GRD Season 4 Episode 2_If you could change anything in the tax code, what would it be_mixdown
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[00:00:00] Hi, I'm Ed Slott. And I'm Jeff Levine. And we're two guys who just love to talk about retirement and taxes. Look, our mission is simple to educate you the saver, so that you can make better decisions because better decisions on the whole lead to better outcomes. And here's how we're going to do that. Each week, Jeff and I will debate the pros and the cons of a particular retirement strategy or topic with the goal of helping you keep more of your hard-earned money.

At the end of each debate, there's going to be one clear winner you. A more informed saver who can hopefully apply the merits of each side of the debate to your own personal situation. Decide what's best for you and your family. So here we go. Welcome to the Great Retirement Debate. Hello, hello, hello again, and welcome back to the Great Retirement Debate.

Ed. Good to see you again. Yeah, you too. So what are we talking about today? Well, ed, you know, I, I said, good to see you again and Right. I noticed something a little different about you. You, I can't [00:01:00] quite put my finger on it, but something's changed about you recently. What, what is it, does that help you? Now you look like yourself!

Uh, no. Glasses. That's a change. What, what, what happened there, ed? Uh. Eye surgery, cataracts. That's what happens when you get old. It's a miracle. Things that were, I thought were yellow, are now white, but I didn't know the, you know, I hear that from so many people. They say the biggest thing is that the colors, they didn't realize the colors that they couldn't see.

Yeah. So you changed that. Was that a positive change for you, Ed? Yes, it was a great change and, uh, but you can't, uh, look, um, this is not a medical show, so don't go by my recommendation. The, uh, Ed said, right. We need all, all the disclosures. Like, insert them here, all the caveats. All right. You're legally safe now, Ed, to say whatever you want.

Yeah, I think it's fantastic. I think it's a miracle and people should check it out, but it, you know, I did it because I'm at a certain age and, uh, the, according to the ophthalmologist or the surgeon, your eyes have to [00:02:00] be what he called ripe for it. You can only get one shot, so, Hmm. All right. Ripe for, there you go.

Well, positive change for you and, and Ed, that kind of leads me into our discussion topic for today. Positive change, change that we would like to see if, if Ed, our question today is, our topic for today is. If you could change one thing, if you could give cataract surgery to the tax code, what would it look like?

Right. What would, what would it look like if you could change one thing in the tax code? And you don't have to even stick to one, but I've got one of the things that you would like to change. Yeah. Well, but why I think is a good follow up, right. Well, uh, on, just on now, nobody calculates anything on a tax return 'cause it, the tax writers have made it impossible.

But if there could be just one item of income, not just adjusted gross income or modified adjusted gross income, or adjusted, modified adjusted gross income, or adjusted adjusted gross income, or a different income for capital gains and a different income for Roth. [00:03:00] It's so many different. Don't forget provisional income for social security provisional social security that's, you have so many incomes. Uh, again, this is all done by computer now, but in your tax planning, oh, your income for this and income for that, shouldn't there just be one number that everybody can rely on? And we don't have that at all. I remember. Uh, when we were first when, years ago, when you first started getting into the taxes, I was explaining what modified adjusted gross income is.

And I remember saying to you, it's actually adjusted, adjusted gross income. That's right. But that's, but they couldn't use the word adjusted twice 'cause in like word, it would say delete repeated word. So they have to have modified adjusted gross income. So I would get rid of all of that, but that would change so many provisions.

But wouldn't it make it easier for planning? It would, it, it would absolutely make it easier. And I think, you know, let's, let's pause there. Let's, let's dive in a little bit there before I kind of go off of my own tangent about [00:04:00] what I might change. But, so we talked about these different incomes and you mentioned a bunch of them, but the reality is like beyond just joking, right?

We literally do have. We have adjusted gross income, right, which is effectively after you've taken your above the line deductions on a tax return, but before you've taken your below the line or standard deductions. Then you've got modified adjusted gross income, which as you said is adjusted gross income, where that's what you're starting with.

But then congress says for this specific purpose, start with adjusted gross income and then make these specific changes. Right? And it's not like we have just one modified adjusted gross income. There are about 10,000, like for each different provision almost. Congress says for this one, here's the things we want you to look at.

And there are some weird things that you add back and subtract things. Foreign income. Yeah, exactly. Foreign income excluded, or 10 40 instructions, which almost nobody looks at. It's loaded with worksheets. [00:05:00] Yes, that's right. And we've gone even further to that, right? By every time they say, well, we're gonna make the tax return shorter, they add another worksheet to make the package longer, right?

The stack of paper rises, but the front page looks a little bit shorter. So you've got adjusted gross income. Then you've got all these different versions of modified adjusted gross income. Then at some point after that. You take your below the line deductions, either being your itemized deductions or your standard deduction, and you get to quote unquote taxable income.

But even those are not it because we have, uh, a, a series of deductions that, uh, that, that come off after taxable income is sort of calculated or, or after you take your standard deduction, but. Before you get to ultimately taxable income, right. Things like the QBI deduction happen after your itemized. We don't even have a name for that type of thing.

I did, but those are, those have circular calculations. Yes. Ones based on another, that's based on another. Yeah, it's complicated, which is probably why you wanna change it. And then we get to all the other stuff. Like we said, that's not [00:06:00] even on a tax return, right? Like Social Security says, we would like you to calculate income this way when you're looking at social security stuff like Medicare or whatnot.

And that's a completely different type of income called provisional income. It does make things very co uh, complicated. But Ed, it also impacts planning, right? And things we do as an advisor, uh, or when we're looking at trying to help clients minimize that lifetime tax liability, there are some very valuable things that we can do that.

Um, for instance, one that comes to mind Ed, is if we're looking at giving away money to a charity, right? And we are seven and a half or older, one of the reasons, uh, we like a QCD so much. Is because of its play on those different income. Maybe take a second and, and dive us through that, what that looks like.

Well, the qualified charitable distribution, most people get no longer since the law was changed a few years back, uh, no longer get a any tax benefit. Now, tax benefit I'm talking about of course you get benefit for giving a charity [00:07:00] no longer get any tax benefit for giving to charity. 'cause most people take the higher standard deduction, the QCD.

Qualified charitable distribution lets you get what you called an above the line deduction. A deduction before adjusted. I hate to use the terms again that we just said we don't wanna use anymore. Uh, give you a, an exclusion from income so it can reduce the taxable amount of your IRA distribution. The only downside that I see.

It's a great provision. One of the best is that it's not available to enough people. It's only available to IRA owners or beneficiaries who are 70 and a half years old or older. So other than that, it's a great provision. But if you are in that ballpark and you give to charity anyway, this is the way to do it.

IRAs are the best assets to give to charity because they're loaded with taxes. So, so two things we, we, we mentioned there, right? One is that if you don't itemize, you don't get that deduction. [00:08:00] So it doesn't really help. But the other thing is let, let's say you do itemize, right? We talked about all these different layers of it.

If, if you itemize, I often call adjusted gross income, like halftime on a tax return. Yeah. Right. And I think about the, the, the tax return in quarter, like a itemized deduction is a third or fourth quarter deduction. But the halftime score doesn't change by anything that happens in the third or fourth quarter.

So if you give, like, Ed, if, if, if you gave a billion dollars to charity this year, how much would your a GI change? Nothing would change. Wouldn't change at all. Nothing. Right, right. Because it happens afterwards. So your taxable income would be, that's right. You'd lower your taxable income, which is nice.

But you're a, people might say, but Ed, who cares if my taxable income is low? Why do I care about a GI? So why might someone still care about that? Because it impacts certain other taxes that are based at taxes, benefits, credits, uh, all of these items that are based on [00:09:00] adjusted gross income. Even if you pay no tax, even if you have no taxable income.

So we, when we say no tax, we're really saying like income tax, right? But you might end up paying a, a large three point. You could pay a whole bunch of 3.8% surtax and still have $0 of taxable income, right? Or you could pay more on your social security taxes because your a GI is higher. You could have higher, you could give a billion dollars away to charity and it would change your future Medicare part B premiums By $0, you would still have.

Higher Medicare Part B premiums, all because they're tied to that middle, weird income number of adjusted gross income or some version of it, like you talked about, modified adjusted gross income. So I, I would be on board with that change. That seems like something that would be a, a, a nice feature to change.

And Go ahead. I see you got something. I don't think it's, I don't think it's possible though. It's so entrenched into the tax code. You'll pull it out. It has tentacles everywhere. So it does, it would be a [00:10:00] difficult thing to change for sure, but it would be nice to think about, and at the very least, it, it highlighting the reason to want to change.

That does give everyone listening the sense that when they're planning, they can't just think about their taxable income. Right? Too often people focus only on the bottom line. But so much of what is actually, uh, occurring on their tax return and off the tax return that increases their cost is tied to other income numbers that aren't their taxable income.

Right. That's the big message. So here's another thing that I would pull out. If you ask me what would I change in the tax code? Yeah, you have two eyes, so I'll give you two things to cataract out the uh, alright. All right. Go ahead. Here's another one. Uh, RMDs. In RMDs, the lifetime RMDs, I see no reason for required minimum distributions during your lifetime anymore for a couple of reasons.

First, you have the secure act, which did away with the stretch. IRA. Most beneficiaries, [00:11:00] non-spouse beneficiaries will now. There's an end date now. So the government was worried, oh, people are gonna go 20, 30, 50 years now. For most ultimate non-spouse beneficiaries, there is an end date. All of that money will come out and be heavily taxed probably by the end of the 10th year after death date.

Uh, right. Life plus 10 years. Yeah. By the end of this, like a sentence, ed. Yeah. Life plus 10. By the end of the 10th year after death. So the government's gonna get their money and lots of it, because many beneficiaries, they wait till the end of the 10th year. The government's, if they look long term, if they ever did long term planning, they're gonna make a fortune with that and they'd end up.

I think bringing in more revenue. If there were no RMDs, first of all, during your lifetime, I'm talking about none of this 70 and a half or 72 now 73 and one day 75. And people that age, they can't figure out, even when it was 70 and a half, it was so complicated. Uh, people didn't know, am I 70? Am I 71? Which [00:12:00] age do I use 70 or 71?

Which chart? How do I do it? How do I make the calculation? And the IRS numbers themselves, they came out, I think in 2019 when this was being discussed in the Secure Act. Turns out that 80% of people taking RMDs take more than they're required to because they need the money. So let people take whatever the heck they want.

They're probably going to take more and pay more in tax. Anyway, so I think the whole system is, is useless. It's meaningless. All it does is cause complications and who is affected older people that the last they want is complicated tax things to worry about with their advisors or figure out for themselves.

Wouldn't it be great if people could just take money out anytime from their IRA, uh, without worrying about required minimum distributions and pay the tax they have to pay? Yeah, the government I think would do a lot better long run. 'cause they're gonna get all the money by the end of the 10th year after death.[00:13:00]

Yeah, I agree. I like changes that, simplify things that, uh, you know, that, that don't. Impact the tax code, like or tax revenue too much because it's one of those things where you say, like your first answer and you said it like it's highly unlikely that we'll get rid of adjusted gross income and modified adjusted gross because it is very entrenched.

It would take a, a dramatic rewrite of the tax code even beyond what we saw with the tax cut and jobs act in order to do away with that type of system. But getting rid of RMDs, that's really realistic. Right? That's a, it's stroke and a pen. That's it. And it probably, to your point, wouldn't change long-term revenue too much.

Now Congress tends to look at a 10 year budget window 'cause that's what they look at. So in the 10 years it would impact things. But long-term, what is really important, you know, as a, as a country from an income and expense perspective, you're right. Probably wouldn't change things too much 'cause the money still has to come out at some point, which actually brings me to the thing that I would change the most.

[00:14:00] Right. And I, I. I'm very pragmatic as an individual, Ed, I, I like things that I, I think can actually happen. So I've got a couple others I'd love to see, like, I'd love to see Social Security taxed in a much more simple way, because as you said, you know, older people do not need more complication, and there's probably few things more complicated than the way that Social Security, I mean, when you take out $1 from your IRA.

And you're in the 22% tax bracket and you find yourself with fairly modest income paying a 40 plus percent federal income tax rate, and there's not even a 40% bracket. And you go, how could I be paying $400 of taxes when I only took out a thousand dollars more from my account? Yeah, that's really complicated for people to understand, but I don't think they're gonna change that.

Here's what I would change. Get rid of the stupid rule that requires. People not, or that prevents people with high income from putting money into a Roth IRA. I agree with that one. It's a silly rule. I, that was next on my [00:15:00] list. It's the dumbest rule. And you can explain why, because everybody works around it anyway.

That's right. We all work around it. There's no limit on contributing money to a traditional IRA. And there's no income limit on converting money from a traditional IRA know to a Roth IRA. So in what you could do and in two, I, let me not use the word steps here.

A transaction followed by a second transaction, let's put it that way. And, you know, for those who are wondering, why doesn't he wanna use the word steps? The IRS has this thing called a, the step transaction doctrine, where if you do things in multiple steps just to get around rules that you can't do in one step, they sort of can, uh, the, the, the tax court can effectively wipe it out and treat it as though it was all done in one step and undo your transaction.

Uh, but the IRS has sort of. Passively blessed this and so did Congress back in its committee reports when it passed the [00:16:00] Tax Cuts and Jobs Act. So the idea that, alright, I make too much money to put money directly into a Roth, fine, but now. I'll just contribute to a traditional IRA and I'll, I mean, it even has a strategy name to it, the Backdoor Roth, and chances are you've heard of it because it's such a darn popular strategy.

So why make people do all this extra work? It's extra work for individuals. It's extra work for their advisors. It's extra work for custodians. It's extra work for the IRS who has to get extra 10 90 nines every year. It's more work for everyone and it collects exactly. Well, maybe not exactly $0 more of revenue because those who have existing traditional IRA money may be impacted by something known as the pro rata rule.

But for a lot of high income individuals, it makes no difference whatsoever. It's just more busy work. And there's another problem with it. Some people don't know there are income limits and they put mm-hmm. Roth IRAs anyway, [00:17:00] and then all of a sudden they get hit with a 6% excess contribution penalty. Then they gotta figure out how to get the money out, figure the net income attributable.

Uh, this what, I don't even know. What are these terms that you're saying? And this is like gibberish too much. Well. Here, here's an example. Uh, people go to their accountants or I, you know, I don't know why they don't pick up on it, but I make $400,000 and Okay. And I put money in a Roth IRA. Now, a lot of times they don't even tell their accountants because, uh, where does a Roth IRA contribution appear on a tax return?

Nowhere. It doesn't fall on the tax return. So you have an average preparer, they're doing their taxes. Oh, nice, you made 400,000, 500,000 this year. Here's this, blah, blah, blah, blah, blah. And then all of a sudden they find out, or maybe they never find out that they put in, uh, they funded, they contributed to a Roth IRA when, because of the income limits, they were legally not allowed to do it.

So have an illegal excess contribution [00:18:00] that has to be pulled out. If you don't pull it out, you have a 6% penalty each year till it's taken out. And plus you have to figure the income eligible to that excess contribution. That's called net. Income attributable. I don't even want to go there. But it's part of the, basically if you put in 6,000 and it went up 10% to 6,600.

Right. You gotta take out the earnings along with the money that you put in. Exactly. Right. That's a better way to say it. But the point is that, uh, adding onto your point of the complexities, it can cause tax penalties and Sure. And problems you don't even know are brewing because you didn't even file the form to.

To report an excess contribution 'cause you didn't know, it didn't qual, you didn't qualify. Yeah, not knowing that you're subject to penalties and then finding it out down the road is very, very frustrating. Again, you know, as we sit here, I, I would have to add one more to the list of, of things I would change, and it's not super retirement related, so we won't dwell on it too much.

But I would also change the rules for the qualified business income tax deduction [00:19:00] because in large impact, first off, it is brutally complicated, one of the more complicated provisions across the tax code for all individuals, and so. I don't like complexity. I look, my, my honest opinion is you and I should not have a job, or at least we should have a different job than the one we have.

The fact that we exist in order to help people explain the rules so that they can pay low is, is, means the system is too complicated. Well, the QBI deduction is, uh, a, a, an area of the tax code where it's very complicated. But the other thing it does is it treats different businesses. Yeah. I don't like that entirely different, right?

Like a, an accountant like you or you know, someone in your profession might be treated entirely different than the construction worker down the block, or the widget maker versus the doctor. Even if they employ the same number of people, even if they're generating the same amount of income. And not only that, it's a personal income tax deduction that is.

Based on business income. So Ed, let's say you and I [00:20:00] were partners in business, right? And we each do exactly the same thing. In our partnership, we do the same amount of work, right? And we each make exactly the same amount of business income from our partnership. One of us might have a really big deduction, the other one might have no deduction, right?

Because of the other things maybe our spouses do and have income or don't have income, it's right, right. It's a very inequitable. Provision in the tax code. I don't like inequity, so I would change that. But now, now I will like pop off my soapbox Ed. No, no, no, no. I agree with that one because it picks winners and losers and I never think that's fair in a tax code.

Oh, I'm in the wrong business. I don't get the deduction. But I like what you said about that. So what you're saying, without being too complicated on these pass through entities, you would like to see that deduction as a pass through item based on the business income, is that what you're saying? Yeah, either based on the business income or just make it simple.

Just get rid of all the phase outs and what, like there are so many different rules. If you're high income, if you're low [00:21:00] income, if you work in this business, if you work in that business, like just make it simple so that people can understand what is going on, right. It should. Want to put us out of a job Ed.

That is what I want. Well, at least with respect to that. It's funny you said that a couple of years ago at the A-I-C-P-A National conference, they call it Engage. And I talked about exactly what I talked about. When I ended, I used to do this whole thing on IRA horror stories. And at the end, I just threw it out there to eliminate RMDs for exactly the reasons I said here.

And I ended the program and I said, if anybody, 'cause sometimes you have people from Congress there or rep. A lot of tax authorities there or influential people. So I said, please put us out of our misery and lifetime RMDs. And my last line of the program was Put me out of business. Amen. Yes, that which, but you know what, ed, unfortunately I don't think that's gonna happen.

I think you and I will have job security [00:22:00] for the indefinite future. Thanks to Congress, and you know what? It just means that we've got more opportunity here. You're right about the QBI. It picks winners and losers, but one thing we don't do, we don't pick winners and losers. We only pick winners. Ed, the winner of every one of our debates is the consumer, the listener who has more information and can make a more informed decision for them.

And their families in the future. And our hope is that after this discussion, you've learned a thing or two that can help you think about our current tax policy a little bit differently, and how it might impact you and your family so that you can make a better decision for yourself. Ed, thanks as always.

This was fun. Great. All right, we'll see you next time on the Great Retirement Debate.

Jeffrey Levine is Chief Planning Officer at Focus Partners. This podcast is for informational and educational purposes only, and should not be construed as specific investment accounting, legal or tax advice. Certain information mentioned may be based on third party information, which may become outdated or otherwise superseded without notice.

Third party information is deemed to be reliable, but its accuracy and completeness cannot be [00:23:00] guaranteed. The topic discussed and corresponding arguments are those of the speakers and may not accurately reflect those of focus partners.