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What Planning Lessons Can We Learn From The President's Tax Return?

Last week the White House released the President's 2013 tax return. Being curious financial professionals we decided to take a look and see if there are any financial planning lessons that can be learned from the tax return of the most powerful couple on the planet. We should of course acknowledge that we have no idea if some of these things were discussed between the client (Mr. and Mrs. Obama) and their accountant, or if there are certain limitations of the office of President that would make our points moot. If someone happens to have answers to some of the questions we pose, please contact us and we'll be happy to update this post.

First, the President received quite a large tax refund this year. Their overall tax liability last year was just over $98,000. In addition to having just over $100,000 withheld from his regular salary of $400,000, he paid estimated taxes of nearly $17,000. Hence, he got back those estimated taxes and then some. We conjecture that the estimated tax payments were 'protective' payments to ensure that his income as an author did not create a tax penalty. But, with a bit more planning during the course of the year one wonders if it was possible to see that his income was going to be in a certain range and that he was clearly overpaying his taxes unnecessarily? (He was providing the US government with an interest-free loan! Maybe this was his own personal contribution to reducing the deficit?) With a bit of late year planning he might have been able to skip the last estimated tax payment and thus reduce what was a fairly large refund.

Second, the President's salary is $400,000. It appears based on this reported wages of $394,796 he did not contribute to a voluntary retirement plan. (We are guessing the difference in salary and reported wages is a health insurance deduction, but we would need to see the W-2 statement.) All federal employees are eligible for the Thrift Savings Plan which is a 401k type of plan for federal employees. Hence, the President could have deferred $23,000 last year. ($17,500 regular deferral + $5,500 catch-up for those 50 and older.) This would have been a great tax deduction for the Obamas. I am not aware of any reason why the President could not contribute to this plan.

Third, the President did have over $100,000 of self-employed income as a result of royalties from this books. For this income he DID contribute to a SEP. (Self-employed retirement plan.) We wonder if he should be considering a solo 401k plan so he can shelter even more of this income and get a larger tax deduction? By our estimates he could shelter an additional $23,000 of his self-employed income if he used a solo 401k plan instead of a SEP.

Fourth, the President had $3 of dividend income. Basically, he does not own any equities in his non-retirement investment portfolio. From what we can gather, the only investments he owns outside of his retirement assets are US Treasury obligations which are taxable at ordinary income tax rates. One recommendation would be to use tax-free municipal bonds in the non-retirement portion of his portfolio instead of US Treasury bonds. This would reduce his taxable interest from the US Treasury obligations. Again, are there certain limitations that restrict the President from owning municipals?

It appears the President does own equities through a Vanguard 500 Index fund in a retirement account from previous employment. From an asset location standpoint, it would be better to own tax-efficient equity funds such as an index fund in a non-retirement account and then use the retirement account for assets that are less tax-efficient. (Like taxable bonds which he owns in his non-retirement account!) Furthermore, based on my research, the President does not seem to be very diversified in his asset allocation. Owning just the S&P 500 and a few US Treasury obligations leaves out quite a bit in our opinion. What about small cap stocks? Or international equities? Or real estate investment trusts (REITs)?

Fifth, the President reported home mortgage interest of more than $42,000 last year. His 2012 financial disclosure statement indicates that his mortgage is between $500k-$1M and his interest rate at that time was 5.625%! My first thought when I saw this is why has this mortgage not been refinanced? Last year, 30-year mortgage rates were down below 4%. Even with a jumbo loan he should have been able to do better than 5.625%. With US Treasury bond rates below 3% for 10-year bonds, it begs the question as to whether or not he should simply cash in some bonds and pay off the mortgage? There would seem to be an immediate arbirtrage opportunity of nearly 3%. Yes, he gets a nice tax deduction for paying that interest but he also pays tax on the interest on the bonds he owns. Hence, the tax considerations should not be a major factor in a decision to pay down the mortgage. Assuming the mortgage is at least $750,000 then a 3% pick-up (difference between interest paid on mortgage and interest earned on Treasury obligations) would be $22,500/year. May not be a big deal to someone who will earn millions of dollars giving speeches the rest of his life, but that is still money that could be used towards those many charities that are important to the Obamas.

Finally, we noticed that yes indeed, the President paid those Obamacare taxes!

To repeat, this post was meant to use the President's tax return as an example of various tax/financial planning ideas that that the rest of us should be thinking about. It is entirely possible there are good reasons behind all of the decisions that were taken or not taken.

We welcome any feedback that you may have on this post.

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