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Why middle-income tax planning is dead

April 11, 2015

Bloomberg and Wall Street Journal ran articles this week that compile and analyze federal income tax data. These articles were meant for use as an exposé of policy tax policy. I skipped the social policy discussion entirely and I looked at the data from the perspective of a small solo CPA’s income tax service.

It is interesting for me to note that I left a job with a Wall Street firm 28 years ago because I was tired of helping rich people get richer. I’ve tried to serve an economic cross section of clients. Yet today, as I analyze the data, I conclude that the only viable business model for a CPA tax practice is to serve the wealthy segment in managing their tax burden. All my efforts to appeal to a broad audience with a range of tax and financial planning tools are effectively wiped out by the hard numbers of how our federal income tax system works today.

I have taken significant steps to promote middle-income tax planning. My comments in Money Magazine last fall and my articles on tax planning (like this one) for middle-income people have been popular. But they have not really translated into any business for my practice.

A few take-away points from this week’s news articles combined with my own practical observations:

WHO PAYS INCOME TAX – The top-tier of affluent people pay the majority of income taxes. The richest 20% pay 84% of all federal income taxes.

WHO DOES NOT PAY MUCH INCOME TAX – People making less than $150,000 collectively pay only about 10% of the nation’s total income tax that is collected. Apparently this amount of tax is not painful enough to motivate this segment to pay for professional tax planning services.

MARGINAL AND EFFECTIVE TAX RATES – At incomes below $100,000 almost everyone pays taxes that might be considered reasonable; say 10% to 15% of total gross income. The tax rates for higher income people is much more variable and is more likely to depend on the tax planning and positioning. Effective tax rates of 25% to 28% are common in my new clients prior to tax planning. Marginal tax rates are even higher and this is what really motivates requests for tax planning services.

AUDIT RISK – The only category of taxpayers facing increased audit risk are those with more than $200,000 income. Audit risk increased sharply with the use of common tax planning strategies including side businesses, home office deduction and unreimbursed employee expenses.

A GROWTH MARKET – The number of tax returns with income ove $200,000 grew by 24% in 2014 over the prior year. That may explain why all but one of my new tax clients this year fell into this income category despite my willingness to handle any tax return.

TAX FILERS – About 60 million working Americans file income tax returns. About half of them file a tax return online themselves without a tax professional. But among the top tier of income earners almost all use a tax professional.

All of this leads me to a regretful conclusion that I should abandon my efforts to bring tax planning to middle income clients and that I should focus exclusively on serving more affluent clients. (I can already hear me peers saying “I told you so”).

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