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IRS “Fortunate 400” Report Shows Evidence of Significant Income Shifting to Avoid Fiscal Cliff Tax Rate Hikes

3 min readBy: Scott Hodge

The IRS has released an update of its annual breakdown of the 400 largest taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. returns for 2013. The initial media reporting has highlighted the increase in the average tax rateThe average tax rate is the total tax paid divided by taxable income. While marginal tax rates show the amount of tax paid on the next dollar earned, average tax rates show the overall share of income paid in taxes. paid by these “Fortunate 400” from 16.7 percent in 2102 to 22.9 percent in 2013, which prompted the Washington Post’s Wonkblog to declare “Really rich people are suddenly paying quite a bit more in taxes,” as a result of the fiscal cliff tax deal signed by President Obama at the end of 2012.

But the story is not as simple as that. While the richest 400 taxpayers did pay $1.9 billion more in taxes in 2013 than they did the prior year, they did so while reporting dramatically lower incomes compared to 2012. The table below lists some of the major sources of income the IRS compiled from the 400 wealthiest tax returns (all figures are in billions of dollars). Nearly all of these income sources are down significantly from 2012.

Figures are in Billions of Dollar
2011 2012 2013 Dollar Change 2012 to 2013 Percent Change 2012 to 2013
Adjusted Gross Income $87.90 $134.30 $105.90 -$28.40 -21%
Salaries and Wages $4.90 $10.10 $8.90 -$1.20 -12%
Dividends $9.50 $21.70 $11.40 -$10.30 -47%
Sale of Capital Assets (net gain less loss) $49.90 $76.30 $54.70 -$21.60 -28%
Capital Gains Subject to Preferential Rates $54.80 $91.90 $57.40 -$34.50 -38%
Net Business Income (net of losses, Schedules C and F) $0.40 $0.81 $0.48 -$0.32 -40%
Partnership and S Corporation Net Income $14.20 $14.10 $16.30 $2.20 16%
Taxable Income $73.90 $111.10 $85.10 -$26.00 -23%
Income Tax $15.40 $22.40 $24.30 $1.90 8%
Average Tax Rate 17.1% 16.7% 22.9% 6.2% 37%
Source: IRS,

Starting with adjusted gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” , we can see that the Fortunate 400 reported $28 billion less overall income in 2013 compared to 2012, a drop of 21 percent. The biggest contributors to this decline were: dividends (down 47 percent); the sale of capital assets (down 28 percent); and, capital gains subject to preferential tax rates (down 38 percent). The only source of income for which the wealthy reported significantly higher growth in 2013 was from partnerships and S corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). s.

Finally, we get to the bottom line and can see that taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. declined 23 percent in 2013 to $85 billion from $111 billion in 2012.

So what explains this? Well, the more interesting narrative to come out of the IRS report is the evidence of income shifting in 2012 as the 400 wealthiest taxpayers anticipated the eventual tax increases on personal and investment income that would result from the fiscal cliff tax legislation.

Nearly all the major sources of income for these 400 taxpayers were up significantly in 2012 compared to 2011, as they pulled income from the future into a lower-tax year. For example, in 2012, they reported more than twice the amount of income from both salaries and wages and from dividends than they did in 2011. Also, the amount of income they reported from various forms of capital gains was at least 50 percent greater in 2012 compared to the previous year.

Overall, the taxable income for these taxpayers was 50 percent greater in 2012 compared to 2011, and they paid $7 billion more in taxes as a result.

The lesson here is that high-income taxpayers have considerable flexibility as to how and when they report income. Headlines reporting that the rich are paying higher average tax rates as a result of the fiscal cliff deal don’t really tell the whole story.