What is meant here?

[mike777]

Out of Sidley, out of Austin, out of NY and out of Chicago?

Is there a reason lawyers always have to get out of places??

Joking, joking

 

tell me, I married into a whole family of lawyers, then there are lawyers on my side and I went to Law school, though I never practiced law.

 

 

BTW she is single, never married and just bought her first car and single family house. She is a partner in the firm.

[ArtK78]

Anyway, I recall the client complaining about a gift his mother had given him. She wrote him a check for, if memory serves, some $300,000 and his complaint was that he had to pay tax on it.

Mike, if the client was a US citizen, he had the gift tax law backward. The recipient of the gift does not pay the tax - the person making the gift pays the tax.

 

The reason for this is that the estate tax law and the gift tax law are part of a unified structure. One can pass wealth from generation to generation by making gifts during lifetime and by making gifts at the time of death by will or otherwise. It is the privilege of transferring property from generation to generation that is being taxed. The US federal estate and gift taxes provide for a unified system. Under current law, an individual can transfer up to $5,430,000 (2015) before paying any gift or estate tax. I assume that the incident that you are referring to occurred a number of years ago. As recently as 2001, the amount that one could pass by lifetime gifts or gifts at death was "only" $675,000. So, it is quite possible that a very wealthy family would have to pay gift tax on a gift of $300,000 from mother to son if there were significant prior gifts. But, again, it is the one making the gift that pays the tax, not the one receiving the gift.

 

There was a concept of a net gift - the gift made was net of the gift tax. This would involve a circular computation, since the amount of the tax removed from the gift would reduce the amount of the gift, thus reducing the tax, and on and on. It would be one of the few times that one would use algebra in computing a tax liability. I don't know if this concept still exists, as I have not heard it being discussed in years. I wrote a research paper on the subject of net gifts in law school. So, if the client received a net gift, he might think that he was paying the gift tax.

 

[Trinidad]

Except for estate taxes, where really the tax is on money being transferred from one person to another, have we ever done this? Do other countries do this?

Yes, I would say it is actually quite normal. To be precise, in the Netherlands the rate is that you pay 1.2%* of tax over the wealth that exceeds € 21 330 (US$ 24 755) (the tax exemption for 2015).

Excluded from this wealth are:

- The value of your first home

- The value of property in normal use (your car(s), laundry machine, clothes, laptop, you get it.)

- Any money in government based social security

- Any money in the pension system. (which is built up in collective, private funds where employers and employees are allowed to put money, up to a given amount, from the gross income, which is deductable for income taxes.) The pension will pay out its benefits, in essentially the same amount (perhaps corrected for inflation) each year, after the age of 67.

- Certain insurances

 

 

So, every year, banks report to the individual tax payer, and the tax office, how much wealth each tax payer has in:

checking accounts

savings accounts

stocks

bonds

mutual funds

options

etc.

 

(I am no financial expert)

 

In addition, each city annually appraises the value for all property. (City taxes are calculated based on the value of property. People with an expensive home pay more city tax than people with a a cheap house or renters. That is fair since a large part of the city taxes go into protection against flooding: the more you have to protect, the more tax you pay.) So, if the property is not your first home, you will pay tax on its value.

 

Rik

 

* The official wording of the tax code is that it is a tax on income from wealth, supposed to tax interest, dividends, etc. So, officially, the tax code says that you are expected to get a 4% return on all your assets or investments. (This 4% is fixed and does not change with the markets, the economy, or the type of investments you make.) This return is taxed at a fixed rate of 30%, translating into a tax rate of 1.2% per year on the value of your assets that exceeds the exemption.

But since the 4% and 30% are fixed, nobody views this as a tax on income, since there is no relation between the actual interest or dividend that was obtained and the amount of tax that needs to be paid. In practice this means that -at the current interest rates- people pay more taxes on their savings (exceeding the exemption) than they get in interest. Given that currently the interest rate on a savings account is 1%, this means that the income from interests above the exemption is taxed at a rate of 120%.

[blackshoe]

rich people exploit the loopholes to avoid paying tax on their investment income is his (accurate) point i think.

Obama should know. After all "rich people" includes him, does it not?

[blackshoe]

Yeah, those poor top 1%, they will be starving soon.

Clearly being financially successful is reprehensible and should be punished.

 

See, two can play this game.

[Trinidad]

Clearly being financially successful is reprehensible and should be punished.

 

See, two can play this game.

As MikeH has pointed out, taxes are not punishments. Taxes provide the infrastructure of our society.

 

The more you own, or the more income you have, the more you use this infrastructure. So, it is only fair that people who own/earn more, pay more in taxes, since they benefit more.

 

Note that this argument does not contain any moral or social reasons why the rich should be taxed more than the poor. It is a pure cost/benefit, let me call it "free market", argument.

 

When the rich are taxed at a lower rate than the poor (since the rich can exploit constructions that are unavailable to the poor) this simply means that the rich are paying less than their fair share: The poor are net facilitating the accumulation of wealth by the rich by financing the infrastructure that the rich use to accumulate their wealth.

 

Now, I know that you are not into socialist ideas of the rich helping the poor, but I find the idea of taxing the poor to help the rich get richer alien, if not -to use your word- "reprehensible". And I think that some rich, financially successfull people, such as Warren Buffet, agree with me on this.

 

Rik

[PassedOut]

Obama should know. After all "rich people" includes him, does it not?

Not according to Forbes. I understand his assets are under $10M and his Chicago home is mortgaged. Comfortable, for sure, but not rich by a long shot.

[Vampyr]

Not according to Forbes. I understand his assets are under $10M and his Chicago home is mortgaged. Comfortable, for sure, but not rich by a long shot.

 

I guess his assets are well under $10M if he is not rich!

[Trinidad]

Not according to Forbes. I understand his assets are under $10M and his Chicago home is mortgaged. Comfortable, for sure, but not rich by a long shot.

So, if Obama would live in the Netherlands (and his assets would be $10M) he would pay:

 

$10 000 000

$       24 755 -

$  9 975 245

                  1.2% x

$     119 702

 

in tax over his assets in 2015.

 

Rik

[Mbodell]

Mike, if the client was a US citizen, he had the gift tax law backward. The recipient of the gift does not pay the tax - the person making the gift pays the tax.

 

Right, I'm pretty sure this is a US/Canadian difference. In Canada the person receiving the money/inheritance owes taxes on it (potentially). In the US it is the giver (potentially).

 

The OP question about Obama was definitely talking about primarily the stepped up basis that Barmar accurately described (although note in Obama's proposal it would only be once you clear a certain amount of capital gains would you have to worry about this - again just the very, very rich. See here for more). From the accompanying slides you can see that:

 

Closing the "Trust fund loophole" will raise $210 billion dollars (possibly including raising the top bracket capital gains rate to the 28% that it was under Reagan instead of the 23.8% it is currently). You can see that:

 

81% of that $210 billion - $170.1 B - come from the top 0.1% of families.

18% - $37.8 B - come from the rest of the top 1%.

And the last 1% - $2.1 B - come from the rest of the top 5%.

 

Note based on 2012 numbers:

 

Top 0.1% average net worth $72.8 million (every family worth >= $20.6 M is in the top 0.1%; these folks own 22% of all the wealth)

The rest of the 1% average net worth is $7.29 million (every family worth >= $3.96 M is in the rest of the top 1% - taken as a whole the top 1% average $13.84 million net worth; these folks own 19.8% of all the wealth - 41.8% if you count the top 0.1% with the rest of the top 1%)

To make the rest of the top 5% you need about $1.4 million net worth.

[ArtK78]

The stepped up basis loophole was closed in the repeal of the Estate Tax in 2010. When the Estate Tax was brought back in 2011, the stepped up basis came back as well.

 

There have been attempts to eliminate stepped up basis in the past. None has survived.

[barmar]

Obama should know. After all "rich people" includes him, does it not?

POTUS's finances are kept in a blind trust while he's in office. So he has no way of knowing. :)

[kenberg]

Ok, I will trust that Obama meant what barmar and Mbodell says he meant.

 

Might he have been clearer? I don't know, and I have no reason to learn, what "stepped up basis" means. When someone says he is going to close the loopholes on the tax on accu,ulated wealth, I figure he means something along the lines of what Rik describes in the Netherlands. Or really, I have no idea what he means. It could be of interest to survey members of congress and find out how many of them know what "stepped up basis" means, but anyway I don't know what it means and I had no idea that was what was being referred to.As to 1% and 99%, my guess is that at least well over 90% of the audience also had no idea what was meant. But of course closing loopholes always gets applause. Who could object to closing loopholes.

[aguahombre]

1a : a small opening through which small arms may be fired b : a similar opening to admit light and air or to permit observation

 

I can think of a few people who might object to closing loopholes.

[ArtK78]

Ok, I will trust that Obama meant what barmar and Mbodell says he meant.

 

Might he have been clearer? I don't know, and I have no reason to learn, what "stepped up basis" means. When someone says he is going to close the loopholes on the tax on accu,ulated wealth, I figure he means something along the lines of what Rik describes in the Netherlands. Or really, I have no idea what he means. It could be of interest to survey members of congress and find out how many of them know what "stepped up basis" means, but anyway I don't know what it means and I had no idea that was what was being referred to.As to 1% and 99%, my guess is that at least well over 90% of the audience also had no idea what was meant. But of course closing loopholes always gets applause. Who could object to closing loopholes.

Well, you may not have any reason to learn what stepped up basis means, or you may but just don't know that you do.

 

Under current US tax law, when a person dies, his or her property is inherited by the heirs with a tax cost equal to the fair market value of the property on the date of death. The tax cost is also known as the "basis" of the property. The basis of the property is the starting point for determing gain or loss on the sale of the property. If one sells 10 shares of IBM stock for $1,000, and the original price paid for the 10 shares of IBM stock (the "basis" of the IBM stock) was $500, one has a gain of $500 on the sale.of the IBM stock. However, if one inherited the stock from someone who died one month ago, and the value of the stock was $990 on the date of death, the gain on the sale of the stock would be only $10. It doesn't matter that the person who died bought the stock for $500 many years ago. The basis of the stock for the heir is "stepped-up" on the death of the previous owner. The potential capital gain in the hands of the original owner disappears upon his death, and his heir gets the stock with a basis equal to the value on the date of his death.

 

Basis can also be "stepped-down" if the value of the stock on the date of the decedent's death is lower than what the decedent paid for it. But it is unusual for that to happen, as prices tend to rise over time. So we usually refer to basis being stepped-up upon the death of the decedent.

 

So, if this is the loophole that Obama was referring to, then he intends to eliminate the step-up in basis and have the heirs inherit the property of the decedent with the same tax cost as the decedent had. This will result in more capital gains on the sale of the decedent's property by the heirs.

[Vampyr]

I don't know much about this sort of thing, but wouldn't a law like this encourage people to keep as much of their assets as they can in cash? Wouldn't this discourage investment?

[kenberg]

Thanks Art. In fact I do appreciate this and I will think about it. Being 76, I imagine it is none too early to think about it. My eyes usually gloss over as soon as I try, political speeches like the State of the Union have the same soporific effect, but maybe I can get past that. .

 

My early life was such that I could remain blissfully ignorant of such matters. My father died in 1977 (my mother in 1963) and the amount of money involved was of no interest to the IRS. To a pretty fair degree this applied to my wife's parents as well, although there was somewhat more. We don't have to worry about which of our kids (I have two, she has three) gets the non-existent yacht, but I suppose the IRS will take some note of our passing.

 

We have not completely ignored the fact we will someday be dead, We have set up a trust, we have chosen who will handle matters afterward, but I suppose it wouldn't kill me to learn more. The kids, I am pleased to say, take care of themselves (with the occasional stumble) but there is no point in enriching the government, that is so.

 

Anyway, thanks for the useful comments.

[ArtK78]

I don't know much about this sort of thing, but wouldn't a law like this encourage people to keep as much of their assets as they can in cash? Wouldn't this discourage investment?

Exactly the opposite.

 

If one has cash, one gets no return (other than interest earned on an interest bearing account). One pays income taxes on the interest during lifetime, and then, upon death, the heirs get the cash.

 

But if one has investments in property which appreciate over time, one does not pay income tax on the appreciation until the investment is sold. If one never sells the investment, the heirs will inherit the investment and they will never have to pay the tax on the appreciation, as their basis - their tax cost - will be the fair market value of the investment at the time of death of the previous owner.

[Vampyr]

Exactly the opposite.

 

If one has cash, one gets no return (other than interest earned on an interest bearing account). One pays income taxes on the interest during lifetime, and then, upon death, the heirs get the cash.

 

But if one has investments in property which appreciate over time, one does not pay income tax on the appreciation until the investment is sold. If one never sells the investment, the heirs will inherit the investment and they will never have to pay the tax on the appreciation, as their basis - their tax cost - will be the fair market value of the investment at the time of death of the previous owner.

 

OK, I guess I misunderstood. I was under the impression that the proposal was that the basis be the purchase price of the previous owner.

[ArtK78]

OK, I guess I misunderstood. I was under the impression that the proposal was that the basis be the purchase price of the previous owner.

There is no proposal at present. Some are speculating that the proposal might be to replace stepped-up basis with carryover basis (the basis in the hands of the beneficiaries would be the same as the basis in the hands of the decedent).

[Mbodell]

I think Vampyr was talking about the proposal and ArtK78 was mainly talking about the current law.

 

But note even in the proposal it is favorable to have investments. The capital gains could be worked out each and every year, because if you own 1,000 shares of IBM at $100 at the start of the year and they are worth $125 at the end of the year then you've gained $25,000 in value. That's a positive return, and that is good. Normally, when you do things that cause your net worth to go up (work for wages for most people), you have to pay income tax on that. If IBM had instead of raised its price from $100 to $125 kept its price at $100 and given each share holder a $25 dividend, you'd have had to pay income taxes on that. So by instead retaining profits and increasing the value of the stock you can mostly avoid paying taxes each year, and you can actually help control when taxes need to be paid by controlling when you sell the shares. If you are in the 0.1% you might have your $70M net worth largely in stock positions that rise like this, and may never (or basically never) need to sell your stock - especially since the stock likely does kick out a few percent dividend along the way (in the long run you probably get ~2-3% in dividends and ~4-5% in real increases in value of the shares - on $70M that works out to $1.5 M in income and more than $3M in real capital appreciation each year - obviously with potentially high volatility).

 

Being allowed to defer needing to pay capital gains each and every year (the way you would with most other forms of net-worth-appreciation) is an advantage. Saying that at death you are forced to pay these capital gains, or at very least the people who inherit are required to pay the gains when they sell, means you can't escape with never ever needing to pay taxes on these gains.

 

Note again, that there are very large exclusions on these capital gains requirements at death in the proposal (similar to the very large exclusion for estate tax in general).

 

To ensure that it would impose neither tax nor compliance burdens on middle-class families, the President’s proposal includes the following protections:

 

* For couples, no tax would be due until the death of the second spouse.

* Capital gains of up to $200,000 per couple ($100,000 per individual) could still be bequeathed free of tax. Note that, since capital gains generally represent only a fraction of an asset’s value, this exemption would allow couples to bequeath more than $200,000 without owing taxes. The exemption would be automatically portable between spouses.

* In addition to the basic exemption, couples would have an additional $500,000 exemption for personal residences ($250,000 per individual). This exemption would also be automatically portable between spouses.

* Tangible personal property other than expensive art and similar collectibles (e.g. bequests or gifts of clothing, furniture, and small family heirlooms) would be tax-exempt. In addition to avoiding any tax burden on these transfers, this exclusion would prevent families from having to value and report them.

 

As a result of these provisions, only a tiny minority of small businesses could possibly be affected by the repeal of stepped-up basis. However, the President’s proposal also includes extra protections that ensure no small family-owned business would ever have to be sold for tax reasons:

* No tax would be due on inherited small, family-owned and operated businesses - unless and until the business was sold.

* Any closely-held business would have the option to pay tax on gains over 15 years.

[barmar]

Ok, I will trust that Obama meant what barmar and Mbodell says he meant.

 

Might he have been clearer?

As I understand it, the SOTU speech is not where he goes into detail, it's just broad outlines and sound bites like this. The details will be in bills that he proposes to Congress. Also, he's going around the country making followup speeches, where he fills in the gaps.

 

I didn't watch the speech, I learned about this particular detail on the news before the speech even aired. The White House had already leaked information about what Obama would be proposing this year, and that's where I heard that he was proposing various tax changes, including this one.

[ArtK78]

I think Vampyr was talking about the proposal and ArtK78 was mainly talking about the current law.

 

But note even in the proposal it is favorable to have investments. The capital gains could be worked out each and every year, because if you own 1,000 shares of IBM at $100 at the start of the year and they are worth $125 at the end of the year then you've gained $25,000 in value. That's a positive return, and that is good. Normally, when you do things that cause your net worth to go up (work for wages for most people), you have to pay income tax on that. If IBM had instead of raised its price from $100 to $125 kept its price at $100 and given each share holder a $25 dividend, you'd have had to pay income taxes on that. So by instead retaining profits and increasing the value of the stock you can mostly avoid paying taxes each year, and you can actually help control when taxes need to be paid by controlling when you sell the shares. If you are in the 0.1% you might have your $70M net worth largely in stock positions that rise like this, and may never (or basically never) need to sell your stock - especially since the stock likely does kick out a few percent dividend along the way (in the long run you probably get ~2-3% in dividends and ~4-5% in real increases in value of the shares - on $70M that works out to $1.5 M in income and more than $3M in real capital appreciation each year - obviously with potentially high volatility).

 

Being allowed to defer needing to pay capital gains each and every year (the way you would with most other forms of net-worth-appreciation) is an advantage. Saying that at death you are forced to pay these capital gains, or at very least the people who inherit are required to pay the gains when they sell, means you can't escape with never ever needing to pay taxes on these gains.

 

Note again, that there are very large exclusions on these capital gains requirements at death in the proposal (similar to the very large exclusion for estate tax in general).

 

 

Where did you find this proposal?

 

This idea, in various forms, has been around for quite some time. It would reduce the advantage of investments for higher wealth individuals, but it would not eliminate them.

[kenberg]

As I understand it, the SOTU speech is not where he goes into detail, it's just broad outlines and sound bites like this. The details will be in bills that he proposes to Congress. Also, he's going around the country making followup speeches, where he fills in the gaps.

 

I didn't watch the speech, I learned about this particular detail on the news before the speech even aired. The White House had already leaked information about what Obama would be proposing this year, and that's where I heard that he was proposing various tax changes, including this one.

 

Compare the statement about taxing accumulated wealth with the statement about community colleges. He said that he wants to reduce the cost of attending community colleges to 0. Now it is true I don't know exactly the details of this, presumably the students still have to pay for their own books for example, but basically I understand it. I had no understanding at all of what taxing accumulated wealth meant. I understand from your explanation, which I accept until I hear otherwise, that he was referring to the transfer of wealth to heirs at the time of death.

 

I can imagine he was being intentionally vague since I suppose if he were more precise we would then be talking about death tax and all of that. But if he wanted to be vague, I would have preferred that he be even more vague. eg "The rich have too much going for them, I plan to address that". As he presented it, I understood him to mean what Rik says happens in the Netherlands. Apparently that is not at all what he meant, but I think it is very reasonable for me and others to draw this conclusion from his words. Or the more cynical conclusion that what he says is blah blah blah, one blah as good as another blah, why bother to listen. Becky didn't. And you didn't. Good choice, I would say.

 

Added: Obviously it is time for me to let this go and I will. It was a speech, not anything that anyone should take seriously. But I really was stunned by what I thought that he was saying.

[Mbodell]

Where did you find this proposal?

 

This idea, in various forms, has been around for quite some time. It would reduce the advantage of investments for higher wealth individuals, but it would not eliminate them.

 

There is a lot of information about the proposal online. This wasn't a top secret new thing in the speech, the white house had been seeding the ground for the speech with releases of information about these programs over the past week. For instance http://www.whitehouse.gov/the-press-office/2015/01/17/fact-sheet-simpler-fairer-tax-code-responsibly-invests-middle-class-fami is a press release with many of the details of the plan. You don't need to have an official draft of a legal bill in order to know there is in fact a concrete proposal. You can like it or hate it, and if the proposal were to be passed it would undoubtedly be negotiated over anyways (and basically zero chance of passing a republican congress), but there really is a specific proposal. There are a number of news reporting and opinion articles pro-, anti-, and just analyzing the proposal online.