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What Should High Net Worth Individuals Do?

Amidst fears of an impending tough tax regime during Obama presidency, tax experts are of the opinion that High Net Worth individuals such as CEOs, Major League Baseball players and other executive officials, who earn in excess of $250,000 annually, should move to protect their assets now and failing to do so would mean losing …

Amidst fears of an impending tough tax regime during Obama presidency, tax experts are of the opinion that High Net Worth individuals such as CEOs, Major League Baseball players and other executive officials, who earn in excess of $250,000 annually, should move to protect their assets now and failing to do so would mean losing millions of dollars in taxable income. Though the busiest season for taxes is usually the spring, it could pick up in the next two months prior to Obama’s inauguration as the new President, tax experts reveal.

Speaking to CE Online, Philip Tortorich, tax expert and attorney specializing in estate planning and tax law, says: “Most immediately, we’ll see our clients looking to get the most from estate tax minimization. That will be true through the end of the year especially as they try to make changes before any major new policies go into effect.”

Similar to Major League Baseball players and other professional athletes, many high net worth individuals are looking for ways to beat a proposed income tax rate hike of about five percent by legitimately shifting as much income into 2008 as possible. This can work particularly well for cash basis taxpayers (taxpayer who reports income and deductions in the year that they are actually paid or received), say experts.

Anticipating stringent tax laws ahead, Tortorich says, with a Democratic-control over U.S Congress and a Democratic Presidential inauguration in the offing, the new tax structure will likely include provisions which will increase the tax rate for the top two income brackets (those who file jointly and have income over $250,000 or those who file individually and have income over $200,000) back to 36% and 39.6% respectively, from the current threshold of 33 percent and 35 percent. This would mean shelling out huge money in the form of taxable income by the high income groups, he says.

President-elect Obama is expected to take a more regulated, Clinton-esque view on family limited partnerships and close any perceived “loopholes” that currently allow clients to transfer assets to minimize their tax burden.

According to Tortorich, one of the crucial aspects of the new tax policy would be the revision of capital gains tax from the existing 15 percent to an enhanced 20 percent, which will have considerable impact on such individuals who are holding appreciated assets.

“Individuals with appreciated assets (or low-basis assets) could also be impacted by the new tax policies as details of Obama’s proposal on capital gains tax show a clear hike of 5 percent. Many clients are already considering methods of intentionally incurring capital gain now in order to lock in the current 15 percent long-term capital gains tax,” Tortorich points out adding that, while this goes against conventional wisdom of deferring tax recognition events for as long as possible, the large potential increase in the tax rate makes it more effective to pay the tax now, says Tortorich.

Interestingly, according to the 2005 returns filed with the IRS, there are as many as 3,550,000 high net worth individuals with an income of over $200,000, who will likely face an increased tax burden in 2009 based on the implementation of the proposed tax initiatives and which is why these HNIs need to bring income into this calendar year, experts point out.

Citing an example, Tortorich explains how the new proposed tax structure will affect an individual categorized as HNI: “For instance if a family sells its business for $50 million and has no basis in the stock of the business, then the capital gain under current law would be $7.5 million.  However, if the new tax proposals become effective, the same family would require shelling out $10 million as capital gain tax, which is in excess of $2.5 million, in comparison to the current existing rates.”  The difference between closing a sale between now and the end of the year could have a substantial impact on the family’s net after-tax realization, says Tortorich.

Additionally, he says, CEOs and executives are looking for ways to report as much of income as possible into this calendar year, so that it can be taxed as per the existing tax policy. “For instance, if a CEO of a company is entitled to some profits bonus, the CEO should see that this bonus is paid to him in 2008 to make maximum out of it. If his bonus is included in the current year’s income, for every $1million in bonus, the CEO will save roughly $50,000 in taxes,” explains Tortorich.

However, Charles Harris, also an attorney specializing in estate planning and tax law says although the new capital gains tax would affect the HNIs in long term , but in the short run it would be mostly meaningless. “The increased capital gains tax can have the effect of preventing high net worth individuals from selling their assets in the long term. However, in the short term, this provision is probably meaningless in that many clients will have capital losses and not capital gains until the market rebounds,” feels Harris.

Given the current economic crisis, Tortorich says, the primary concern for the new administration should be to find workable solutions that hold individuals accountable for triggering economic crisis, at different financial institutions, besides also ensuring that credit markets continue to thrive and operate.  “A bailout without accountability will not work – it is merely a temporary bandage which will not help businesses recuperate from the severe economic crisis,” quips Tortorich. 

Tortorich feels that the tax laws need a comprehensive overhaul to get it universal acceptance across all the taxpayers groups. “The idea of creating different classes of taxpayers is not a precursor to a sound tax policy, ” Tortorich remarks. 

Related Links: 

  1. Obama Presidency Will Have Tax Implications
  2. How will Obama presidency affect your taxes?

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