Payroll Taxes Go Up, Up and Away

The news for 2005 is the same and sorry old story: Social Security taxes are in the stratosphere. Your take-home pay will be lower in 2005.

First the basic rules. Social Security taxes are imposed not only on employees and employers but on self-employed individuals as well. The FICA (commonly called “Social Security”) rate on employers is 7.65%; the same rate applies to employees; and the self-employment rate is a 15.3%. These rates have remained unchanged since 1990.

The total 7.65% for FICA taxes actually has two components: 6.2% is Social Security tax and 1.45% is the Medicare hospital insurance tax. The equivalent figures for self-employment tax are 12.4% for Social Security and 2.9% for MHIT (total of 15.3%).

The Social Security tax is based on the amount of your salary or earned income, if you are self-employed. The ceiling amount is adjusted annually for inflation. The ceiling was $87,900 for 2004. The ceiling increases by $2,100 for 2005 to $90,000. There is no ceiling on the MHIT.

Now, let’s crunch the numbers for 2005, using the new $90,000 Social Security tax ceiling and determine the exact cost to the employer for an employee (call him Ed). Suppose Ed earns $100,000. Here’s how you compute the expensive tax result:

$90,000 X 6.2% = $5,580

$100,000 X 1.45% = $1,450

Total cost $7,030

Remember, Ed gets hit for the same amount. That’s $7,030 each (for the employer and Ed), or a total of $14,060 for both. Compare that to the total top cost of $2,808 in 1979.

Are you self-employed? You, and you alone, must bear the entire payroll tax burden. For example, the tax for a self-employed business owner (not incorporated) earning $100,000 is the same as for Ed and his employer combined: money-or-your-life amount of $14,060. The tax law gives you one break: You can deduct one-half of the self-employment tax. Tell your professional to see Section 164(f) of the Internal Revenue Code.

Tax wise charitable giving

Here’s how to leverage a relatively small amount of dollars into millions for charity and your family, and actually make a huge profit.

If you are a logical thinker, you are asking, “Irv, how is it possible to give money away and still make a profit?” Well, let’s start with the basics.

The law has only two significant tax-free environments: charity and insurance. By marrying these two tax-advantaged environments, we create a stream of powerful economic forces that — over time — multiply tax-free wealth for charity, your family, and — when done properly — for both.

Here’s a classic example. Suppose Walt Wealthy is worth $10 million. He has a $2 million portfolio (assets) of significantly appreciated stocks and income producing real estate. Walt uses a two-step strategy.

Step No. 1. Walt gifts the assets ($2 million) to a charitable remainder annuity trust that pays a 5% annuity ($100,000) to Walt and wife Wilma (both 60 years old) for as long as either one of them is alive. What are the tax consequences of this gift? When the CRAT sells the assets given to it by Walt, he escapes all income and capital gains taxes on the sale. Walt gets an income tax deduction for the value of the “remainder interest” of the CRAT. This deduction puts about $120,000 in cash in his pocket (courtesy of income tax savings).

Step No. 2. Walt creates an irrevocable life insurance trust to own two second-to-die life insurance policies on Walt and Wilma. The first policy is a single-premium policy for $2.4 million, which is paid for using the $120,000 in tax savings from the gift to the CRAT. A single premium policy means only one premium is paid to acquire the policy.

The second policy is for $5 million using $60,000 (of the $100,000 annual annuity from the CRAT) to pay the traditional annual policy premium.

The astounding economic results: In a 55% estate tax bracket, the $2 million of assets would have netted Walt’s family only $900,000. The combination of the CRAT/ILIT strategy turns the $900,000 into $7.4 million (the $2.4 million policy, plus the $5 million policy). And because the two policies are owned by an ILIT, the entire $7.4 million escapes all taxes — income, gift and estate. When the plan is completed, Walt and Wilma will have made a $6.5 million profit, all taxes paid in full ($7.4 million in tax-free insurance less $900,000, after tax-value of the $2 million of assets).

And don’t forget the CRAT. After Walt and Wilma are gone, charity gets the remainder in the trust, about $2 million.

Irv Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Suite 900, Chicago, IL 60606; 312/207-1040, or e-mail [email protected].