Note: This article was written prior to Clinton's inauguration and was based on his campaign documents. The actual tax legislation signed in 1993 bears scant resemblance to Clinton's original campaign proposals.
President Clinton has promised to jump-start the economy with a complex, interrelated combination of government programs and tax reform. Clinton has also vowed to reduce our annual federal deficit by 50% over the next four years. Taxpayers need to consider the tax and investment ramifications, since both tax increases and tax incentives are major components of his economic plan.
Clinton plans to pay for his new programs by increasing taxes for wealthy individuals and foreign corporations, and decreasing defense spending and other programs. To stimulate the economy, Clinton will provide tax deductions and credits specifically targeted for domestic job creation. He strongly believes the federal government should invest in rebuilding the country's infrastructure (roads, bridges, and optical fiber cabling) and in retraining the country's work force to effectively compete with German and Japanese workers.
Clinton believes that:
To a large extent, the income of wealthy taxpayers depends on the economy: An expanding economy generally increases their income. But how much must the economy expand for a taxpayer with $300,000 in AGI to off-set Clinton's higher tax proposal? As it turns out, not much! An income increase of only 2.6% will off-set the higher taxes. In general, most wealthy taxpayers should be better off if Clinton's proposals revive the economy, despite a rise in their marginal tax rates.
Individuals whose taxes will increase under Clinton's proposal should consider accelerating income into 1992. Year-end bonuses, distributions from retirement plans and other lump-sum payments should probably be received in 1992. Also, businesses operating on the cash basis method of accounting should expedite their receivables collection. When marginal tax rates rise, tax-free investments such as municipal bonds become more attractive. For instance, a municipal bond that yields 6% per annum produces the after-tax equivalent of an investment earning 9.3% per annum, and is subject to the proposed 36% tax bracket.
Although accelerating income into the current year appears to be a sensible precaution, the effect of deferring deductions until 1993 is uncertain. Clinton discussed raising the marginal tax rate to 36% on AGI's over $200,000. Under the current tax law, taxes are calculated on taxable income, not AGI. Currently, AGI is the sum of all income categories, minus contributions to retirement accounts. AGI does not include itemized deductions (medical expenses, state tax, mortgage interest, charitable deductions) and dependency exemptions (currently $2,200 per dependent). Therefore, if Clinton is serious about calculating a tax based on AGI rather than taxable income, then deferring itemized deductions to 1993 will not off-set the higher marginal tax rates. Business deductions, however, will reduce AGI, and wealthy taxpayers engaged in businesses should defer these expenditures until 1993.
Those taxpayers earning less than $200,000 per year (99.4% of all taxpayers), the good news is that their taxes should not be raised. Those earning $60,000 or less, may receive a modest tax cut. There are, however, several intriguing tax incentives in the Clinton plan, including investment tax credits and capital gains deductions that could provide an immediate boost to the economy.
Clinton favors a 10% investment tax credit for investments in new factories and equipment. For example, if a company invested $100,000 in a new computer, it would receive a credit of $10,000, applied directly against its tax liability. Since the credit will reduce federal revenues and, therefore, could increase the federal deficit, the credit will be focused only on those investments that will produce jobs.
Clinton also favors a capital gains tax deduction of 50% for long-term investment in new enterprises. For example, an original purchase of stock in a new enterprise (defined as a business with $5 million or less in capital), which is then held for 5 years, would be entitled to a 50% deduction. So if you purchased stock in a new enterprise for $10,000, held it for 5 years and then sold it for $100,000, the $45,000 gain (50% of the $90,000) would be excluded from taxation.
After the Tax Reform Act of 1986 ("TRA 86"), many small corporations elected "S" corporation status (income and losses of an S corporation are reported by the shareholders, not the corporation) since the individual tax rates were lower for individuals than for corporations. Prior to the TRA 86, corporations often used their lower corporate tax brackets to accumulate profits, rather than to distribute those profits to the shareholders.
Under the Clinton proposal, the individual tax rate will once again be higher than the corporate tax rate, individuals earning over $1 million may be subject to a 10% surtax, and corporations that pay their CEO's over $1 million in salary might not be permitted to deduct the excess over $1 million. This combination may cause small corporations to switch from operating as S corporations to operating as regular taxpaying corporations to accumulate income in their corporations. These corporations may want to consider increasing benefits to shareholder-employees, rather than paying salaries of over $1 million.
Corporations that are concerned about the $1 million deduction limit on payments to their CEO's, however, may want to operate as S corporations, since corporate earnings are taxed directly to shareholders, where the $1 million deduction limitation would not apply. Undoubtedly, the decision whether or not to operate as an S corporation will involve a great deal of number crunching.
The Clinton administration will attempt to use the tax law to stimulate the economy and create jobs. Because of the huge deficit and Clinton's promise to reduce the deficit by 50% over the next four years, tax incentives will be applied sparingly and for narrowly prescribed purposes. This approach will renew the debate as to the ability of government to fine-tune and direct the economy through tax policy. Whether it will succeed will be proven with time.
| Home | Search | E-mail | Firm Profile |
**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**