Plan to Limit a Retirement Tax Break for the Rich Could Hit the 99% Too

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In trying to save for retirement, tax-favored retirement accounts like IRAs and 401(k)s are valuable tools. They give savers tax benefits for putting money into retirement accounts and let them profit from those investments without having to pay taxes until they withdraw the money in retirement.

But some policymakers are concerned that the wealthy are taking unfair advantage of IRAs and 401(k)s, accumulating extremely large balances in them tax free. In order to rein in that abuse, the Obama administration proposed earlier this year to limit the amount of money that you can hold in tax-favored retirement plans.

Essentially, the plan would cap your the size of a retirement account at an amount that would allow a person to buy an annuity that pays out $205,000 a year, at that year's prevailing interest rates. So the cap is variable, depending on how interest rates move. (Why $205,000? It's already the federal limit for defined-benefit pension plan annuities.)

Based on those numbers, the initial cap would have been $3.4 million in April, which makes it clear the proposal is aimed at only the wealthiest of Americans. Yet further analysis shows that the proposal could actually affect a much wider swath of the American population, thanks to unintended consequences that could make it harder for millions to save for retirement.

Hitting a Moving Target

The nonpartisan Employee Benefit Research Institute recently took a look at the administration's proposal, seeking to figure out its impact both now and in the future. The study found that in the short run, implementing the balance cap would affect a very small number of savers.

Over time, though, the impact would be much larger. The EBRI found that even if interest rates remain the same as they are now (and they won't), more than one out of every 10 401(k) participants would be likely to reach the proposed limit at some point before they reach age 65.

%VIRTUAL-article-sponsoredlinks%The effect is even bigger if you make some realistic assumptions about the future direction of interest rates. Rates are important because the proposal doesn't refer directly to a total-balance limit but rather ties it to what an equivalent pension plan would produce in annual income. If rates rise, then the $3.4 million figure would drop. Specifically, if the interest rates used to determine the limit were to double, between 20 percent and 30 percent of savers could end up being affected by the limits.

Cutting Off Small-Business Employees

Having maximum balances for IRAs and 401(k)s is problematic, but it would still allow savers to get sizable benefits from tax-favored retirement accounts. However, a second-order effect of retirement-account limits could actually prevent many workers at small businesses from having any access to 401(k) plans.

The EBRI noted that in many cases, small businesses establish retirement plans in order to give their high-income owners the maximum ability to save money on a tax-deferred basis. If such business owners were to hit the maximum limit allowed under the new proposal, however, they might decide that it no longer made any sense to keep offering plans to their employees. If owners terminated their plans, their workers would lose access to the 401(k) retirement savings option.

The analysis is built on many broad assumptions, making it hard to reach firm conclusions. But under one set of conditions, between 30 percent and 40 percent of participants could suffer reduced 401(k) balances when you take the possibility of businesses terminating their retirement plans into consideration.

In particular, younger workers could be hit the hardest. With the most time to accumulate assets and reach the retirement savings limits, the EBRI found that as many as 70 percent to 80 percent of employees aged 26 to 35 would see some reduction in their 401(k) balances by the time they reach age 65.

Be Smart About Retirement Savings

The EBRI's findings show how hard it is to craft legislative proposals to reach what seem to be desirable ends. Even with the intent of reducing abuse of retirement plans, these limits could end up hampering the retirement prospects for millions of Americans. Regardless of what happens with this proposal, you can expect the battle over tax-favored retirement accounts to continue well into the future.

Galling Tax Loopholes Costing The US Government Billions
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Plan to Limit a Retirement Tax Break for the Rich Could Hit the 99% Too
Several major U.S. corporations dodge domestic taxes by moving profits internationally to tax havens.
For example, a company can utilize the "double Irish" formula to minimize their U.S. taxes.

If the profits from the sale of a good stayed in the U.S., they would be taxed at the federal 35 percent rate. However, some companies sell the intellectual property rights to an Irish subsidiary to minimize tax obligations.

The profits from that U.S. sale are paid overseas to the Irish subsidiary. As long as the Irish subsidiary is controlled by managers elsewhere - for instance, a Caribbean tax haven - the profits can move around the world without a dime of taxation.

At this point, the profits are moved to a nation with no tax, skirting around the U.S. 35 percent rate.

Source: NYT

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This is the "Double" part of the Double Irish, and also entails a trip through the Netherlands.

When the same company's product is sold overseas, that profit is routed to a second Irish subsidiary, Since Ireland has treaties with the Netherlands to make inter-European transfers tax free, the profits are then routed through the Netherlands, and then back to the first Irish subsidiary, and then to the no-tax Caribbean Island.

As a result, the U.S. company never has to repatriate the money and they never has to pay taxes on the products.

Source: NYT

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Carried interest - profits made by private equity investment managers, hedge funds, venture capitalists, and real estate investment trusts - constitutes a major source of income for many financial professionals.

However, carried interest isn't taxed as income. Instead, it's taxed at the capital gains rate, which, at 15 percent, is considerably less than the top bracket tax rate of 39.6 percent that many of the financial professionals would pay.

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Facebook reported $1.1 billion in pre-tax profits in 2012, but paid zero federal and state taxes while receiving a federal tax refund of around $429 million.

The reason is that the company took a multi-billion dollar tax deduction for the cost of executive stock options and share awards following their IPO.

In essence, Facebook was able to write off its entire federal tax obligation and more for paying its executives. This has raised the ire of a number of people in Washington, including Michigan Democratic Senator Carl Levin.

Source: CBS, Bloomberg Businessweek


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A line in the tax code allows a depreciation schedule of five years for private jets instead of seven, the standard for the rest of the airline industry.

Depreciation is an income tax deduction that allows taxpayers to recover the cost of buying the jet. This means that private jet owners can write off their expenses faster (in five years) and make back the money for the jet in less time.
This costs the U.S. government $300 million annually.

Source: CBS

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Originally designed for small farmers trading assets like livestock or property, the Section 1031 tax break allowed two farmers to avoid capital gains taxes on those transactions.

Since then, major corporations have successfully lobbied for an expansion. Because of this, many companies can go about their business of buying and selling assets, but can escape the capital gains tax, as long as they use all the proceeds from a sale to buy a "like-kind" asset.

For example, a real estate investment group can avoid taxation on a major land sale by invoking Section 1031, and using all proceeds from the sale on another land buy.

Wells Fargo, Cendant, and General Electric were recently sued for abusing the practice, but the law remains on the books.

Source: NYT

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In 2011 you could write-off the full cost of an SUV, provided it was used exclusively for business and weighed more than 6,000 pounds. 

Since then the relevant section of the tax code — Section 179 — has been scaled back significantly, but the process still allows people to deduct the full purchase price of qualifying equipment or software if it's used for business. 

Today, acceptable write-offs include taxis and vehicles that can seat more than nine passengers, have no seating behind the drivers seat, have a fully enclosed driver's compartment, or have a cargo area at least six feet in length (like a pickup truck). 

Source:, Forbes


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The tax code permits yacht owners to claim a boat as a second home, provided it has sleeping quarters, a kitchen, a bathroom, and that the owner sleeps on the vessel at least twice a year.

This means that - just as homeowners do - yacht owners may deduct the interest on their yacht's mortgage from their taxes.

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When an executive flies on a private plane for business reasons, the company pays the bill and deducts the expense. However, if the flight is provided to the executive for personal reasons, the executives are required to pay income taxes on the amount the company paid for the flight, as the IRS considers travel as a form of compensation.

But if an outside security consultant says that the executives need a private jet for security reasons, the executive doesn't need to pay the tax.

According to Dealbook, it's "a common corporate tax trick," that allows many virtually anonymous executives - Melvin J. Gordon of Tootsie Roll Industries, Terry Lundgren of Macy's, the heads of Cablevision, Time Warner, Kraft, Waste Management, and Home Depot, for instance - to enjoy the kind of "security" that Apple didn't bother providing Steve Jobs.

Board members are also frequently rewarded with flights for "security" purposes.

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As part of the TARP bailout, NASCAR owners got a huge tax gift written into the tax code. It's still around today, as it was extended for another year as part of the "Fiscal Cliff" deal.

Much like the private jet depreciation advantage, NASCAR track owners are now allowed to write off the cost of building facilities in seven years, rather than the 39 years the government estimates it actually takes for the tracks to depreciate.

This means that NASCAR track owners make their money back even faster, but the government loses $40 million each year.

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