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Alternative to Taxmageddon 

Two MLaw profs. hatch alternative to "Taxmageddon"

By John Masson
Oct. 9, 2012

Death and taxes. If you're a retiree, it would be convenient if the former happened before the latter deprived you of your means of support.

Unfortunately for millions of seniors, taxes will become even more central a question Jan. 1, if Congress doesn't extend the current tax rate on the mutual fund and stock dividends seniors—encouraged by the near-zero interest-rate policy of the Federal Reserve—increasingly rely on for retirement income.

The experts, including Michigan Law professors Douglas Kahn and Lawrence Waggoner, are calling it "Taxmageddon," a term coined by The New York Times' David Leonhardt. It's when dividends retirees expected to be taxed at a special 15 percent rate suddenly become ordinary income, taxed at a rate as high as 39.6 percent, or even higher. It's also when net capital gains will start being taxed at 20 percent.

The days of special treatment for dividends and capital gains are "clearly under assault," the professors write in their recent paper, "Retirees Beware: Don't Worry About the British—2013 is Coming," published in the journal Tax Notes in July. A shortened version will appear in the next issue of the Law Quadrangle, Michigan Law's alumni magazine.

But Profs. Kahn and Waggoner have crafted a compromise that might put a little enjoyment for American seniors back into the rapidly approaching New Year.

What if dividends and capital gains were combined into a single figure, then taxed on a graduated scale?

Profs. Waggoner and Kahn don't suggest what levels Congress should set, but do provide guidelines to create examples. Say the first $250,000 of combined dividends and capital gains combinations were taxed at 15 percent, the next $250,000 at 20 percent, 25 percent on the next $500,000, and 30 percent above $1 million.

Such a system would go a long way toward protecting retirees who worked hard and invested carefully, while also ensuring that the super-rich pay tax rates more in line with, say, those paid by middle-class families with two working parents. Because the super-rich rely more on capital gains than dividends, they would pay significantly more taxes under the Kahn-Waggoner graduated scale than they would pay even if the "Taxmageddon" rates go into effect.

"Our compromise would undoubtedly be fairer," Prof. Kahn said.

Prof. Waggoner agreed.

"It's less likely to have such a serious impact on millions of retirees who worked hard, played by the rules, and invested carefully, with plans to live on the proceeds."

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