World War I, and 94 percent from 1944 to 1945, during World War II.
If Congress does nothing, top income tax rates would return to 39.6 percent, their level under former President Bill Clinton. Obama and congressional Democrats had wanted to return to Clinton-era rates for individuals earning more than $200,000 and couples making more than $250,000.
The extension of all tax cuts provides an unexpected, one-time benefit to many wealthy taxpayers, says Stephen Baxley, director of tax and financial planning at Bessemer Trust. Starting in 2010, all taxpayers, including those in high income brackets, could convert traditional, tax-deferred individual retirement accounts, or IRAs, to tax-free Roth IRAs. Importantly, in 2010 only, the law allows taxpayers to spread the tax payments required by such conversions over 2011 and 2012. When it looked like tax rates would rise in 2011 and 2012, this looked like a bad deal, Baxley says. Now, with rates remaining the same over the next two years, a Roth conversion can be a lucrative move.
For the country's wealthiest families, income from wages can be far less important than income from investments. According to a Tax Policy Center analysis of 2006 returns, 18.1 percent of all Americans' cash income comes from business ownership or capital investments, compared with 64.5 percent from labor. For those in the top 1 percent of earners, however, business and capital income make up 53.6 percent of income and labor accounts for 35.3 percent.
Thus, Cooper notes, taxes on capital gains and dividends can be far more important to the rich than income tax rates. The tax compromise extends a 15 percent top tax rate on long-term capital gains and dividends enacted in 2003, which is the lowest rate since 1933. The top capital-gains rate was 77 percent in 1918 and, since 1921, its highest point was 39.9 percent in 1976 and 1977—though certain gains could be excluded from taxation.
Estate planning experts say their wealthy clients could be entering an unprecedented period when tax rules—along with low interest rates and previously existing loopholes—make it easier than ever to transfer large sums to children and grandchildren. The estate tax rate would be set at 35 percent in 2011 and 2012. Except for 2010, when the estate tax was replaced by a complex capital-gains tax on inherited assets, the rate has not been lower since 1931.
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