Private Wealth

March 2011 issue

Taxed To The Limit

Despite the recent federal tax compromise, many rich Americans still feel they’re being asked to surrender too much of their wealth to Uncle Sam.


At a 2007 fundraiser for Sen. Hillary Clinton’s presidential campaign, Warren Buffett took aim at a U.S. tax system that would allow him to pay a lower tax rate than that of his secretary and house cleaner.

Noting that he was taxed at a capital gains rate of 17.7% on the $46 million he made the previous year, while his secretary was taxed at a rate of 30% on $60,000, he told the crowd, “If you’re in the luckiest 1% of humanity, you owe it to the rest of humanity to think about the other 99%.”

Many in that 1% grouping may beg to differ. While many wealthy individuals are charitable and philanthropic, there’s no evidence that they’re chomping at the bit to pay more in taxes. If they’re going to make charitable donations, many say they’d rather do it themselves than give it to the government to dole out.

“We look at Washington and see enormous inefficiencies and are not willing to feed our hard-earned income into that inefficient system,” says Robert Fragasso, president of Fragasso Financial Advisors in Pittsburgh, and a wealthy individual in his own right.

Not surprisingly, those who believe America’s richest should pay more are those who earn less. A Quinnipiac University poll conducted a year ago found that 60% of Americans think the Obama administration should repay the gaping budget deficit by raising taxes on those who make $250,000 or more. Apparently, however, someone forgot to convey this wish to Congress. In December, a month after his party suffered historic losses in Congress, President Barack Obama signed a compromise tax bill that extended the controversial Bush-era tax cuts—the biggest beneficiaries of which were the wealthy. The package, brokered by Obama and Republican leaders, angered many progressive Democrats, but their efforts to scale back the bill’s benefits for taxpayers at the highest income levels failed, and the measure passed with bipartisan support.

Despite the eleventh-hour win, many wealthy individuals still believe tax rates in the U.S. are too high, says Kathy Boyle, founder and president of Chapin Hill Advisors, a financial planning firm in New York.

“We hear a lot of anger, we hear a lot of frustration, especially in states like New Jersey,” Boyle says. “Gov. Chris Christie has taken a lot of heat for things like cancelling the tunnel project, but the people who live in New Jersey who are high-net-worth are applauding him.”

Boyle says she has baby boomer clients who have made a lot of money and have fixed costs of about $500,000 to $600,000 a year, and they resent that their tax bills are eating into their income.

“They’ve created this lifestyle, and they don’t like that they’d have to cut back in their 60s because the government is trying to get a bigger piece of what they earned,” she says. “A lot of them are just saying, ‘I’m going to keep my income under $250,000.’ I hear this from a ton of people.”

These are people in the $10 million range, with multiple homes and Porsches, she says. They’re concerned they haven’t made back what they lost in 2008. She’s watching them rein in their philanthropic dollars, sell their jets and consider getting into shared jet arrangements, even pulling their kids out of Montessori schools. One client, with a net worth of $100 million, let one of his golf memberships go. Another, who had $40 million to $50 million in net worth, made a large gift of $7 million to $8 million to his college alma mater, and he had to go back and ask them to agree to an installment plan. Boyle says she has two clients who are executives-turned-handymen, who used to do work for wealthy families in Westchester and Long Island, N.Y., and both have said their estate-type clients are no longer calling. Some have had to put off selling the house and move to a lower-tax state for retirement because their adult children have moved back home.

That’s not to say all rich people are displeased with U.S. tax rates. Timothy Speiss, who heads the personal wealth advisors practice at EisnerAmper LLP, a financial accounting and advisory firm based in New York, says a lot of his rich clients don’t see U.S. tax rates as that onerous.

“Income tax rates and estate tax rates are the lowest they’ve ever been. I think it’s odd that people are asserting they don’t like U.S. tax rates,” he says.

Indeed, up until the late 1970s, U.S. income tax rates were as high as 70%. Now, the top end is near 35%. And capital gains rates, which have brushed up against 40% several times in the last 50 years, are now just 15%.

“Our clients simply want to be advised on how to use the rules to their proper advantage,” he says. “The only frustration I’ve heard is why did we come to the eleventh hour with this tax legislation. And they don’t want to have to go through it again in two years.”

Jonathan Crystal, who is one of Speiss’ wealthy clients, says most affluent individuals are more focused on what their tax obligation is, and how to best address it and be in compliance.

“I think it’s a red herring to suggest that this whole group of individuals has an emotional reaction to taxes,” says Crystal. “There may be a group of people out there foaming at the mouth about the current tax environment, but that’s not been our experience working with the clients we work with.”

Crystal, executive vice president at Frank Crystal & Co., a national insurance brokerage firm, says the conversations he has with his wealthy clients are much more about planning and structuring than about reacting emotionally, he says. They have the resources to get good advice and take a long-term perspective.

Of course, the wealthier the individual is, the more incidental their tax bill becomes.

“The $10 million-plus crowd has the luxury of objectivity,” says Evan Kirkpatrick, senior investment consultant at LBG Advisors LLC, a boutique financial services firm in Lynwood, Wash. “They’re not as close to the income tax thresholds to the point where they’re keeping tabs on taxes.”

Paul Hokemeyer, an attorney and a family therapist who works with high-net-worth individuals in New York City, says the way the wealthy feel about paying taxes largely comes down to whether their money was earned or inherited. The psychology of each can be quite different, he says.

Those who inherited their wealth look at themselves as stewards of money they did not earn, and that part of their journey in life is figuring out a way to make the best use of the wealth they were given. They tend to be more philanthropic and socially conscious and feel a heightened sense of social justice and helping others, he says.

“There are a lot of people with inherited wealth who have a sense of guilt around it. Some of them are really uncomfortable with it,” Hokemeyer says. “They’re looking for ways to feel better about their wealth.”

Those who earned their money, on the other hand, tend to operate more from a sense of scarcity, he says. There’s a constant sense that there’s not enough and that they will lose their wealth, so they’re not as comfortable or generous in terms of paying taxes, Hokemeyer says.

“They tend to look for ways to avoid paying taxes, and they’re not as philanthropic,” he says.

Alexander A. Maguire Jr., a financial advisor with Adare Asset Management LLC in Wayne, Pa., doesn’t necessarily agree. While the wealthy may want to give back, they don’t necessarily want to do it through taxes, he says.

“Obviously, there are the Warren Buffetts out there who champion the idea of higher taxes as a way to give back. From what I’ve seen with this crowd, they want to give back but not in the form of higher taxes. They want to do it with charitable giving,” he says.

Not only would they rather finance their own charitable giving—instead of paying taxes to the government for social programs—but some would rather have the private sector finance the economic recovery, Maguire says. Some affluent Americans don’t want to give their money to the government because they simply don’t believe Washington will spend it effectively. Job growth, for instance, is better handled by the private sector, Maguire says, where the jobs tend to be long term.

Government-created jobs, like census work or those related to stimulus-financed transportation projects, are short term, perhaps lasting six months.

“Investment in the private sector, by anyone, particularly the wealthy, will drive job growth,” he says. He points to a product created by his company that invests in North Carolina community banks. The product helps raise capital for the banks, which, in turn, lend out money that fuels the economy and eventually helps create jobs, he says.

In fact, many were worried that if the capital gains tax rate rose, as it was supposed to do prior to the passage of the new tax legislation, it might hinder the economic recovery further. Maguire says he knew a lot of people running money in the 1960s, ‘70s and ‘80s who didn’t want to sell their positions because capital gains rates were too high. The same thing happened last year, as managers and investors feared the capital gains rates were going to rise, he says.

“People think, if I give away 28% of my position, I have to do that much better in my new position. So they wind up saying, I’m just going to keep that position,” Maguire says.

When the government raises rates, wealthy investors often find ways to get around those hikes, and money is sometimes diverted into projects that serve only to lower one’s tax bill and do no one any good, says Fragrasso. In the early 1980s, for instance, wealthy investors poured money into tax-advantaged limited partnerships, many of which provided little benefit to society, he says. In the southwest, for instance, acres and acres of office buildings were built because people wanted to take advantage of the tax benefits, and it took ten years to soak up all the supply.

“They weren’t built on viability. They were bought by wealthy individuals looking to redirect tax dollars. That’s not good for the economy,” Fragasso says. “No responsible person rejects the obligation to pay taxes. It’s the arbitrary decision-making that seems to go behind some of the tax code and seems to go way beyond funding the legitimate forms of government.”

It’s counterproductive for the government to tax people earning more than $250,000, says Thomas Belesis, CEO of John Thomas Financial, a broker-dealer in Manhattan. He says if he paid less taxes, it would give him an incentive to go out and invest more in his business, and that, in turn, would help the economy and spur job growth.

“This is the United States. People who make money should pay taxes. But it should be reasonable. There should be a fairer, simpler tax code for everyone, whether you’re making $250,000 and over, or under,” he says. Income taxes, for instance, shouldn’t be higher than 10% to 15%, and capital gains should not exceed 5%, he says.

“All taxes are too high. Even at 15%, capital gains feels too high,” he says, noting that changing the tax landscape so often is almost as bad as having rates too high. “Instead of making decisions to move forward with something, because you know the tax situation, a lot of people are hesitating if not stepping back.”

Richard Carey, president of Stone Legends, an architectural stone supplier in Dallas, says he could actually create jobs if the government didn’t make it so costly for him to hire people. Carey, whose stone company is labor intensive, says his compliance issues have increased, and his unemployment insurance bill has doubled, now that the government allows people to collect unemployment longer. Employees are privy to so many entitlements—potentially more after health care reforms are adopted—it’s difficult to pay for people without passing those costs onto the consumer, which he can’t do if he wants to remain competitive, he says.

“Unemployment insurance, health care insurance, regulatory compliance issues that you must send in, and it escalates the more employees you have. Why are they doing this? A person capable of employing 250 people, and he’s being penalized for hiring them,” he says. “I can create jobs, but I’m being penalized. So where’s my incentive to help the economy?”

Winthrop Baum, a commercial real estate executive in New York, says the government is going about it all wrong. If it truly wants to create jobs, extending unemployment is not the way to do it. Using tax policy to incentivize people to invest in the economy would be more productive, he says. If it reduced the depreciation rates of certain assets, people would be more motivated to invest in those assets, and that, in turn, could spur economic growth.

“If you really want to see a spike in commercial development, reduce the depreciation rate. That would make it more attractive to go out and buy,” Baum says, noting that the current rate at which commercial real estate depreciates is 29.5 years.

To revitalize the economy, the government needs to motivate the people who have the means and the wherewithal to make things happen, and not just those with money, Baum says. It needs to motivate people who have expertise and experience.

“We all want the country to succeed. We believe that we work for our personal benefit and, in return, that personal benefit assists so many other people,” he says. “But when you look at how the money we entrust to the government through taxes is spent, you really have to question whether we’re entrusting the right people.”


Copyright © 2011 Charter Financial Publishing Network Inc. All rights reserved.