Some people relax by reading, going to a gym or just taking a walk. I like to review tax returns! I like to see where, if I was doing their return, I might be able to lower their taxes. Bill and Hillary Clinton just released their tax returns, so here's a peek at where I think they could've saved some money:
Total income: For 2013 and 2014, their income was $27 million and $28 million dollars, respectively. This puts them in a 39.6-percent federal tax bracket. New York State charges them 8.82 percent. On top of that, there are the new Obamacare surcharges that add an additional 0.9 percent on earned income and 3.8-percent on investment income. What this means is that, for every additional dollar they earn, they lose about half (49.32 percent). In investment income, for every additional dollar they earn, they lose 52.22 percent. If you lose half your money in taxes, you need to have a proactive tax plan.
Interest income: This is money in the bank and generally banks are paying nothing. In 2013, they received $27,143 in interest and in 2014, they received $25,171. In 2014, their interest income cost them $13,144 in taxes. Assuming they're earning half a percent interest (the average for savings accounts, according to Bankrate.com), they should have about $12.5 million in cash in the bank, which is way too much.
Where to save
Investment tips: Why not look into New York state muni bonds? They are exempt from federal and New York state income tax and pay pretty competitive rates for high-income earners. Why not invest some of the money in dividend-producing stocks? The S&P 500 has a yield of 2.01 percent and that yield is taxed at capital-gains rates vs. ordinary income. What this means is that their tax rate would drop to 32.62 percent from 52.22 percent. That is a significant reduction in their tax liability, plus the yield is four times what they're getting on their cash!
Business income: In reviewing the Schedule C (which reports business income) there are a few things that could have a big impact on their income.
- 401(k) — both Hillary and Bill have their own businesses which means that they can put aside $59,000 each ($53,000 plus a $6,000 catch-up contribution as they are over age 50). This would save then around $59,000 in taxes annually.
- Pension — On top of the 401(k), they can also do a pension plan that allows for much larger contributions than traditional 401(k) plans. The older you are and the higher your income, the larger the tax deductions and contributions that you can make. Easily, they could get an additional $250,000 each in deductions saving them around $250,000 in taxes annually.
- Long-term care — Owners of companies can deduct the cost of long-term care insurance policies as a business expense and it is an "above-the-line" deduction on their personal taxes. Since they are both over 60, they can get a $3,800 deduction each for a total of $7,600 annually. This would save them around $3,800 in taxes. This deduction increases to over $9,300 after they hit age 71.
- Why not an "S" corp.? In an LLC (which is what they both have), all wages are subject to Social Security and Medicare taxes. While they are way above the limits on Social Security wages, they still have to tax (1.45 percent as both an employer and employee — 2.9 percent combined). They had about $13 million in profits that cost them an additional $377,000 in Medicare taxes. If they had an "S" corp., they would have to take a "reasonable salary," but any additional profits would not be subject to Medicare wages.
- Loss carry-forward — I am seeing a $3,000 loss, which indicates to me that they have a long-term loss carry-forward ($702,540). We can use this to offset ordinary income with a maximum of $3,000 per year (which will take 234 years) or we can take some gains and use that loss to offset any taxes, which would be much better (and a lot faster.)
Charitable contributions: Cash is probably the least effective asset to give to charity and they gave around $3 million last year. So this is how it works using the $3 million that they gave to their foundation in 2014.
To give away $3 million, they would've had to have earned at least $6 million —and pay taxes on that, which we've already established is at a rate of almost 50 percent for the Clintons. Sure, they can deduct the charitable donation, but that would only save them about $1.5 million. If they'd used appreciated securities, they would not have to pay capital gains on the gain and would get the same tax deduction on the value of the gift. That would save them around 33 percent, or $2 million, on the gain in their investments.
With some proactive planning, the Clintons could save hundreds of thousands of dollars. For most people, tax planning is collecting receipts, putting them in a shoe box and giving them to their CPA. If they get money back, their CPA is great. If they have to pay, they yell at their CPA and threaten to fire them. That is not tax planning…that is scorekeeping.
Proactive tax planning means that you review your tax situation today, and develop plans to be proactive, during the tax year. You have 5 months left in the tax year. What is your proactive tax strategy?