On October 3rd, 1913, President Woodrow Wilson signed into law the Underwood-Simmons Act, creating what would be the first modern U.S. income tax.
The tax legislation was only 16 pages and imposed a base tax rate of just 1%. The actual tax code and regulations were just 400 pages in total. The highest tax rate was set at just 7% for individuals earning more than $500,000 or about $12.6 million in today’s dollars.
At that time, the tax was not meant to be permanent but was to pay for the costs of World War I. In fact, the tax rates were cut some four times during the 1920s.
Today, tax code and regulations are more than 70,000 pages in length! It has so many rules and code sections you would need a tax program just to remember them all. In fact, most CPAs today rely a great deal on such software to navigate the ever-increasing code.
It was rather ironic recently when House and Senate Republicans decided that tax cuts and simplification would be a good thing!
The results of their laborious process have been bills from both houses to slash tax rates for both individuals and corporations.
These bills are now in reconciliation, a legislative process of the United States Congress that allows expedited passage of certain budgetary legislation on spending, revenues, and the federal debt limit with a simple majority vote in both the House (218 votes) and Senate (51 votes). The two bills will be combined into a single workable bill that can go to the President for his signature.
The Senate bill alone is 479 pages in length. The House version of the bill is 429 pages in length. Ironically even the tax simplification bills are longer than the original tax code and regulations from 1913.
Both House and Senate versions of the bill reduce tax rates for individual and corporate
taxpayers with subtle differences in the number of tax brackets and income thresholds for each tax bracket. They also either raise the estate tax exemption or phase out the estate tax all together.
Both bills lower the corporate tax rates substantially for both corporate and pass-through entities. The exact brackets, thresholds and rules are beyond the scope of this analysis, but each bill is different enough that it has many anxious to see what the reconciliation process produces.
However, if you stand back and you look objectively at this process, as I am sure the rest of the world has been able to do, this process has been nothing but pure theatre.
Not only did Congress not simplify the tax code, but in all likelihood, they lengthened it. We used to joke when I was in Public Accounting that whenever Congress tried to simplify the code, it just meant more work for us!
A great example of how this process really simplified nothing is how special interest groups managed to keep mortgage interest deductions, charitable and other itemized deductions in the tax code, while at the same time, Congress raised the Standard Deduction so fewer people would be able to deduct such costs.
Although they raised the Standard Deduction to roughly $24,000 in both versions of the tax bill for Married Filing Joint taxpayers, they eliminated Personal Exemptions. For example, my family of four stands to deduct $16,200 in Personal Exemptions in 2017 that in 2018 will now part of the Standard Deduction.
If you add, the 2017 Standard Deduction of $12,700 for married couples filing jointly to the Personal Exemptions and deduct $24,000, my family actually stands to lose $4,900 in deductions in 2018.
In the past, we have also benefited from using itemized deductions to cut our tax bill, but with the new higher Standard Deduction, that is now unlikely in most years. This means I am likely to have higher taxable income in the future before applying the lower tax rates.
Just a quick back of the napkin calculation based on 2017 projected income did show I
stand to possibly save $300 - $500 in taxes based solely on the lower tax rates and brackets, but it was nowhere near the $2,200 that the Tax Foundation estimated I could save.
Now, I am a past Certified Public Accountant so these kinds of calculations are quite simple for me, but how many of us have my kind of tax knowledge?
Even with all my past knowledge, there is much in the tax code that I either do not know or would be hard pressed to apply.
Truth be told, why do we need this kind complexity?
What’s wrong with a 400-page tax code (and regulations) like in 1913 where I would guess most taxpayers understood most of its provisions. Unlike now where you need a team of professionals just to navigate the annual filing requirements.
Think about how much more productive we could be if we were just focused on providing the best service or product possible and not spending and an estimated 8.9 billion hours and $409 billion as a country complying with the tax code, according to the Tax Foundation?
As much as we can dream of a slimmer tax code, the reality is that the length of the federal tax code and regulations have grown steadily over the past sixty years.
In 1955, the tax code and regulations were a mere 1.4 million words in length. Since then, they have grown at a pace of about 144,500 words per year. Where today the federal tax code is roughly six times as long as it was in 1955, while federal tax regulations are about 2.5 times as long as you can see in the chart below.
Washington just doesn’t seem to have the will to actually simplify our tax system and code. It is obvious to most that special interest groups and corporate lobbyists control a large portion of our elected officials and thus what does or does not happen to our tax code.
Obviously, the only thing one can do is fight fire with fire!
That is dig into this mammoth tax code and find the advantages that allow you to prosper while less savvy persons pay more than they probably need to or should!
This is something we help our clients do every day. In fact, I issued a Tax Planning Alert just a few days ago to our affluent clients on a couple of simple suggestions that struck us about the recently passed House and Senate bills.
When these House and Senate bills are reconciled and signed into law, I believe there will even be more opportunities to save valuable tax dollars just by arranging your business or investment affairs in such a way as to minimize future tax drag.
As famed author Robert Kiyosaki likes to say, “it’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.”
We can help you keep more, make it work harder for you and preserve it for multiple generations! Schedule your free consultation today!
In Part I of The Unexpected Downside of Longevity, we alluded to a study by Harvard that showed that between 1992 and 2008, life expectancy for people aged 65 increased from 17.5 years to 18.8 years. This means that the average American can now expect to live much longer than their parents due to the wonders of modern medicine.
We outlined three unexpected side effects that this increased longevity created:
The bottom line is not only will junior be waiting longer to inherit assets, but he or she is likely inheriting much less. Exhausting one's assets in retirement is a growing concern for many in America.
In Part II, we will look at ways to sustain your savings and income for your lifetime and for future generations.
Let's start first with a few ideas to sustain your savings and income over your increased lifespan:
First, as mentioned in Part I, long-term care (LTC) is something 70% of the population will need going forward but is a cost that only 30% of the population insures against. It is costly to be in a skilled nursing facility with costs running upwards of $100,000 per year in many parts of the country. With an average stay is skilled nursing home stay of 835 days, according to LifeHappens.org, this cost can quickly destroy a nest egg.
The simple solution to this is to purchase long-term care insurance but many do not because it is costly and it is a "use it or lose it" cost and rightly or wrongly many do not like to purchase insurance they may never use.
The solution is permanent life insurance with a living benefit rider. This is life insurance that builds cash value that can be used for future medical costs or even lifestyle needs in retirement. If it is not used for medical or lifestyle, it will become a benefit for ones heirs. It is cost effective and most people need some form of life insurance anyways!
Second, is a suggestion that might seem obvious but is ignored by much of the population and that is to work longer and wait on retirement. Did you know the average retirement age for Americans is 63?
This means the average person cannot even wait till 65 or the current full retirement age for most Americans for full social security of 67 years. Just continuing to work to age 70 will do two things: 1) it will allow you to save longer and delay drawing on accumulated assets, and 2) it will allow you to delay taking social security.
Most people don't know that for each year you delay taking social security, it adds 8% to your benefit. That is a great investment return with no or limited downside!
Third, if you have an existing annuity and enough assets for retirement, consider converting part or all of that annuity in a tax free exchange to annuity with a continuation of benefits rider. In many cases you will get a magnified LTC benefit AND in certain policies will get to pay those future LTC costs with annuity funds that come out tax free. This works well for those with very low or zero cost basis annuities.
Next, here are a few ideas to on how to get the younger generation some of their inheritance earlier, while they can still enjoy it. Obviously, this only applies to those families who have plenty for their retirement and financial needs.
First, is an absolute "no-brainer" for affluent families. However, I see very few affluent families fully utilizing this option. The tax law currently allows an individual to gift $14,000 without gift tax to as many persons as he or she would like per year.
This means a couple can gift up to $28,000 per year to as many heirs as they would like annually. Over a series of years, this can be a pretty big deal to those heirs.
The best news here is this idea is something you can do right now and is not dependent on whether Congress or the President simplify the tax code (and potentially the estate tax regulations) or not. It still makes sense!
Second, the tax law allows you to pay for educational costs and medical costs for an heir if paid directly to the provider and this is on top of the $14,000 per annum per person.
The good news is that payments for medical insurance also qualify for this exclusion. Except in rare circumstances, you cannot deduct the medical expenses you pay for another person, and they cannot deduct the expenses either, since they did not pay the expenses. Thus, careful consideration should be given regarding whether you make the gift directly to the individual, subject to the $14,000 annual limit – which would allow the recipient of your generosity to pay the medical expenses and claim the medical deduction on his or her tax return – or whether you pay the medical expenses directly.
Educational payments can be for any level of schooling including elementary, secondary and post-secondary. Unfortunately, the cost of room and board aren't eligible as direct payments, nor are contributions to qualified tuition programs (such as Section 529 plans). When you pay the qualified post-secondary education tuition for another individual, it does not mean – as is usually the case for medical expenses – that someone cannot benefit tax wise. Tax law says that whoever claims the exemption for the student is entitled to the American Opportunity Credit or Lifetime Learning Credit for higher education expenses if they otherwise qualify.
The Take Away
You are going to be impacted by this trend of increasing longevity. Living longer is great, but it will likely lead to many more Americas who flat out run out of resources in retirement.
A great way to overcome this hurdle is to make sure you are prepared by making sure they are taking advantage of all available saving options, such as maximizing contributions to a 401(k) or some other retirement plan. Additionally, that you have some form of LTC insurance as you approach your 60s.
Probably most importantly you need a financial plan to navigate all those years in retirement. This is someplace where we can help you, click here to find out more.
According to a 2016 Harvard study, the combination of increased longevity and improved health status has led to a spike in life expectancy among older Americans. The study showed that between 1992 and 2008, life expectancy for people aged 65 increased from 17.5 years to 18.8 years. This means that the average American can now expect to live much longer than their parents due to the wonders of modern medicine.
The fact that Americans are living longer today than at any time in history has created some unexpected side effects!
First, by living longer Americans are putting a real strain on their savings. I wasn't in the business when many of my older clients started saving for retirement, but my guess is their financial plans did not anticipate them living into their 80s, let along 90s or 100s. In fact more than a few scientists are predicting that within the next decade it may not be uncommon for human lifespans to approach a maximum age of 120. I shutter to think what that might do to my client financial plans!
So not only is running out of retirement funds a real issue for Americans, but also for our government. You may have already read or heard that our Social Security and Medicare/Medicaid trust funds are quickly headed for insolvency. Just imagine how fast we get to insolvency if humans are living to age 120 after retiring at today's average retirement age of 62?
Second, is the unexpected toll on the next generation. Let's use my client who will have turned one hundred by the time you read this as an example. We will call her Dorthy.
In her case, she is a very affluent American who has planned well for her retirement and for her heirs. However, when she sits around the table as President of her family foundation, her kids are no longer spring chickens. In fact, they average from the mid-50s to the low 70s in age. Yet here they are still be beholden to mom and still waiting to take control over these assets as much older adults.
Because mom is involved in this organization as well as every trust or entity established to minimize estate taxes, the investment allocations within these entities tend to be conservatively managed. I have to believe that if these assets were already in the hands of her children they would be managed more aggressively and therefore growing more quickly outside of her continued oversight.
I also have to believe that with the mantel finally passed, these children could finally rise to official adulthood and not the children they felt like around mom's table for the past 50+ years.
Third, is the rising effect of health care costs and the devastating effect they can have on the value of the assets passed by those living longer. Let's face it, health care is not cheap! Someone must pay for the revitalizing care that prolongs longevity and increases the quality of life. Right now much of that cost is born by Medicare or Medicaid, but, as we alluded to above, how much longer can Uncle Sam afford to foot the bill for a society that is living much longer than anticipated when such social safety nets were established? The answer is likely not much longer based on the current structure.
So the result will likely be in the future that you, Mr. or Mrs. taxpayer, will have to foot more of the bill. Since just 30% of Americans have some form of long-term care insurance and health care deductibles, outside of Medicare and Medicaid, keep increasing this is likely to have a negative effect on the value of assets passed to future generations.
What this means is not only is junior waiting longer to inherit assets, but he or she is likely inheriting much less.
In our next post, we will give you some specific ideas you can use to overcome the unexpected downside of longevity.