The Rich Are Different

Back in the Gilded Age, an ambitious social climber and noted toady named Ward McAllister coined the phrase “the Four Hundred,” named for the number of people that Manhattan heiress Caroline Astor could fit in her Fifth Avenue ballroom. In 1982, Forbes magazine borrowed that same number for their annual “Forbes 400” list of the richest Americans. Ten years later, our friends at the IRS borrowed it again for their annual report on America’s top earners. And while the IRS doesn’t give us the names we really want (or tell us which ones are currently single), it’s an insightful look into some of the fattest wallets in the country.

Last week, the IRS released the Fortunate 400 report for 2013. It took an adjusted gross income of $100,066,000 to join the elite group (down from $139,663,000 in 2012). But that was just the price of entry. The average income was nearly $265 million. That means the 400 as a group reported $106 billion, or 1.2% of the entire country’s personal income for the year. It’s also about the gross domestic product of a minor-league country like Morocco or Ecuador.

As usual, wages and salaries made up a surprisingly small fraction of these incomes — just 8.45%. That means our average winner isn’t some corner-office executive raking in a nine-figure salary. Taxable interest made up 5.75% of the total, and taxable dividends another 10.78%. So we’re not talking idle heirs and heiresses clipping coupons, either. The real action comes on Schedule D, where our lucky winners report capital gains. The average “Fortunate 400” reported 51.69% of their income from capital gains, or $139 million each. (That’s way down from $191 million in 2012 — more on that little info-nugget in a bit.)

Brass tacks time: How much tax did our 400 supersized earners actually pay? For 2013, their average IRS bill was $60.8 million, or 22.9% of their income. That’s up considerably from just 16.7% in 2012. So why was 2013’s bill so much higher than 2012’s? Blame changes in the tax code, especially on capital gains. The 2013 “fiscal cliff” bill raised the top rate on most long-term gains from 15% to 20%. And the Affordable Care Act piled on an additional 3.8% “net investment income tax” on capital gains, interest, and dividends. Those changes encouraged sellers to unload assets in 2012 rather than wait for 2013’s higher rates. In some cases, corporate muckety-mucks (including Walmart founder Sam Walton’s heirs) accelerated dividend payments into 2012 as well.

The top 400 earners could see even more changes in capital gains taxes after this year’s sure-to-be-entertaining presidential election. Democratic candidates Hillary Clinton and Bernie Sanders have proposed raising rates on capital gains and investment income. On the Republican side, nearly all the candidates propose lowering those rates, while Marco Rubio has proposed exempting that income entirely.
4,474 taxpayers have joined the IRS top 400 over the last 22 years. 3,213 of them appeared just once, which reinforces the fact that most of those lucky winners make it by selling a business they spent a lifetime nurturing. (Really, isn’t one hundred-million-dollar year enough?) Just 129 taxpayers have appeared on the list 10 or more times, and you can imagine they all had pretty nice holiday seasons on their private islands somewhere warm.

What does all of this mean for you? It means that even for us ordinary mortals, tax planning really can make a difference, especially when it comes to cashing out your gains. And now is a great time to start. Why not resolve to make 2016 the year you finally take control of your tax bill, and call us for the plan you need!


In The Headlines

Will Recent Drug Price Increases Fan a Government Backlash?

Drug PricesTwo years ago Gilead caused an uproar when it announced its new Hepatitis C drug, Solvaldi, would cost $84,000 for a 12-week treatment, which put it out of reach of many patients. Meanwhile, earlier this year Valeant, another pharmaceutical company drew scrutiny of its own pricing policies by increasing prices 200% to 500%. Martin Shkreli, former CEO of Turing Pharmaceuticals, became America’s most detested businessman when he raised prices on an AIDS drug 5,500%, from $13.50 a pill to $750. Shkreli defended the price-gouging, unapologetically claiming his obligation was to serve investors. His extreme indifference to the patients whose lives are upended by his massive price hikes allowed the media to cast him as a “greed is good” Wall Street villain. The actions of these companies may turn the full force of public opinion against the pharmaceutical industry.

The latest round of drug-price increases by pharmaceutical companies such as Turing Pharmaceutical and Valeant have stirred up a public furor. As a result, the U.S. Senate Committee on Aging held hearings on these enormous increases on December 9, during which senators from both parties denounced the unconscionable price increases on decades-old drugs.

The pharmaceutical industry’s rationale—that it needs high prices to afford the research—has been turned on its head by Valeant’s business model of spending less than 3% on Research and Development (R&D), and paying less than 3% in taxes. Under CEO Mike Pearson’s leadership, Valeant attracted many investors and increased its stock-market value to more than $90 billion by last August. Since then, serious operating problems and questions about its business practices have contributed to a 60% share-price decline.

Pearson, a former management consultant, says 3% is sufficient because Valeant R&D is much more efficient than that of the big pharmaceutical companies. Many experts question whether any pharmaceutical company can create breakthrough drugs for just 3% of revenues. The most productive pharmaceutical companies such as Merck, Eli Lilly, and Roche spend 17% to 24% percent on R&D. They have deep internal expertise and take on scientific risk, rather than just acquiring small drugs and marketing them.

As egregious as these price increases may be, they are just the tip of the iceberg. A much deeper problem threatens the financial viability of the Affordable Care Act (ACA), known as Obamacare. When President Obama’s former chief of staff Rahm Emanuel was putting together ACA in 2009, he negotiated deals with leading pharmaceutical companies. For their support of ACA and $70 billion in payments to the federal government, the pharmaceutical industry obtained legal guarantees that the government could not negotiate drug prices. Now the consequences of that deal for the government and private health plans is becoming clear as pharma makers regularly increase prices 6% to 10%—and many go far higher.

As a result, the pharmaceutical industry faces twin threats, just as the new generation of promising life-saving drugs is in final development. First, the entire industry is at risk of being vilified for not caring about patients. Second, the industry’s research-driven business model is under pressure from short-term investors arguing to abandon research in favor of simply acquiring drugs from start-ups. The pitfalls of price gouging are now being exposed, as are the consequences of simply buying drugs from others.

Many in the industry believe it is time for the leaders of the pharmaceutical industry to speak out forcefully against these practices, and reaffirm their primary commitment to patients and research. That is what Merck CEO Ken Frazier did at a recent conference declaring, “Turing is not the market. This is a hedge-fund guy masquerading as a pharma exec.” Frazier is following the mission established by founder George Merck, who declared, “Medicine is for the people. It is not for the profits.” All pharmaceutical companies may need to adopt that motto before the U.S. government, in response to public outrage, contravenes ACA to set strict price controls. The recent congressional hearings suggest that time is running short, and public patience is wearing thin.


1. – CNBC
2. – Forbes

Russia’s Gazprom Learns to Play Nice with Europe

RussiaGazprom, the state-controlled, Moscow-based natural gas giant has long played a double role: as an instrument of Kremlin foreign policy; and as a major source of tax revenue for Vladimir Putin’s government. Things have changed. Gazprom has been accustomed to dictating terms because of its size. In the European Union (EU), it supplies about 30% of the gas. But with a 70% drop in profits, the Russian company finds itself fighting to protect its share of a market it depends on for as much as a third of its revenue of $100 billion. Gazprom is no longer a potent diplomatic tool at a time when customers have many more options.

By 2025, says the International Energy Agency (IEA), gas imports by the EU will account for 77% of its consumption, up from 63% now. Gazprom will not necessarily be supplying Europe with those extra imports. American companies will be providing liquefied shale gas to European power plants starting next year. “U.S. shale gas will provide a very important opportunity for European consumers to strengthen their hands,” says Fatih Birol, executive director of the IEA. U.S. exports may make up half of flexible liquid natural gas volumes heading to Europe by 2020, says Philip Olivier, chief executive officer of Engie Global LNG, a shipper of flexible LNG. “Flexible” means the gas can be shipped anywhere.

It is not just America. “There will be competition between American gas, Russian gas, Algerian gas, Middle Eastern gas,” Total CEO Patrick Pouyanné said in October. In response, Gazprom has dropped the bluster and threats it used with European clients that protested Moscow’s actions in Ukraine last year and whose governments imposed sanctions on Russia. (The Western sanctions do not restrict purchases of Russian natural gas.) Instead, the company is paying more attention to customer needs, announcing plans for a pipeline that would transport its gas directly to the EU and pushing to settle an EU antitrust claim that could cost it billions of dollars.

The new approach complements Russia’s attempts to ease tensions with the West over Ukraine and boost cooperation in fighting terrorists in Syria. Those efforts have met with limited success, but Russia is persistent. “The position of Gazprom and the Russian side is becoming flexible in light of the changing situation, defending our interests but also taking into account the demands of the European side,” says First Deputy Energy Minister Alexey Teksler. Gazprom is trying both to appease the Europeans and look for new customers. “In the aftermath of the Ukraine crisis, gas diversification became a mantra for both the EU and Russia,” says Simone Tagliapietra, energy fellow at Bruegel, a think tank in Brussels. But “Russia needs the EU gas market as much as—if not more than—the EU market needs Russian gas.” Gazprom’s room to maneuver is limited. All the gas for Europe is shipped by pipeline, meaning Russia cannot divert it to other markets. Links to China are not expected to be built until after 2019. Russia shelved plans to turn Turkey into a conduit to Europe after the Turks downed a Russian warplane near the Syrian border in November. “Gazprom’s export policy has always been balanced and adaptive,” says spokesman Sergei Kupriyanov. He argues that European customers have become more interested, not less, in Russian gas, given Europe’s own decline in production.

The Kremlin’s traditional hardline approach to customers was on display last year when tensions over the crisis in Ukraine led to the worst breach in relations with the West since the Cold War. “Europe has lost,” Gazprom CEO Alexey Miller declared after Russia signed its first gas supply deal with China. He said another deal would come in the “nearest future” that would allow Russia to redirect some EU-bound gas from deep in West Siberia to Asia. In September 2014, Gazprom started to limit gas deliveries to some EU members, including Poland and Slovakia. They had been supplying gas to Ukraine to replace supplies that Russia had cut off in a pricing dispute with its neighbor. Russia warned that the conflict with Kiev could disrupt supplies to Europe, as had happened in 2006 and 2009. In both those episodes, Gazprom cut off gas to Ukraine. Because Europe got most of its Russian gas via Ukraine, Gazprom’s actions imposed shortages on the EU as well. In January 2015, Miller told the EU’s new energy chief, Maros Sefcovic, that Gazprom would cut off shipments to Europe via Ukraine after the current pipeline contract ran out in 2019. That would force customers to build new pipelines. “We don’t work like this,” a stunned Sefcovic told reporters in Moscow.

But since the spring, the pressure has been growing on Gazprom. The plunge in gas prices has begun to bite. Gazprom expects revenue in Europe in 2016 to be down 16%, the lowest in 11 years. Its giant Siberian fields are operating far below capacity. It says production this year will fall to a record low because of weak demand, primarily from Ukraine, which is not buying much. In April, Brussels unsealed an antitrust complaint alleging Gazprom sold gas to Poland and the Baltic states at prices up to 21% higher than the average. If the charges are proven, the gas giant could pay as much as $3.8 billion in fines, VTB Capital in Moscow estimates. Gazprom denies all the charges.

In negotiations to export more gas to China, talks have stalled. After a September visit to China again failed to yield a deal to expand shipments, Gazprom hastily signed a pact with five big EU companies including oil major Shell and utility E.ON to build a pipeline under the Baltic Sea to Germany. Russian officials say they are ready to offer lower prices to gas customers that help fund construction, as well as concessions to ensure the pact wins EU approval. The company later made a formal offer to settle the EU’s antitrust charges. Miller has publicly backed off from threats to cease shipments via Ukraine after 2019. Gazprom is also giving in to calls by European clients for more pricing flexibility. Slowly, Gazprom is learning how to operate like an ordinary company that has to work on its customer relations.


1. – Bloomberg
2. – The Guardian

The Good News Is . . .

Good News• Consumer confidence improved in December after a November dip, the Conference Board said Tuesday. The index hit 96.5 in December. That’s up from the November reading, which was revised up to 92.6 from 90.4. Consumers’ assessment of the current state of the economy remains positive, particularly their assessment of the job market. A closely followed barometer of consumers’ expectations, the index measures the average appraisal of current economic conditions.

• Smart & Final Stores, Inc., a value-oriented food and everyday staples retailer serving household and business customers, reported earnings of $0.24 per share, an increase of 20.0% over year earlier earnings of $0.20 per share. The firm’s earnings topped the consensus estimate of analysts by $0.01. The company reported revenues of $1.1 billion, an increase of 10.8%. Management attributed the company’s results to solid transaction growth in its Smart & Final and Cash & Carry stores as well as stable gross margin rates.

• Icahn Enterprises announced a definitive agreement to buy the Pep Boys chain in an all-cash deal for $18.50 a share, or $1 billion. Pep Boys is based in Philadelphia and has more than 800 retail locations in 35 states, selling a range of products and services including tires, accessories, maintenance and repair. Mr. Icahn, who bought Auto Plus in June, has said he was looking for another acquisition that could build that business. Scott P. Sider, Pep Boys’ chief executive, said the deal “provides new opportunities for Pep Boys employees and allows Pep Boys to benefit from the significant expertise and resources of Icahn Enterprises.”


1. – The Conference Board
2. – CNBC
3. – Smart & Final Stores, Inc.
4. – NY Time Dealbook

Planning Tips

Estate Planning Strategies to Protect Your Family’s Money

Estate PlanningYou might assume only the very wealthy need to worry about estate planning. However, the bigger issue in estate planning for the majority of people is managing the step-up in basis on inherited assets and income taxes. The step-up in basis refers to how assets such as investment property and second homes are valued and taxed after a death and how taxes are levied against traditional IRAs and 401(k)s inherited by someone other than a spouse. What is more, states may want to assess well. Below are some straightforward strategies you can use to help protect the money you leave to your heirs. Be sure to consult with your financial advisor to determine what estate planning steps are most appropriate for your particular situation.

Draw up a will – This is an essential first step, but many people do not even bother to draw up a will. In fact, a 2014 Rocket Lawyer survey of 2,048 adults found 64% of Americans do not have a will. What is more, 17% said they did not think they needed one. However, without a will, your estate must be divided in probate court, a process that could leave your beneficiaries potentially footing a big legal bill.

Check your beneficiaries – Not all assets are disbursed through a will. Some accounts, such as retirement funds and life insurance policies, let owners name beneficiaries for that particular asset. Without a named beneficiary, an account will need to go to probate court, where a judge will decide who gets the money. It is a good idea to review beneficiary information after every major life change, including the birth of children, marriage or divorce to be sure your money goes where you want it to go.

Set up a trust – If you have a sizable estate or are worried your heirs will not be wise with your money, you can set up a trust and appoint a trustee to distribute your wealth. Trusts can be set up in several ways, but irrevocable, or permanent, trusts may offer the most tax benefits. When money is put into an irrevocable trust, the assets no longer belong to you. They belong to the trust itself. As a result, the money cannot be subject to estate taxes. While a trustee ultimately controls the money, you can create stipulations on its use, and money can be distributed from a trust even while you are alive. A trust does have to pay taxes on its income from dividends, interest and other sources, and the tax rates for trusts can be higher for individuals. For that reason, you might want to pay expenses from a trust, whenever possible. For example, if you were planning to help your child with a down payment on a house, it may make more sense to transfer money from a trust rather than pull cash out of a different account. Using money from a trust will cause income to be taxed at the beneficiary’s potentially lower tax rate, instead of the trust’s tax rate. Because of the complex nature of trusts, you will want to consult with an estate attorney to determine how best to create one that meets your goals.

Convert traditional retirement accounts to Roth accounts – The biggest surprise for many people is that their traditional IRAs and 401(k)s are subject to income tax if passed to a beneficiary who is not a spouse. That money is subject to income tax. Currently, those taxes can be spread over the life of the beneficiary, but that might change. You can avoid leaving your beneficiaries with that tax bill by gradually converting traditional accounts to Roth accounts that have tax-free distributions. You might consider making a series of conversions over several years. Since the amount converted will be taxable on your income taxes, the goal is to limit each year’s conversion so it does not push you into a higher tax bracket.

Gift your money while you are alive – One of the best ways to ensure your money stays in the family is to simply give it to your heirs while you are alive. The IRS allows individuals to give up to $14,000 per person per year in gifts. If you’re worried about your estate being taxable, those gifts can bring its value down. The money is also tax-free for recipients. A similar way to reduce your estate value is through charitable donations. One option for this is to set up a donor-advised fund. This gives you an immediate tax deduction for money deposited in the fund, and then lets you make charitable grants over time. By naming a child or a grandchild as a successor for the fund, it would keep the family involved in philanthropy. Complex strategies and the ever-evolving tax code can make estate planning feel intimidating. However, ignoring it can be a costly mistake for your heirs, even if you don’t have a lot of money in the bank.


1. – Investopedia
2. – Forbes
3. – Business Insider
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