100 Taxing Years Later (Many Times Greater)

In 1913, the 16th Amendment to the Constitution, in an effort to fund a war, made the income tax a permanent fixture in the U.S. tax system. The amendment gave Congress legal authority to tax income and resulted in a revenue law that taxed incomes of both individuals and corporations.

Over the last one hundred years the tax code has become much more complicated. The number of words in the first tax law was 9,337. In 2010, the number was 3,800,000. Our leaders have obviously been busy!

To further complicate a complex system, the Senate waited until January 1, 2013 to pass a tax law that affects every American in some way. Here’s a recap of what to expect.

Affecting the majority of working Americans.
The elimination of the temporary payroll tax cut means you will take home a smaller paycheck. The payroll tax cut reduced the employee portion of the Social Security tax to 4.2 percent in 2011 and 2012. This year the employee portion reverts back to 6.2 percent. A worker earning $50,000 can expect to take home $1,000 less
in 2013.

Affecting the wealthy.
If you are fortunate enough to have a taxable income greater than $450,000 (or single filers above $400,000) you can expect a higher marginal income-tax rate. The top marginal income-tax bracket has increased to 39.6 percent. Previously the highest bracket was 35 percent. These same filers will also pay more in capital gains taxes. The top capital gains rate has increased to 23.8 percent. This is up from last year’s 15 percent.

The wealthy are hit again on deductions. Those making more than $300,000 ($250,000 for single filers) will see their deductions and personal exemptions phased out. On a positive note, the Alternative Minimum Tax (AMT) threshold will now be adjusted for inflation.

The Alternative Minimum Tax was originally designed to make sure wealthy Americans were not using loopholes to avoid paying taxes. AMT knocks out a lot of exemptions, deductions, and credits forcing those affected to pay a minimum amount of tax. Previously the law was not automatically updated for inflation and every year more and more Americans were being hit by this limiting tax.

Estates over $5 million can expect to pay 40 percent in estate taxes. Last year the estate tax rate was 35 percent. This is of course after the $5 million Estate Tax Exemption.

Some good news.
The child tax credit has been extended. This is a great benefit to families with children and can mean up to $1,000 in tax credits.

Unemployed workers will continue to receive benefits.

Contribution limits.
There are few ways for wage earners to reduce their tax liability. One way to help now and when it comes to retirement is making contributions into qualified retirement plans. If you have a company sponsored retirement plan such as a 401(k) or 403(b) you can make a maximum contribution of $17,500 in 2013. If you are 50 years or older, you can make an additional contribution of $5,500.

Traditional IRA and Roth IRA contributions have also increased this year. You can make a maximum contribution of $5,500. Those over 50 can make an additional contribution of $500.

It took a great deal of political posturing and arguing for our elected officials to come to agreement on this recent tax law. Let’s hope they are more open minded and courageous when it comes to what may be this country’s greatest hurdle—reducing spending. This is only a short recap of the recent tax changes. Please contact our office for additional information or to discuss your individual situation.

Celebrating 100 Years of Taxes!

Dear Valued Clients,

Motivating the citizens of the United States to pay their Federal Income Tax has always been a struggle. Various strategies have been implemented over the years to improve tax collection. Some meant to force tax payers and others to encourage them.

The first income tax in our nation was enacted by Congress in 1862 to help support the Civil War. (Blockades against the ports of the North limited supplies and cut off tariffs.) President Lincoln himself paid $1,296 in 1864 for his income tax. In order to encourage ordinary citizens to pay the government made tax returns public. Americans were encouraged to turn in those they suspected of not paying their fair share.

This Civil War Era income tax was removed ten years after it began, only to be brought back in 1894 until the Supreme Court voted in 1895 that it was unconstitutional.

In 1913, Congress passed the 16th amendment of the U.S. Constitution. This new law created the first permanent income tax in our country. At that time, the highest rate was 7 percent. Five years later the top bracket was at 77 percent. (See the full history of the top brackets in the graphics on pages 3 and 4.)

By the time World War II came, the nation had a serious problem with deficits. Congress was not about to make tax returns public. Instead, the nation turned to Donald Duck who explained to Americans their duty to pay the government: “Taxes to bury the Axis.”

Today, most of us might relate more to Arthur Godfrey who said, “As an American I am proud to pay my taxes. But I’d be just as proud for half as much.” Nevertheless, our nation needs us and so, taxes are here to stay. I hope you enjoy this issue of the Money Moxie® as we “celebrate” the 100th anniversary of the U.S. Income Tax.

James R. Derrick
SFS Chief Investment Strategist

Source: David Kestenbaum, “From Abe Lincoln to Donald Duck: History of the Income Tax,” NPR, 3/22/2012.