Why Millionaires Could See Their Taxes Increase in a Hillary Clinton Presidency

By Markets Fool.com

Democratic presidential nominee, Hillary Clinton. Image source: Flickr user Nathania Johnson.

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Ready or not, it's officially election crunch time.

Over the coming six weeks the presidential candidates, Donald Trump of the Republican Party and Hillary Clinton of the Democratic Party, will be laying out their case why they should be elected as the 45th president of the United States. Regardless of who wins, one thing is for sure: The victor will make history. We're either going to witness the first female president in the Oval Office, or the first individual with no prior political background who didn't serve in the top ranks of the U.S. Armed Forces.

What's interesting with six weeks to go is that the American public is still trying to figure out where these candidates stand on a number of key issues. The upcoming debates should help resolve many of these inquiries.

Millionaires could see big tax hikes if Clinton wins

However, one issue that's clear as day is that if Hillary Clinton becomes president, and she's able to get her policy proposals passed into law, millionaires could wind up forking over a considerably larger amount of their annual income or wealth to the federal government via taxes. Here are five specific ways a Clinton presidency could mean tax increases for the wealthy.

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1. Ordinary income tax increase

One of the easiest ways to identify that Clinton expects millionaires to pay more can be found by examining her ordinary income tax tables next to the current tax schedule. Below you'll the current tax schedule for 2016, complete with seven progressive ordinary income tax brackets that peak at 39.6%.

Table by author. Data source: Internal Revenue Service.

Now, let's have a closer look at what Clinton has proposed:

Table by author. Data source: Tax Foundation, Hillary Clinton campaign website.

As you'll note, Clinton's ordinary income-tax brackets are identical to the current system for single filers, married couples, and head-of-household filers with less than $5,000,000 in earned income. However, once any of these tax filers reaches the $5 million mark, a 4% tax surcharge kicks in that bumps them into the new highest progressive tax level at 43.6%. This tax is only expected to affect about one in every 5,000 taxpayers in the U.S., and it's estimated to net an additional $150 billion in revenue over the next decade.

Clinton would also institute the "Buffett Rule," which would apply a minimum tax rate of 30% on individuals earning $1 million or more in income.

2. Capital gains tax reform (along with continuation of the NIIT)

In addition to possibly owing more in ordinary income tax, Hillary Clinton wants to completely reform how individuals and couples earning more than $5 million a year pay capital gains taxes.

Under the current system, capital gains taxes are assigned in two ways: either short-term or long-term. Short-term capital gains taxes, which include assets held for 365 days or less, are taxed at your peak ordinary income-tax bracket, whereas long-term capital gains for assets held at least 366 days are taxed in three progressive tax brackets. If your peak ordinary income tax bracket is 10% or 15%, you'll owe nothing in long-term capital gains taxes. If you fall into the 25%, 28%, 33%, or 35% ordinary income tax brackets, your capital gains tax is 15%. Finally, if you're in the highest tax bracket, your long-term capital gains tax rate is 20%.

If Clinton's proposals were passed, medium-term holdings would be taxed at a substantially higher rate, as seen below:

Table by author. Data source: Tax Foundation. "Marginal tax rate" = Capital gains tax rate before net investment income tax and surtax on incomes exceeding $5 million.

People with $5 million or more in earned income would have to hold their investments a minimum of two years before they'd even begin to see a reduction in their long-term capital gains tax, with the full benefit not realized until the sixth year.

Also, as you'll note, Clinton plans to leave the Net Investment Income Tax (NIIT) firmly in place. The NIIT is a 3.8% tax on investment income for individuals and couples earning more than $200,000 and $250,000, respectively, and would be added on top of the ordinary income tax surcharge and capital gains tax. In sum, wealthy short-term investors could be dinged or more than a 47% tax on their investment gains.

3. Estate tax reform

Just last week, Clinton unveiled her plan to completely revamp the real estate tax for some of America's wealthiest households.

Image source: Getty Images.

As of 2016, the estate tax exempts leaving up to $5.45 million per individual to their heirs which is free and clear of federal taxation. This means a married could shield up to $10.9 million of their wealth from being taxed upon their passing.

Clinton's real estate tax reforms would specifically go after millionaire households with more than $10 million in assets. Under Clinton's proposal:

  • A 50% tax rate would apply to estates over $10 million a person.
  • A 55% tax rate would apply to estates over $50 million.
  • A 65% tax rate would apply to estates with assets exceeding $500 million for an individual and $1 billion for a married couple.

Keep in mind that these high tax rates will likely prove to be mostly symbolic as the IRS logged just 223 estates on its records as having more than $50 million in assets in 2014 (though Donald Trump is one). According to the Committee for a Responsible Federal Budget, Clinton's estate tax proposals would be expected to increase federal revenue by $140 billion over the next decade.

4. Social Security tax reform

Fourth -- and you may not even have to be a millionaire to feel the impact of this proposal -- Clinton wants to shore up the future of Social Security by having the well-to-do pay more.

Image source: Getty Images.

Social Security isn't in the best shape. The latest Trustees report suggests that the program will burn through its $2.8 trillion in spare cash by the year 2034, potentially leading to a cut in benefits of up to 21%. Clinton, wanting to protect Social Security benefits for those who need it most, wants to tackle this budgetary shortfall by raising the payroll tax earnings cap.

Currently, the payroll tax earnings cap is $118,500, although it tends to move a bit higher each year with inflation. This means any earned income below $118,500 is taxed at a rate of 12.4%, which you and your employer usually split down the middle, or you pay in its entirety if you're self-employed. For wealthier Americans, all income earned above and beyond $118,500 is free and clear of taxation for the purposes of Social Security.

Clinton has suggested raising the payroll tax cap, possibly to $200,000 or $250,000. Doing so would leave the current tax structure in place, provide a payroll tax moratorium between $118,500 and $200,000 or $250,000, and then reinstitute the 12.4% payroll tax on earnings above $200,000 or $250,000.

Clinton also hints on her website at removing some of the income that's exempt from Social Security taxation, including dividends from stock, interest from loans, and income received from a limited partnership.

Image source: Getty Images.

5. Close an assortment of tax loopholes

Finally, Clinton aims to close a variety of tax loopholes that millionaires and even billionaires have used to keep more of their money.

For instance, Clinton is taking aim at closing the Bermuda reinsurance loophole, which is costing the federal government an estimated $10 billion per decade.

Select wealthy hedge-fund managers have been forming reinsurance companies in tax-free havens like Bermuda and transferring cash from their funds to these reinsurance companies. This cash is then reclassified as "insurance company reserves" and transferred back to the fund to be invested. However, profits from these insurance companies aren't taxed until the stake in the fund is sold. More importantly, hedge-fund managers get to pay the considerably lower capital gains tax on the profit and not ordinary income tax.

Clinton is also planning to introduce contribution limitations on tax-advantaged retirement plans, such as Traditional and Roth IRAs and 401(k)s, of $3.4 million. Under Clinton's proposal, once the sum of all tax-advantaged retirement accounts hits $3.4 million, contributions to these plans would be cut off.

Keep in mind that in order for any of these proposals to be enacted, Clinton would have to first get them through Congress, which may not approve them.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.

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