UNITED STATES TAX ISSUES

On this last day of 2012 United States citizens and resident do not know how much they will pay in income taxes tomorrow. The days where the United States Internal Revenue Code was based on logic and reason are indisputably gone. Income taxes are now based on backroom negotiations with the majority of our elected representatives having little or no input on how the people they ostensibly represent are going to be taxed.

On New Year’s eve 99 US senators and 435 members of the House of Representatives sat idly by while Senator McConnell of Kentucky and Vice President Biden played “let’s make a deal.”  At about 3 a.m. on New Year’s Day the Senate passed the “fiscal cliff” tax bill by a vote of 89-8. The House of Representatives will take up the bill on January 1 or 2, 2013.

Senate Bill

• Tax rates: Current tax rates will increase from 35% to 39.6% for individuals with income over $400,000 and married couples filing jointly with income over $450,000.
• The estate tax: It was set to increase from 35 % to 55 % in 2013. Instead, the compromise sets the new rate at 40 % with the first $5 million worth of property exempt from being taxed.
• Capital gains tax: Long term capital gains and qualified dividend tax rates will permanently increase from 15% to 20 %.
• Alternative Minimum Tax: Permanently indexes the alternative minimum tax for inflation
•  Doctors will be shielded from a massive 27.5% reduction in reimbursements for treating Medicare patients.
• Unemployment benefits: Unemployed workers will receive their benefits which expired over the weekend for an additional year.
• Social Security taxes will return to 6.2% on the first $113,700 of earned income
• Exemptions and deductions will be subject to a phase-out for individuals with income over $200,000 and married couples filing jointly with income over $250,000

What Was Left Out?

How much to increase the debt ceiling and how are we going to reduce what Chief Justice John G. Roberts Jr. described as a “truly extravagant and burgeoning national debt.”

How Are We Going to Pay for Private Pensions?

The Pension Benefit Guaranty Corporation (PBGC) was created by the Employee Retirement Income Security Act of 1974 to encourage the continuation and maintenance of private-sector defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at a minimum. Today, PBGC is responsible for the current and future pensions of about 1.5 million people, a little over 3% of workers in private industry.

Part of this legislation was a mandate for private employers to fully fund pension plans. Through a combination of lax oversight and a loose formula as to the amount of employer contribution necessary to fully fund private pensions, most private pension funds are significantly underfunded. As an example, American Airlines entered bankruptcy in November 2011 and immediately announced plans to terminate its four pension plans. American‘s plans are underfunded by $12 billion and cover 130,000 workers and retirees. In Hawker Beechcraft’s case, pension plans are underfunded by $750 million and cover 18,000 people. Why did government allow this to happen and why hasn’t anyone one taken responsibility to see that this does not happen again?

How Are We Going to Pay for Public Pensions?

States and local municipalities also have ignored funding pension plans for retirees. A recent article conjectured that no one actually knew how much was underfunded but that the total amount was somewhere between 3 and 4 trillion dollars. It was almost as if the difference of $1,000,000,000,000 was a rounding error of some kind that could be readily covered by a petty cash fund. The unfunded amount is apparently greater than the combined budgets of all 50 states.

Where Are We Going?

There are several realities that most of us must face.  We need representatives in Congress who should be more concerned with balancing the budget than in being re-elected. The majority of us will not be able to retire at 55, 60, 65 or even 70 and enjoy the same lifestyle we do today. We need to be concerned as to whether the pension that we worked for will be there when we need it. We will need to earn more in our current job and even take on a second job to have a comfortable retirement. And we all are going to have to pay more taxes. Having only 53% of the population paying income tax is unsustainable.

Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own U.S. tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsabo@expatriatetaxservices.com