Taxation The Mother of Invention
MBMG GROUP RESEARCH PAPER
MBMG GROUP RESEARCH PAPER BY EUGENE CATRAMBONE BANGKOK, MAY 2012
Important Disclaimer This commentary has been prepared using informa on based on the research capabili es of MBMG Group and represents the current opinions of MBMG Group. The opinions expressed are subject to change without no ce. Where informa on has been sourced from par es outside MBMG Group, these are generally believed to be reliable but reliability and accuracy is not guaranteed. This commentary is for informa onal purposes only and does not in any way cons tute investment advice and should not be construed as an offer to sell, a solicita on to buy, or an endorsement or recommenda on of any company or security in any jurisdic on. Nothing in this document cons tutes a formal legal opinion or cons tutes investment advice. Each reader should consider whether this research is en rely or par ally suitable for their par cular circumstances and, if appropriate, seek addi onal, specific , professional advice. Neither MBMG Group nor its officers can accept any liability for the consequences of any ac on taken or not taken as a result of reading this commentary. MBMG Group is an independent researcher of informa on and does not provide investment advice or asset or financial management in Thailand. MBMG Group is affiliated with MBMG Asset Management Limited, a Mauri an ins tu on that is authorized and licensed to provide investment management services in Mauri us. All investments contain risk and may lose value. Past performance is not a guarantee or reliable indicator of future results.
What’s on the Horizon for U.S. Taxpayers? While we can’t be certain about the direc on for U.S. taxes in an elec on year, it is all but certain, however, that the future tax landscape will be clouded with problems for U.S. taxpayers. The expira on of the Bush tax cuts at the end of 2012 (in lieu of actual Tax Reform) will result in an immediate tax increase for high net worth investors: -
The top marginal tax bracket will increase to 39.6%. The addi on of the new Medicare tax will increase this to 43.4% for high net worth individuals. The long-term capital gains rate will increase to 20%. The Medicare tax will increase this to 23.8%. Addi onally, most states tax long-term capital gains rates as ordinary income. As a result, most investors will be looking at a combined rate on long-term capital gains rate of 27-30%. High net worth investors in New York and California are facing combined income tax rates in excess of 50%.
On the estate and gi -tax front: -
Rates will increase to 55% The exemp on decreased to $1 million per taxpayer.
The President’s budget proposal calls for an exemp on equal to $3.5 million. It is ques onable if anything gets done before the 2012 Presiden al elec on.
A Game of Hide-and-Seek For U.S. ci zens living abroad the filing requirements have taken on new obliga ons, in addi on to filing your U.S. tax return and repor ng your worldwide income, the new Bank Secrecy Act requires you to file a report of your foreign bank and financial accounts (FBAR) with the Treasury Department if you have financial interest in, signature authority, or other authority over one or more accounts in a foreign country, and the aggregate value of all foreign financial accounts exceeds $10,000 at any me during the calendar year. The penal es for failure to file an FBAR are worse than tax penal es. Failing to file an FBAR can carry a civil penalty of $10,000 for each non-willful viola on. But if your viola on is found to be willful, the penalty is the greater of $100,000 or 50 percent of the amount in the account for each viola on—and each year you didn’t file is a separate viola on.
The Internal Revenue Service is also reopening a voluntary disclosure program for taxpayers who have evaded taxes by hiding money offshore in secret bank accounts. Two previous IRS programs, in 2009 and 2011, brought in more than $4.4 billion in taxes from tens of thousands of tax evaders. The revival of the tax-dodger forgiveness program comes at a me when the U.S. government, facing enormous budget deficits, is cracking down hard on offshore tax evasion. IRS Commissioner Douglas Shulman said, “We’re con nuing to collaborate with other governments to get informa on about taxpayers hiding assets overseas, and we con nue to have inves ga ons of banks, advisers and other individuals.” The reopening of the forgiveness program also signals that the IRS believes there are many, perhaps tens of thousands, of U.S. taxpayers who are s ll evading taxes. By reopening the program, the IRS may be giving Americans with overseas accounts a vehicle to avoid criminal prosecu on. “This signals that the IRS is an cipa ng a wave of increased enforcement,” said Jeffrey Neiman, a former federal prosecutor now in private prac ce. Unlike the previous programs, the reintroduced program does not have a deadline by which taxpayers must enroll and carries slightly less generous terms compared with those of previous years. Par cipants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years, as well as paying accuracy-related or delinquency penal es. Par cipants face a 27.5% penalty, but some may qualify for a 5% penalty or a 12.5% penalty, depending on the amount of assets they hold overseas. Foreign Banks Closing Doors on Americans? In addi on, foreign banks and financial ins tu ons are star ng to close their doors to American depositors as a result of the Hiring Incen ves to Restore Employment (HIRE) Act passed in 2010. The law, the Foreign Account Tax Compliance Act (FATCA), requires all foreign banks with U.S. account holders to report annually to the Internal Revenue Service about their American customers ac vi es. Ins tu ons are required to collect a 30 percent withholding tax on U.S. income from any American customers unwilling to have their ac vi es reported back to the IRS. Ins tu ons that refuse to agree to these terms will be deemed noncompliant and will be hit with a 30 percent withholding tax of their own on U.S. source income, including the sale of U.S. securi es. The law is scheduled to come into effect in 2014.
The goal is to track down tax evaders who squirrel away funds in offshore accounts. However, rather than making an effort to find these individuals itself, the IRS proposes to farm the task out to foreign financial ins tu ons, forcing them to do the legwork of iden fying American account holders and tracking their holdings. FATCA has drawn intense cri cism from foreign financial ins tu ons and governments. The US introduced the law in response to numerous high-profile tax-evasion cases, including several involving secret accounts in Switzerland. But banks began lobbying against it almost as soon as it was passed. Several large banks, including Credit Suisse, Barclays and the Canadian bank TD Bank have spent millions figh ng the law. European Union officials have also sought changes to reduce the burden on European banks while other ins tu ons pass the administra ve cost of compliance on to the U.S. investor. The 21st Century Fund, for example, closed its offshore fund to U.S. investors but now offers an IRS-compliant version for an addi onal 1% fee. While some financial ins tu ons certainly will choose to pay the price of ac ng as de facto IRS agents in order to keep their American customers, it is likely that others will not, op ng instead to sever es with American ci zens and firms. The German financial ins tu on HypoVereinsbank has informed its customers that it will no longer offer certain services to its US-based clients or to US ci zens as of Jan. 1. Deutsche Bank already cancelled such accounts held by American ci zens in the middle of 2011. Germany’s second largest bank, Commerzbank, is considering a similar move. Bri sh banking giant HSBC has also reported that it will no longer serve US investors as has the Swiss bank Credit Suisse. If American customers come escorted by American tax collectors, banks will close their doors.
“Read my lips, no new taxes” --George H.W. Bush, 1988 The U.S. has been running large fiscal deficits since the beginning of the global financial crisis, ramping up an increasingly unsustainable debt burden. In 2011, the deficit was almost $1.3 trillion, or about 8.7% of GDP. Over the next 10 years (2013-22) most official and private es mates suggest that the cumula ve U.S. fiscal deficit will be around $10 trillion, or an average of $1 trillion per year, given current fiscal policies. Any sensible analysis suggests that U.S. fiscal sustainability cannot be reached without both spending cuts and increasing revenues (taxes). In spite of the lack of compromise between the GOP and the Democra c Party on their respec ve sacred cows—tax cuts and government spending—new taxes are inevitable – a bond-market crisis (a la Europe) is projected should poli cians con nue to kick the can down the road. And, although imposing higher taxes on the rich alone may not be enough to reduce the deficit in any meaningful way, the wealthy are nevertheless a prime target.
TaxaƟon: The Mother of InvenƟon The planning need for legal tax-structures which provide for both tax-deferral and tax-exemp on is strong. There are a number of tax-advantaged strategies that high-income earners and accredited investors can employ to minimize further taxa on on a er-tax dollar growth. A small but growing number of wealthy investors have opted for “private placement” life insurance. These special insurance contracts (o en collec vely called “insurance wrappers”) allow policyholders to invest in a wide range of products, including hedge funds. Private placement life insurance offers tax benefits, which include: tax-free accumula on of investment earnings (dividends, interest, and capital gains), if structured properly, withdraws from the policy will not be subject to tax repor ng, thereby making the withdrawals tax free; and income tax free death benefit proceeds to the policy beneficiaries. The policy owner has a wide range of investments to choose from which include hedge funds, private equity, deriva ves, and real estate investment trusts. There are no restric ons on the type of investments that can be managed within the policy, and private placement life insurance can offer financial privacy and significant protec on from future creditors. Private placement life insurance fees and expenses are typically more compe ve than retail insurance products. Provided the policy is structured properly, the annual cost of the policy can be a small frac on of the annual tax associated with similar investments in a taxable environment.
The Open-Architecture Advantage One of the most compelling benefits of private placement life insurance is the freedom of investment choice within the separate account. Most insurance carriers that offer private placement products not only permit investments such as hedge funds, they expect it. Moreover, in the less restric ve environment that exists for offshore PPLI products, the regulatory hassles that accompany admi ng a hedge fund as an investment choice within a domes c policy are a non-issue. With proper planning and design private placement life insurance offer policyholders the “best of both worlds,” tax efficiency and superior risk- adjusted returns.
Comparison of asset classes 1970-2008: Asset Class
Return
VolaƟlity (standard deviaƟon)
Hedge Funds
11.88%
12.71%*
Stocks
9.57%
21.33%
Bonds
8.13%
5.36%
Real Estate
10.62%
20.09%
* 1987-2008
The Growth of PPLI The use of private placement life insurance products are on the rise. John A. Anderson, managing principal of Tempewick Wealth Management LLC, a Mendham, N.J., wealth-management firm, says that he has set up twice as many private-placement insurance and annuity contracts in 2011 than in the previous year. Leslie Giordani, an Aus n, Texas, lawyer, says that her private-placement legal work is growing about 30% a year. Sun Life’s new private-placement business has more than doubled in each of the past three years, the company says. AGL Life Assurance says that its private-placement insurance and annuity premiums have been growing about 40% a year. “The buzz is growing more and more,” says John Hillman, president and chief execu ve officer of AGL. One reason for the growth may be that in recent years the Internal Revenue Service has issued a series of rulings and regula ons that have laid out more clearly what’s allowable and what’s not in private-placement life insurance and annui es. That, in turn, has removed uncertainty among insurers and investors. The regula ons have “given us fence posts,” says Bob Chesner, vice president of AIG Life in Houston. “You know what you can and cannot do.” The rulings were also designed so that insurance companies and investors “could have a clearer example of what’s acceptable and what’s not,” he adds.
Conclusions Given the outlook for rising deficits together with the expira on of the Bush tax cuts, it is clear that taxes will once again take center stage. The poli cal gridlock over raising revenues versus cu ng expenditures may give way to retribu on from bond vigilantes. If a bond-market revolt leads to a spike in long-term government bond rates, the subsequent economic damage will worsen the fiscal deficits—via higher interest payments on the debt—making more difficult the already challenging poli cal task of achieving a sensible compromise on fiscal
consolida on. With that possibility in mind and li le improvement in the overall economy, it is likely that revenue drivers will be seen as a first step in mi ga ng the growing deficit issue. With the onerous FATCA and FBAR regula ons, both the Internal Revenue Service and the U.S. Treasury Department impose new challenges on income repor ng and compliance for U.S. taxpayers. We believe that it is important to review exis ng financial planning in light of the new requirements as there are excellent strategies available for wealth crea on, protec on and preserva on in mee ng these new hurdles.
TaxaƟon and the Second Law of Thermodynamics The Second Law of Thermodynamics states that physical systems cannot recapture the usefulness of the energy originally spent in performing “work” -- perpetual mo on machines simply don’t exist; energy must be con nually added to any system in order to keep it going. As it turns out, economic and taxa on systems are no different -- what starts out pragma cally simple eventually becomes bureaucra cally complex requiring more and more informa on just to maintain its basic func on. For example, there were only four pages in the original IRS 1040 income tax form from 1913, including two pages of worksheets and only one page of instrucƟons. In contrast, just the current 1040-instruc ons, without any forms, counts 189 pages! Further, individual income tax rates started at 1% in 1913, and the maximum marginal income tax rate was only 7% on incomes above $500,000 ($11.6 million in today’s dollars). The personal exemp on was $3,000 for individuals ($69,500 in today’s dollars) and $4,000 for married couples ($92,700 in today’s dollars), meaning that very few Americans had to pay federal income tax since the average income in 1913 was only about $750. Holding the u lity of government expenditures constant it appears the dollar, much like the entropy of heat energy, increases in uselessness over me. 1 TLS, have you transmitted all R text files for this cycle update?
Date
I.R.S. SPECIFICATIONS TO BE REMOVED BEFORE PRINTING INSTRUCTIONS TO PRINTERS 1913 FORM 1040, PAGE 1 OF 4 MARGINS; TOP 1⁄2”, CENTER SIDES. PRINTS: HEAD TO HEAD PAPER: WHITE WRITING, SUB. 20. INK: BLACK FLAT SIZE: 81⁄2” x 11” PERFORATE: ON FOLD DO NOT PRINT — DO NOT PRINT — DO NOT PRINT — DO NOT PRINT
TO BE FILLED IN BY COLLECTOR.
Action
TO BE FILLED IN BY INTERNAL REVENUE BUREAU.
File No.
THE PENALTY
District of
FOR FAILURE TO HAVE THIS RETURN IN THE HANDS OF THE COLLECTOR OF INTERNAL REVENUE ON OR BEFORE MARCH 1 IS $20 TO $1,000.
Date received
Signature
Revised proofs requested
Form 1040.
INCOME TAX.
List. No.
Date
O.K. to print
Assessment List Page
Line
(SEE INSTRUCTIONS ON PAGE 4.)
UNITED STATES INTERNAL REVENUE.
RETURN OF ANNUAL NET INCOME OF INDIVIDUALS. (As provided by Act of Congress, approved October 3, 1913.)
RETURN OF NET INCOME RECEIVED OR ACCRUED DURING THE YEAR ENDED DECEMBER 31, 191
.
(FOR THE YEAR 1913, FROM MARCH 1, TO DECEMBER 31.)
Filed by (or for)
of (Full name of individual.)
(Street and No.)
in the City, Town, or Post Office of
State of (Fill in pages 2 and 3 before making entries below.)
1. GROSS INCOME (see page 2, line 12)
$
2. GENERAL DEDUCTIONS (see page 3, line 7)
$
3. NET INCOME
$
Deductions and exemptions allowed in computing income subject to the normal tax of 1 per cent.
4. Dividends and net earnings received or accrued, of corpora$ tions, etc., subject to like tax. (See page 2, line 11) 5. Amount of income on which the normal tax has been deducted and withheld at the source. (See page 2, line 9, column A) 6. Specific exemption of $3,000 or $4,000, as the case may be. (See Instructions 3 and 19) Total deductions and exemptions. (Items 4, 5, and 6) 7. TAXABLE INCOME on which the normal tax of 1 per cent is to be calculated. (See Instruction 3)
$ $
8. When the net income shown above on line 3 exceeds $20,000, the additional tax thereon must be calculated as per schedule below: INCOME.
1
per cent on amount over $20,000 and not exceeding $50,000
2
“
“
50,000
“
“
75,000
3
“
4
“
5
“
“
75,000
“
“
100,000
“
100,000
“
“
250,000
“
250,000
“
“
6
“
500,000
“
500,000
$
TAX.
$
Total additional or super tax
$
Total normal tax (1 per cent of amount entered on line 7)
$
Total tax liability
$