So we all have our hobbies. Some like to fish, or go to the gym, maybe play a little golf. I like to review tax returns and if one pops up, let’s say like President Obama’s, I feel obligated to review it to see if he paid more than he needed to if he had planned properly.
Most people spend almost no time proactively planning for their taxes which generally is one of the largest expenses that all of us have. The process generally starts in February when you throw a bunch of 1099′s into a shoebox, think of a few creative ideas to say to your CPA to justify some expenses, then hope for the best. Hope is not a plan! So if we were proactive, what could we potentially save in taxes assuming that we were the president.
Now just because you can do something to reduce your taxes, does not necessarily mean that you should do it! It has to make sense with the rest of the plan. In addition, reviewing a return generally shows other issues that you may want to consider relating to how you are spending and investing your money.
First, let’s start with President Obama’s tax numbers by looking at a copy of his return (Barack & Michelle Obama 2014 federal tax return). Last year they had $477,383 in adjusted gross income and this is how their taxes broke out:
Federal: $90,894 (that includes $10,087 in additional taxes due to the Alternate Minimum Tax (AMT))
Self-employment tax: $2,362 (they get a credit for ½ that $1,181)
State income (IL): $24,819
eal-estate taxes: $29,571 (up almost $3,000 from 2013)
Total: $146,465 (This is what we call being very patriotic!)
So this puts the president in a 33 percent federal income-tax bracket and 15 percent on capital gains. He is also subject to the Obamacare surcharges that adds an additional 0.9 percent on earned income and 3.8 percent on investment income above $250,000 for families. Finally, he is a resident of Illinois so we have an additional income tax of 5 percent. So here are his marginal (top) tax rates:
Capital gains: 23.8 percent
As we review the return, these rates are very important to know to understand the after-tax rates of returns. So here is what I see:
Taxable interest: ($16,092 (gain) x 38.9% (tax rate) = $6,259.79 (taxes paid). His return after taxes was $9,832. +He is mainly invested in U.S. government securities that are taxable at a federal level. He would probably be better off in Illinois muni bonds that are exempt from federal and state income taxes, and the returns are very competitive as well.
Qualified dividends: ($0). These are dividends that come from stocks such as AT&T. They get taxed at capital- gains rates, which is about 40 percent less than his earned income rate. Also, just using the S&P 500 as an example, the current dividend of the S&P is 1.94 percent, which is about the same as the 10-year Treasury yield. Better tax rates — better potential upside. This also tells me that the president has very little if any stock investments in his portfolio and that has cost him a lot of money over the past 6 years. We should probably review his portfolio allocation as well.
Capital loss: $3,000. This indicates to me a long-term capital loss carry forward (his return indicated a carry forward of $109,057). This is a planning opportunity, as it allows us to offset capital gains in our portfolio. I would suggest that we proactively sell gains in the portfolio to offset that loss, so we can get the tax deduction sooner rather than later.
Self-employment income: $88,181 (This is from his books). They did do an SEP contribution of $17,400, which is great; however, they did not do the maximum, deduction of 25 percent of income, so they could have deferred almost $5,000 more. In addition, if they did a solo 401(k) plan, they could have done $17,500 plus an additional catch-up contribution of $5,500, plus an additional 25 percent of income. This would have allowed them to more than double their deduction for 2014 and save for their retirement. If I were his advisor, I would suggest we at least explore this option.
Overpayment: $25,641. You should never be getting back checks this size. This means that your returns and income were not planned out correctly and you got a zero-percent return on your money for 15 months. This was even larger than last year’s overpayment, so this needs to be better planned out!
Mortgage interest: $39,566. Let’s assume that his mortgage interest and property taxes ($29,571) have been the same over the past 6 years. That would mean that they have paid $69,137 annually for 6 years (total cost: $414,822) just in property taxes and mortgage interest in a home that they have not been in for 6 years. This property is worth approximately $1.6 million so the additional maintenance on the property is around 1 percent to 4 percent of the value of the home. So, let’s split the difference and use 2 percent, which is an additional $32,000 annually (192,000 over 6 years). So over the 8-year period of time that he will be president, the property would cost $809,096. He would have been much better off selling the home and investing the additional $809,096 over those 8 years.
Charity: The Obamas gave $70,712 to charity last year to some great organizations. For any of my clients that give to charity, I look to do one of two things. Either allow them to give more at the same cost or to give the same amount and have that cost them less. Generally, cash is the worst thing to give to a charity from a tax standpoint. I would rather see them give appreciated securities or actually transfer ownership of the book rights into a charitable trust. This would substantially reduce their taxable income and help them support their charitable causes in a more efficient manner.
I realize that the president does not want to be very aggressive in tax planning as it would not look too good if he did. But when I review tax returns, I see opportunity to at least have the conversation on should we consider changes based upon the person’s tax and personal situation. Specifically with the president, there are hundreds of thousands of dollars (if not more than $1 million), over this 8-year period of time that we need to at least discuss to see if it is an option.
My advice to everyone is to bring your 2014 tax returns to your next financial advisors meeting and say, walk me through this and what we should be doing differently based upon my tax situation. And remember: You don’t get a medal for overpaying your taxes!
Commentary by Jerry Lynch, a certified financial planner, chartered underwriter and chartered financial consultant (CFP, CLU, ChFC). He is president of JFL Total Wealth Management, a registered investment-advisory firm. Follow him on Twitter @JFLJerry.