A Tale of Two Tax Worlds: Obama’s and Romney’s.


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Boutwell, the elder.

We welcome to the Orange Juice Blog our new tax and finance expert who previously commented under the awkward handle TJLocalSA, but will henceforth write under the handle “BOUTWELL,” in memory of [cue Wiki…] George Sewall Boutwell (January 28, 1818 – February 27, 1905) an American statesman who served as Secretary of the Treasury under President Ulysses S. Grant, the 20th Governor of Massachusetts, a Senator and Representative from Massachusetts and the first Commissioner of Internal Revenue under President Abraham Lincoln. Boutwell, an abolitionist, is primarily known for his leadership in the formation of the Republican Party, and his championship of African American citizenship and suffrage rights during Reconstruction. Boutwell, as U.S. Representative, was instrumental in the passage and construction of the Thirteenth, Fourteenth, and Fifteenth Amendments to the United States Constitution.”

Sticking to his areas of expertise as they intersect with the issues that interest us on this political blog, our BOUTWELL takes a comparative look at the recently released 2010 and 2011 tax returns of the two major Presidential candidates.  And … HE’S OFF!  – V.

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It would be fitting that after months of long-winded comments mainly about taxation as well as a few exhausting back and forth, that I write an article about the Presidential candidates’ income tax returns.

After months of interest, Mitt Romney released his tax returns in mid-September, approximately five months after President Obama released his returns. It will be up to everyone to come to their own conclusions about what the figures mean to them, but the numbers are the numbers and the best picture we have of both candidates’ income position. By him also only releasing 2010 and 2011, along with a letter from his Big 4 accounting firm, it will still leave many of us wondering “What is it that he does not want to show us?” So, here goes…

The first thing that sticks out about Romney’s return is the sheer size of it. His 2011 return is 379 pages long of which approximately 280 pages are related to foreign disclosures and investments. The foreign investments obviously are what have struck a chord with so many. The second item is that about two thirds of his income is from investments that benefit from lower tax rates (i.e. capital gains and qualified dividends). These two items are probably the biggest differentiators between most of our tax returns and Romney’s besides the sheer size of the figures reported.

A Tale of Two Tax Worlds

Below is a chart showing Romney and Obama’s tax returns broken down into manageable categories:

[click for slightly bigger image]

I have included wages and Schedule C income as “earned income”; qualified dividends, long term capital gains, short term capital gains if long term is larger than short term as “investment income- qualified”; Interest income, non-qualified dividends, pass-through business income, and rental/royalty income as “investment income- non qualified”. “Other Income” mainly consists of state tax refunds and cancellation of debt income.

Romney’s earned income is all from his Schedule C business for speaking/author income as well as Director Fees from Marriott. Obama’s earned income is his salary for being POTUS as well as his book author income. Note that neither Romney nor Obama have any significant business deductions against their Schedule C business income other than commissions (likely to an agent/broker). This would be quite rare in the real world so they may strategically being quite conservative in taking, or not taking, business deductions. Perhaps if everyone’s tax returns were made public, then taxpayers would not be quite so eager to aggressively take deductions.

Romney’s tax rate is significantly lower than Obama’s which illustrates and magnifies the benefits that our current system has for individuals who are investors rather than earners. Virtually all of Romney’s non-qualified investment income is offset by his itemized deductions meaning that even though he has ordinary income which should be taxed at the highest tax rate, because his itemized deductions are about equal to that type of income, he effectively is paying beneficial qualified investment tax rates on all of his income. Contrast that with Obama who has zero lower taxed investment income (he has a sizeable capital loss carry forward) and as such all of his income is taxed as ordinary taxable income. So, despite both of them having income higher than $1MM, one pays a significantly lower rate than the other.

By the way, all of the above is in reference to federal income taxes and not Medicare, Social Security, Self-Employment Tax, State Income Tax, Sales Tax, Household Employee Tax, etc… Yes, I know that other taxes are also important, especially Social Security Taxes and Medicare.

The Value of Deductions and AMT

There has been a lot of talk about limiting deductions for high income earners, but something that I rarely hear as an option is to perhaps first require deductions to be taken against beneficially taxed investment income and then the remainder against ordinary income, or perhaps a pro-rata scenario. If that were the case, Romney would still get his deductions, but they would just not be worth as much since right now they are fully offsetting his otherwise higher taxed ordinary income leaving him solely paying the lower tax rate on his investment income. Maybe it is something that should be considered although writing this entry is the first time it has really come to my attention to this magnitude. The more I think about it, the more I believe that something should be done in this area.

Both Romney and Obama have been impacted by the Alternative Minimum Tax (AMT). Romney is in AMT primarily due to the size of his itemized deductions for state tax and investment expenses. It is relatively rare for someone with this much income to be impacted by AMT although because he loses approximately $2.4MM of deductions, he now actually has some of his income taxed at 28% (the AMT rate). Without AMT, Romney’s tax rates would be even lower: 9% on AGI and 13.7% on taxable. Again, this simply magnifies the benefits of investment income versus earned income. Obama on the other hand is more impacted by pure math of the AMT rather than a certain taxing regime. He also illustrates that as you earn more, you often earn your way out of AMT. In 2010 when he earned $1.7MM he was not in AMT whereas in 2011 when he earned $789K, he is in AMT. This is due to the AMT tax rate being lower than the top marginal rate. AMT hits those who earn less than $1MM much more often than those who earn more than that. It effectively pushes the higher rates to lower incomes.

Foreign Tax Credits

Both Romney and Obama claim the foreign tax credit (FTC). The FTC is meant to avoid double taxation. When a US taxpayer pays tax on income in a foreign land, the US generally offers a tax credit for the tax paid. The US has a worldwide tax system whereas a US citizen pays tax on their worldwide income, regardless of where it is earned. A foreign government generally will tax income earned within their borders, above certain income floors. Romney has over $100K of foreign tax credits in both 2010 and 2011 likely from his investments in entities that have operations in foreign countries. Romney likely has quite a bit of income that has not been repatriated back to the US and as such it is not taxable in the US. Obama also has some foreign tax credits claimed- $5K in 2011 and $22K in 2010. Although I am not entirely sure, it appears that some foreign tax is paid on his author income.

Cancellation of Debt – for Romney?

Another point of interest that I have when reviewing Romney’s tax returns is that he does have cancellation of debt income from one or more of his flow through investments. Not that it is terribly rare to have this type of income, but I am surprised that I have not heard about this at all in the media, although I really don’t listen to much media- I even missed the 60 Minutes special last night. For one party to have cancellation of debt income, another party has to have not collected something they were originally owed. Maybe he does have a little bit in common with the those who have had their houses foreclosed upon…trying to figure out the cancellation of debt rules.

2013 – Increasing Rates Already In Play

Romney will have a significant increase in his 2013 taxes due to the 2010 health care legislation tax increases. In 2013, for those married filers earning more than $250K, they will have a 3.8% tax on their net investment income and another 0.9% on earned income. It is complicated, but I estimate that Romney would see a tax increase of approximately $468K in 2013 if his sources of income and deductions were the same as reported in 2011. This would increase his rates to 17% of AGI and 26% of taxable income.

What does all this mean?

Well, that is for all of us to decide on our own. For me, it confirms that our current system is picking winners and losers. I look forward to comments and will do my best to answer your questions and presume that you will do the same of my question.

General Disclosures
The above is derived tax figures from publicly available documents. The author is not in control of, nor does he have knowledge of, any private information regarding either of the two parties discussed. The sources are believed to be accurate but are not controlled by the author and as such, they may change without notice and without responsibility to update by the author. As always, the author retains the right to get smarter over time. The author is not recommending any tax advice specific or implied. Everyone’s own tax liabilities are their own and the author take no responsibility over them. The above is the author’s sole thoughts and does not represent the thoughts of any other group, organization, or company.

Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that, unless specifically indicated otherwise, any tax advice, which should be none as previously disclosed, contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any tax-related matter addressed herein.

BOUTWELL signing off.


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