How we're preparing for the incoming administration's tax plans.
This monthly series of articles describes the many steps and occasional missteps we have taken in building our financial advisory business, Garnet Group LLC. Currently, Garnet has eight staff members, more than 90 clients, more than $300 million in client net worth under advisement, and offices in Bethesda, Md., and Boston. Veena Kutler, CFA, and Annette Simon, CFP, are the managing principals in the Garnet office in Bethesda.
Is 2008 an exciting year or a horrible year? However you look at it, 2008 will be seen by historians as a banner year. As we write this, so far this year, the Dow has spanned a range of 13,000 to below 8,000, dropping more than 50% in a three-month period. This year also marks the beginning of a sharp recession, possibly a depression as seen by some economic watchers. Whatever your political views, the 2008 presidential election results are historic and the Obama administration seems poised to implement many changes from policies of the Bush era. As we look ahead to 2009 and beyond we assess the impact of the new regulations on our clients.
The Obama Plan
From the administration's new Web site, here are some of the pieces of the Obama economic plan that, if passed, will impact our clients and our practices. The language is theirs, though we have made some attempt to remove the most biased words:
* Cut taxes for 95% of workers and their families with a tax cut of $500 for workers or $1,000 for working couples.
* Provide tax cuts for low- and middle-income seniors, homeowners, the uninsured, and families sending a child to college or looking to save and accumulate wealth.
* Families making more than $250,000 will pay either the same or lower tax rates than they paid in the 1990s. Obama will ask the wealthiest 2% of families to give back a portion of the tax cuts they have received over the past eight years. But no family will pay higher tax rates than they would have paid in the 1990s.
* Simplify taxes by consolidating existing tax credits, eliminating the need for millions of senior citizens to file tax forms, and enabling as many as 40 million middle-class Americans to do their own taxes in less than five minutes without an accountant.
* Eliminate capital gains taxes for small businesses, cut corporate taxes for firms that invest and create jobs in the United States, and provide tax credits to reduce the cost of healthcare and to reward investments in innovation.
* The estate tax would be effectively repealed for 99.7 percent of estates. For the remaining 0.3% of estates over $7 million per couple, Obama will retain a rate of 45%.
* Create a universal mortgage tax credit for homeowners: Barack Obama believes we should immediately enact a 10% refundable tax credit on the mortgage interest paid by American families who do not itemize their taxes. This credit will help offset the cost of mortgage payments for at least 10 million middle-class homeowners.
* Penalty-free hardship withdrawals from IRAs and 401(k)s in 2008 and 2009: To help families pay their bills and their mortgages and make it through these tough times, Obama and Biden are calling for legislation that would allow withdrawals of 15% up to $10,000 from retirement accounts without penalty (although subject to the normal taxes). This would apply to withdrawals in 2008 (including retroactively) and 2009.
* Instruct the Treasury to allow seniors to delay required withdrawals from 401(k)'s and IRAs: Obama and Biden are calling on Treasury to temporarily suspend the required withdrawals for retirees older than 70 1/2. Because retirees often make these required withdrawals late in the year, there is still time to help millions of affected seniors, but only if done promptly. In addition, because lower-income seniors may have no choice but to take withdrawals this year and in 2008, Obama and Biden will exempt any withdrawals made up to the required minimum amount from taxation. This will give seniors the flexibility they deserve -- to forgo withdrawals if they choose or to take those withdrawals tax free if they need those resources to pay their bills.
Relief to States
* Provide $25 billion in state fiscal relief to help avoid painful property tax increases: Budget crunches across the nation are putting our local governments in the untenable position of having to choose between raising property taxes and cutting vital services. Obama has proposed $25 billion in state fiscal relief that, coupled with the new emergency facility to address the state credit crunch, will help states and localities continue to provide essential services like health care, police, fire and education without raising taxes or fees.
Here's how the administration sees its tax plan effecting taxpayers with a range of incomes and personal situations:
Impact of the Obama Tax Plan
Married couple making $75,000 with two children, one of whom is in college
$3,700 (includes $1,000 Making Work Pay; $500 universal mortgage credit; and $4,000 college credit net of current college credits)
Married couple making $90,000
$1,000 ($1,000 Making Work Pay tax credit)
Single parent making $40,000 with two young children and childcare expenses
$2,100 (includes $500 Making Work Pay; $500 universal mortgage credit; and $1,100 from expansion of the child care tax credit)
70-year-old widow making $35,000
$1,900 (reflects elimination of income taxes for seniors earning under $50,000)
Source: Calculations based on IRS Statistics of Income. Tax savings is conservative; does not account for up to $500 in savings from expanded Savers Credit and the $2,500 in savings per family from the Obama health-care plan
On a more detailed version of the plan released by the campaign, these specific plans for taxpayers with incomes over $250,000 are spelled out:
Ordinary Income: The top two income tax brackets would return to their 1990's levels of 36% and 39.6%. All other tax brackets would remain as they are today. Obama would also restore the 1990s' levels for the personal exemption and itemized deduction phase outs (known as PEP and Pease). Obama plans to work with the Treasury Department to adjust the thresholds of these rates slightly to ensure that no married couple making less than $250,000 (or single making less than $200,000) was affected by these changes.
Capital Gains: Families with incomes below $250,000 will continue to pay the capital gains rates that they pay today. For those in the top two income tax brackets -- likewise adjusted to affect only families over $250,000 -- Obama plans to create a new top capital gains rate of 20%. Obama's 20% rate is equal is the lowest rate that existed in the 1990s and the rate that President Bush proposed in 2001. It is almost a third lower than the rate that President Reagan signed into law in 1986.
Dividends: The top dividends rate for people making over $250,000 would be set at 20%. Dividends will not return to being taxed at ordinary income tax rates. Obama's 20% rate on dividends will be 39% lower than the rate President Bush proposed in 2001 and would be lower than all but five of the last 92 years we have been taxing dividends.
We have clients with incomes ranging from the low six digits to more than $1 million a year. Most fall in the under $250,000 range and will benefit from Obama's proposed cuts for that group. The majority of our clients also have combined estates below the $7 million estate-tax threshold, so they will not suffer from the proposed estate-tax plan.
For our higher-end clients the proposed changes to income taxes and capital gains and dividend tax rates will increase their tax burdens by as much as 5%. While no one wants to pay higher taxes, we think that a slight increase in taxes may be a small price to pay if the new administration is able to stabilize the economy and reverse some of the damage done in recent years.
The biggest question, of course, is whether all or any of the Obama plan will be enacted given our current dire economic condition. Most political experts seem to believe any tax increases will be delayed at least until 2010 while we work to rebuild confidence in the American economic system.
No one can deny we live in interesting times!
Next month we will interview Hilary Joel, our business coach, and discuss her plans for creating a peer coaching program for financial advisors.
Veena A. Kutler, MBA, CFA, and Annette F. Simon, MBA, CFP, are founders and principals of Garnet Group, LLC -- www.garnetgroup.com, a fee-only wealth management firm with offices in Bethesda, MD and Boston MA. Both are NAPFA Registered Financial Advisors with more than 30 years of financial planning and portfolio management experience between them. Garnet serves the needs of high net worth individuals and families in the Boston and Washington, D.C. areas