Obama’s Proposed Tax Hikes & What You Can Do About Them

This post is in: Business

arrowupPres Obama’s 2011 budget calls for some sweeping tax hikes. Some you’ve already heard about, some are even worse then expected. Here’s a summary with some action items.

High-Income households

Currently, high income is defined as anyone making over $250,000 and married, filing jointly. If you’re single making over $200,000, you’re rich. The Senate Health Care Bill (which is probably dead now), rolled those numbers downward. I suspect we’re going to see more pressure on the re-definition of ‘rich’ in what looks like it will be the new economic normal.

Additionally, Obama calls for:

  • Raise the top two individual income tax rates to where they were in 2001, before passage of the Bush tax cuts. The 33% bracket would become 36%. And the 35% bracket would rise to 39.6%.
  • Long-term capital gains tax rate to increase to 20%, up from 15% currently.
  • Increase phaseouts for high-income households (reducing personal exemption eligibility).
  • Limit itemized deductions: Cap itemized deductions at 28%. Currently the value of a deduction is equal to the deductible amount multipled by one’s top income tax rate. Deductions will be worth less to a high-income tax filer.

1. Calculate your true income tax rate. With deductions limited to 28% and personal exemptions phasing out, the actual effective tax bracket for federal is easily closer to 45% for most Americans making over $250,000. Then add in the state tax plus Social Security and Medicare, and you’re easily knocking at the door of 55% – 60% tax.

2. Move income away from your Form 1040 Individual Income Tax. The C Corporation is going to become more popular as individual income tax rates climb.

3. Self-directed pension plans should be the entities of choice for investments in passive business and real estate. In the right circumstance, you can avoid federal income tax, state tax, Social Security, Medicare and the onerous UBIT penalty that hung up IRAs of old. (UBIT is a separate tax calculated on IRAs or SEPs that use financing. Sole 401(k)s and Solo Roth 401(k)s are exempt from UBIT)

4. Legally convert every itemized deduction you can to a business deduction. For example, mortgage interest and property tax are likely to limited deduction if you itemized. But, if you have a legitimate home office, a portion of the mortgage interest and property tax will move from Schedule A (Itemized Deductions) to your business return.

The President also wants to keep the estate tax. Currently, the estate tax is up in the air. The president’s budget assumes the estate tax will be made permanent at a $3.5 million exemption level per person and a top rate of 45% on taxable estates.

STRATEGY: As soon as we know what’s going to happen with estate tax, get to an estate tax planner. For sure, you want to have a revocable trust, like a living trust, to avoid probate. And most likely the old A-B Trust is going to continue to be an important part of your will. Other than that, most likely most estate plans will need an update.

Eliminate capital gains tax on small business stock: The President wants to eliminate the capital gains tax altogether on stock in small businesses held for at least five years. The measure would only apply to stock acquired after Feb. 17, 2009.

STRATEGY: This is great for the larger small business, or the product based company. Unfortunately most small business or closely held companies sell assets of the company, not the stock of the company. So, there is no tax break here.

Permanently protect the middle class from AMT, the “wealth” tax. The administration assumes in the president’s budget that Congress will permanently change the parameters of the Alternative Minimum Tax (AMT). That would protect tens of millions of middle-income families from having to pay the tax, which was originally intended only for the highest earners.

STRATEGY: Celebrate! This is one provision that I wholeheartedly support!

Extend the Make Work Pay credit: The President’s 2011 budget calls for a one-year extension of the stimulus-created tax credit that adds a few dollars to workers’ paychecks every pay period.

Permanently expand a low-income tax credit: The stimulus package temporarily expanded the Earned Income Tax Credit for very low-income families with three or more children. The expansion meant such families could claim a credit equal to 45% of their qualifying earnings, up from 40%, so that they could get a maximum credit of $5,657.

Expand child-care tax credit: Under the president’s budget, families making less than $85,000 would be able to claim nearly double the child and dependent care tax credit for which they currently qualify.

Permanently extend the American Opportunity Tax Credit: Created under stimulus legislation, the American Opportunity Tax Credit expanded for 2009 and 2010 the existing Hope Scholarship tax credit and made it partially refundable — meaning that a tax filer could get money back even if it meant he or she would be getting back more from Uncle Sam than paid in federal income tax.

The credit is worth up to $2,500 for higher education expenses, up from $1,800 previously.

Overall: Stay alert. Watch the changes and especially make sure your tax advisor is up on this. We’ll be moving our clients to C Corporations, where appropriate, and strongly advising Solo 401(k) plans if it works in the overall scheme.


  1. I’m interested in learning more about the Self Directed pension plans to invest in real estate. I remember hearing about those a few years ago.

    Do you think investing these in real estate is a better plan than having a “normal” IRA or 401(k) invested in mutual funds?

  2. I wrote a book a while ago about them “The Insider’s Guide to Tax-Free Real Estate Investing”.

    In a nutshell, you can do passive investing in real estate. You can’t be actively involved with the property (like fixing the roof).

    The underlying investment decision – stocks versus real estate – is just as good as the investment is.

    But in today’s world of reduced real estate prices, it might make sense to look at real estate. Realize it’s for the long term.

  3. Great…I’m going to look at that book. I read Tax Loopholes for Real Estate Investors a few years ago, but not this one. Thanks!

  4. Lorrie says:

    I heard in the past it is not a good idea to have your self-directed IRA own real estate (maybe because the UBIT?). Is this still the case? If so, by passive investing you mean financing another investors RE project/purchase?

  5. Great question Lorrie!

    I think you might have heard negative about pension investing in real estate for one of three reasons:

    (1) You have to make sure that you’re not actively doing work. So, if you do fix n flip, you can’t be the one doing the flipping. That creates a problem for the do-it-yourselfers who want to invest this way.

    (2) UBIT – which you correctly identified. That problem goes away if you use a Solo 401(k).

    (3) Real estate losses don’t help you tax-wise. That’s a tactic that’s largely gone in today’s market. At that time, people bought properties that didn’t cash flow because everything was appreciating. Meanwhile, they wanted the write-offs on the losses. If you bought with your pension plan, losses don’t help your tax plan.

  6. Vickie says:

    Hi Diane! We are going to be refinancing our home that we have lived in for 23 yrs. We currently have an IO loan and will be getting a 30 yr fixed.I have heard that there are certain closing fees that are negotiable. Do you have a list of these fees? I do NOT want to overpay! Thank You!

  7. Thanks for the question Vickie. I can help you with the taxes, but not sure I can help you with refinancing options. My suggestion is to talk to a mortgage broker (someone who handles multiple lines). He/she may be able to give you a better overview of the options available.

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