Obama's rude shock to six-figure earners
What everyone's overlooking in the new budget: a stealth tax on people making more than $250,000.
NEW YORK (Fortune) -- During the presidential campaign, Barack Obama tempered his pledge to substantially raise taxes for high earners with an important proviso: He'd simply restore rates to their levels during the Clinton Administration. The implication was that families in the upper brackets would see their total tax bite go back to the levels of the 1990s, but no higher.
Now, it sure looks like Obama is reneging on that promise. The burden will indeed go far higher than in the Clinton years via a technicality -- one that will come as a rude shock even to the taxpayers already braced for a soaking.
The group that's hit hardest are the taxpayers I call the HENRYs, for "High Earners Not Rich Yet." The HENRYs are families who make between $250,000 and $500,000 a year. I wrote about the HENRYs in a Nov. 17 Fortune cover story, "Who Pays for the Bailout?" They're among America's most productive, hard-working citizens: our doctors, attorneys, architects, and entrepreneurs, the owners and builders of cleaning companies, delis and security franchises. (Read the original HENRY story here.)
Though President Obama brands them as rich, they're usually far from it. "Rich" means personal wealth, or net worth, not income. These HENRYs are already strapped by a combination of high income taxes, soaring property tax levies, and college savings for the kids. Their chance of accumulating the couple of million dollars needed to qualify as rich were virtually nil even before Obama took the stage.
Now, their prospects are dimmer than ever, courtesy of a new, laser-like proposal specially designed to zap the HENRYs. Most of the 5 million or so HENRYs are trapped in the notorious parallel tax system, the AMT, or Alternative Minimum Tax. In fact, the AMT might be dubbed "the HENRYs' tax," since it's targeted to skip the middle class, but aimed straight at the $250,000-to $500,000 crowd. All taxpayers are required to calculate their liability two ways, under the regular tax system and under the AMT, and pay the higher amount.
The AMT was originally designed to prevent high earners from pocketing outsized benefits from big deductions, and the HENRYs have plenty of those deductions, especially state and local income taxes, and property taxes. Put simply, if the taxpayer has loads of deductions, they'll have to pay a lot more under the AMT than the regular tax system. That's why everyone who pays it hates the AMT.
The AMT, however, allows two principal forms of deductions, those for mortgage interest and charitable contributions. Guess what? Under his new plan, Obama is radically reducing the breaks that high-earners get from precisely those two tax breaks.
Here's how the HENRYs will get hammered. Say a family earns $300,000 a year, and pays $50,000 a year in mortgage interest; the family also contributes $5,000 to Boy Scouts, Red Cross and other charities. Under the AMT's top effective tax rate of 35%, they benefit from savings of $19,250 on those deductions.
But under Obama's new plan, the share of that $55,000 that HENRYs can deduct is no longer 35%. It's capped at 28%. Hence, their tax bill rises by almost $4,000. That's a jump in their marginal tax rate, the crucial share of an extra dollar of income they get to keep, from 35% to over 37%.
The limitation on deductions is scheduled to take effect in 2011, the same year Obama plans to raise tax rates back to their levels in the Clinton Administration. Amazingly, many HENRYs thought they wouldn't suffer much from the higher rates, since they were already paying more in the AMT than they would even under the new tax regime. Now, they're no longer protected. Their taxes will rise sharply, courtesy of this laser-like strike aimed straight at their wallets.