Love My Morning Drive With Rush

By Stacie Kitts, CPA

I’ve considered myself a bleeding heart liberal Democrat ever since I knew what a Democrat was, an interesting political choice for a successful business owner / Certified Public Accountant living in the OC. But an even more interesting dichotomy is how much I enjoy my morning drive listening to the lunatic ravings political commentary of Rush Limbaugh.

I can’t help myself. It’s like comedy hour really.

Now I know there are a lot of people who like Rush and that’s okay, I’m not judging. However, this morning he was so over the top that I couldn’t resist making him the subject of this blog post.

In the spirit of full disclosure, I must admit I arrived at work before Mr. Limbaugh’s ranting commentary concluded so he may have redeemed himself later in his broadcast.

Here is what I thought I heard – no quotes here because I am recalling this from memory.

1. Obama wants to tax the rich by increasing the 15% tax rate that many wealthier Americans enjoy on the sale of their investments. ( I have also heard this point made on several other news broadcasts)
2. The 15% tax rate is a double taxation because wealthy Americans have already paid taxes at a 35% rate on the money they invested.

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First, I want to start this discussion by helping my readers to understand that different types of income are taxed at different rates. (I promise I will get to Rush’s points – I can hardly wait to tackle those) This varies from the regular tax rates that you might be familiar with.

So the basic tax rate schedule looks like this for 2011:

But here is what you may not know – tax law has all kinds of exceptions. In addition to the “regular” tax rates mentioned above, there is a whole host of other tax rates that might apply to your income.

Many of these “exceptions” are a decrease to the regular tax rates. For example:

1. Qualified dividend income starting in 2003 and ending in 2012 has a maximum tax rate of 15%.
2. Long Term Capital Gains income (selling stock you held for more than 12 months for example) is taxed at a maximum rate of 15% from years 2003-2012. The maximum rate increases to 20% in year 2013.

Income types that will increase your tax above the regular rate are:

1. Self employment income (so if you are a business owner, you will likely pay more than the “regular” rates)
2. Penalty taxes for early withdrawals of retirement investments (so if you pull money out of your 401K before you are eligible you will pay more than the “regular” rates)

Other exceptions to the regular tax include:

1. Alternative minimum tax
2. Depreciation recapture

So what is the argument?

It is simply this – working American’s, the ones who “work for a living” and are likely receiving a paycheck and Form W2 at the end of the year are paying taxes at a higher rate than individuals who make most of their income from investments. In addition, those American’s receiving a paycheck are also paying Social Security and Medicare taxes on top of the regular tax.

And why does this equate to the wealthiest Americans pay less tax? As Warren Buffett pointed out, working Americans don’t have the “extra” funds to invest. Middle America spends the money earned from their jobs on day-to-day living, not on investments that could earn income at a lower rate.

I like visual aides so here is one to help make the point:

If you are married and filing jointly and your taxable income after everything you can deduct, is $70,000 (and assuming all your income came from your paycheck) you will pay to our government in the form of Federal Taxes 25% of your income – on top of the social security taxes withheld from your check.

Now that you know a bit more about how the tax system works – I hope – here are my answers to what Rush implied:

1. Obama wants to tax the rich by increasing the 15% tax rate that many wealthier Americans enjoy on the sale of their investments .

Well, no Obama wants to tax income earned from investments similar to the way working Americans are taxed. Does this equate to taxing the rich more? More than what? -If most of your income is coming from investments – More than now – YES. More than the average American – well DUH NO.

1. The 15% tax rate is a double taxation because wealthy Americans have already paid taxes at a 35% rate on the money they invested.

First, how does Rush know that wealthy Americans paid 35% on the income they invested? As we have learned, there are all kinds of ways income is taxed. And second, you only pay tax on the net profit – the increase in the value of the investment after you sell it and have control of the cash. The amount used to purchase the asset is subtracted from the profit to come up with the taxable amount and therefore is NOT taxed twice. (see post script)

Post Script: It appears Rush’s comment on the 35% rate relates to income that is taxed at the corporate level before being distributed out at dividends or capital gains.

The tax policy blog explains:

The reality is that capital gains and dividends are taxed at a lower rate at the individual level because this income has already been taxed at 35 percent at the corporate level before it was distributed to shareholders. Both Mr. Obama and his tax advisor Warren Buffett seem unaware that the U.S. has the 4th highest overall tax rate on dividend income among the largest industrialized countries in the OECD at 49.5 percent. Only Denmark (56.5 percent), France (55.9 percent) and the United Kingdom (54 percent) tax dividends at a higher rate.

So here is my take on the argument above:

If I earn money from my job (for which I pay taxes) and I take my money (lets say $1.00) to the grocery store and buy my dinner, then the grocery store takes my $1.00 and adds it to their profits (for which they pay taxes) leaving oh say $.85 – and then they buy merchandise from a vender using my $.85 and that vender adds it to their profits (for which they are taxed) and so on and so on. My dollar, or portions of my dollar were taxed over and over and over.

When a corporation makes a profit it pays taxes, just like I do. A corporation is considered a separate person distinct from its shareholders. So in the same manner as the rest of us, it takes some of the money it makes and its spends it. When it distributes its “profits” to pay investors (investors get dividends – its a perk of ownership and an incentive for them to buy the stock) those investors pay taxes on the income they receive in the same manner (all be it the investors get a tax break) as the grocery store does when I take my $1.oo profit (for which I have already been taxed) and buy my dinner.

I’m still struggling to understand why the profits that I distribute from my job to others are different than the profits distributed by the corporation.

Related articles

• Buffett Rule: Not so simple (money.cnn.com)
• Are rich taxed less than secretaries? (msnbc.msn.com)
• Buffett’s blunder (opinion.financialpost.com)
• Buffett Rule: Easier Said Than Done (businessweek.com)
• ‘Buffett Rule’ for Millionaire Tax Seen as Easier Said Than Done – San Francisco Chronicle (news.google.com)
• The Buffett Rule and Taxing the Ultra-Wealthy (fool.com)