taxes Archives - Page 3 of 5 - Bankers Anonymous

October 25, 2016

Pretending Economic Policy Matters

This Presidential election is absolutely not about economic policy.

To pretend that you’re choosing your presidential candidate in the 2016 election based on economic policy – after this campaign season – is as absurd as claiming you used to purchase Playboy for the articles.

Even so, let’s pretend for a moment that this election was about economic issues. Where do the two major candidates stand?

Trade

First, Trump. Trump introduced himself to the Presidential race in June 2015 by threatening to impose a 35% tax on manufacturing from Mexico. He frequently claims that he would unilaterally renegotiate better trade deals with China, Japan, Saudi Arabia, and Mexico. Although the Republican Party historically has a clearer track record than the Democratic Party of supporting increased international trade, Trump appears somewhat to the left of Bernie Sanders when it comes to trade liberalization. I have the strong impression that he not only does not support international trade, but he also does not really understand how trade agreements work. Trade wars make almost everyone poorer.

Clinton claims to support increased trade, but has chosen to oppose the already-negotiated Trans-Pacific Partnership (TPP), because it might not create jobs, at good wages, while protecting national security. See, again, that’s not how international trade treaties work. Nobody gets a guaranteed job, at a guaranteed “good wage” from a negotiated trade treaty. Some people over time, in fact, lose their jobs or get a worse wage, while other people – like consumers and many business owners – benefit from trade. I think she knows this. Trump appears uninformed, while Clinton appears the opposite of straightforward.

Wall Street

Trump’s stance vis-à-vis Wall Street remains unclear to me. I mean, he’s promised to lower top corporate tax rates from 35 percent to 15 percent, as well as top personal income tax rates to 33 percent, from the current 39.6 percent. That is presumably welcomed in the canyon-lands of lower Manhattan, or wherever executives expect a substantial payday.

In addition, his approach to encouraging economic growth is to roll back or lower government regulations, which might also be welcomed in some parts of Wall Street.

On the other hand, can we be certain he won’t just round up top executives like Jamie Dimon from JP Morgan and Lloyd Blankfein from Goldman Sachs and have them fight – gladiator-style while wearing giant sumo suits – in the middle of Times Square? The winner gets his Wall Street firm automatically nationalized and re-branded “Trump Money,” while the losing executive is drawn-and-quartered by the Budweiser Clydesdales from the 9/11 ad, on live television. Are we sure that won’t happen? Consider the ratings potential! Other than that, I think he’d be fine for Wall Street.

Clinton’s approach, by contrast, appears more predictable. She posits that “Wall Street must work for Main Street,” risky firms must be monitored more closely, and that senior executives must be held responsible for firm losses, each of which might make Wall Street wary of her presidency.

On the other hand, you and I both know what those paid speeches were for. I personally would have no problem getting paid $1.8 million to give 8 boring speeches to Wall Street firms. In fact, I’m just checking my calendar now…Hang on, let’s see, yup, I’m wide open for the next few weeks, so Lloyd, send me a Snap.

Taxes

Speaking of taxes, Trump would repeal the Death Tax, otherwise known as the estate tax, and otherwise known as my favorite tax.

Clinton proposes increasing estate taxes by reverting back to their 2009 level, and increasing taxes on some of the largest estates. I prefer Clinton’s approach, naturally.

Both Clinton and Trump have stated support for eliminating the carried-interest tax break enjoyed by private equity and hedge fund owners, for which I applaud them both. Neither will do it because #campaigncontributions but still, it’s a great thought.

As a side note on taxes: I have zero problem with Trump’s tax return showing nearly a billion dollars in business losses in 1995, which might have relieved him of paying income taxes for the following 15 years or so. I’m sorry to say, Virginia, that the income tax game is a bit rigged in favor of the wealthy. We shouldn’t expect people to pay taxes they don’t legally owe. Trump’s tax-free status is probably entirely legal based on our current tax code, so don’t get mad at him for that.

Energy Policy

Trump proposes a grab-bag of energy-policy liberalization approaches. On his website he announces plans to “rescind all job-destroying Obama executive actions. Mr. Trump will reduce and eliminate all barriers to responsible energy production,” which includes encouraging coal production, and additional oil and gas drilling, in particular on federal lands. It seem plausible to me that this anti-regulation approach would lower the cost of energy for most people and businesses, and thereby provide economic stimulus to the economy.

Clinton has a more mixed approach, which we can intuit from the fact that her official campaign “energy policy” presentation is really expressed in terms of environmental policy, climate change, and an economic safety net for displaced coal workers. As Secretary of State she promoted the “Global Shale Gas Initiative” (read: she promoted fracking), although she has subsequently called for “smart regulations” of the industry in her book Hard Choices. We should probably expect higher energy costs as a result of her administration.

Also, maybe our coastal cities won’t be underwater in twenty years? It’s a trade-off.

Love the gridlock

We have had imperfect candidates for a long time. Often we even elect them to the highest office. So far at least, the inertia of our constitutional system has kept our electoral mistakes manageable. We’ve had a good political run surviving 228 years of imperfect leaders. I’m going to adopt the optimistic view that we’ll survive this next President, and hopefully the next 228 years as well.

The “Washington gridlock” we all claim to hate may be our best insurance against candidates we don’t like. The system, by design, stymies the Executive branch, and that’s a good thing. I’m frightened by this election, but I’m trying to take the long view. I will certainly vote.

Finally, I mentioned Playboy above because economic policy means absolutely nothing this time around.

The centerfold of this campaign has been all about sexual harassment, locker-room talk, “stamina,” testosterone levels, former President Bill Clinton’s womanizing, fat-shaming, and tiny fingers. I suspect we will all vote according to where we stand on these important issues, not the economy.

A version of this post ran in the San Antonio Express News and The Houston Chronicle.

Please see related posts:

Trump – Sovereign Debt Genius

Death and Taxes

Carried Interest Loophole

The Primary Candidates

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September 12, 2016September 12, 2016

Estate Tax Takedown – Levine Defeats Mankiw

I’m a huge fan of Bloomberg’s Matt Levine,¹ who is basically smarter and funnier than anyone writing about finance.

Anyway, I was annoyed to read yesterday’s Op-Ed by Gregory Mankiw (whose textbook of course we all had to have in College) Mankiw’s a Harvard professor with all the respect that comes with that, and he’s attacking a tax position I hold dearly. My view is that the Estate Tax is the best of all taxes, and Mankiw’s view in the Op-Ed is that it’s unfair, because of the different level of taxation that will hit a theoretical household of frugals vs. spendthrifts.

Mankiw’s view is that two households that generate, say, $20 million in wealth will be hit by unequal taxes, depending on how they spend, or don’t spend, their money. To complete the thought, a spendy household will end up avoiding the estate tax – currently 40% of an estate’s value above $5.45 million. Meanwhile, a thrifty household will pay those hefty taxes, when the couple dies. Humph. That did sound unfair when I read it yesterday.

Thankfully, Levine rescues my views, with an important distinction. The taxpayer is actually their heir, not the wealth-generator. The wealth-generator is dead. And when you think about what is “fair” to heirs, the calculus changes. Take it away, Matt:

Here is a curious argument from N. Gregory Mankiw that the estate tax is bad “because it violates a principle that economists call horizontal equity. The basic idea is that similar people should face similar tax burdens.” So if two couples — the Frugals and the Profligates — each start businesses, work hard, and earn the same amount of money, they should each pay the same amount of taxes, even if the Frugals save all their money and the Profligates spend theirs. They do. But Mankiw thinks they don’t:

[Levine now quoting Mankiw:] Under an income tax, the couples would pay the same, because they earned the same income. Under a consumption tax, Mr. and Mrs. Profligate would pay more because of their lavish living (though the Frugals’ descendants would also pay when they spend their inheritance). But under our current system, which combines an income tax and an estate tax, the Frugal family has the higher tax burden. To me, this does not seem right.

Ah, see, the problem here is thinking that the senior Frugals pay the estate tax. They don’t. They are dead when the estate tax is assessed. The two great inevitabilities are death and taxes, but death is in an important sense logically prior. When you pay taxes, you still (usually) prefer not to be dead. Once you are dead, you have no preferences about taxes. We could fund the government with a lovely, efficient, non-distortionary system of taxing only the dead, except — and this is another key point — the dead don’t have any money. The incidence of the estate tax can’t be on dead people. Once the Frugals die, their heirs have the money, and the estate tax taxes them. If the Frugals’ children make $30,000 a year as art gallery assistants and also inherit $20 million, and Mr. and Mrs. Justnotrich’s children make $30,000 a year as Wal-Mart employees and inherit nothing, it seems odd to say that they should pay the same taxes as a matter of horizontal equity.

So anyway, I think Levine the finance blogger wins that round against Mankiw the professor. Also, it fits my worldview, so…

Please see related posts:

The Estate Tax is the best tax

Adult conversation about taxes

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And you should subscribe to his daily email. No wait, don’t, because then you’ll realize how often I’m trying to ape his style. Forget I mentinoed it. ↩

September 5, 2016March 26, 2017

Houston We’ve Got a (Pensions) Problem

Houston’s three public pensions may not be in total distress today, but some of the instrument panels are beginning to flash orange.

One of the warning signs is the hit to the city’s credit-ratings earlier this year, as

Moody’s Investors Service downgraded the City of Houston’s debt on March 16 2016.

You might guess that the main problem with the City of Houston’s credit rating is the slowdown in the oil services business, and that’s certainly a short-term issue.

But Moody’s specifically cited large unfunded pension liabilities as one of the four main reasons to downgrade city debt to Aa3 and keep it on “negative outlook,” calling the liabilities “among the highest in the nation.” Lacking a plan to address the pensions, Moodys wrote in March, could lead to a further downgrade in the city’s bond rating.

Let’s review some statistics on the pensions for firefighters (acronym: HFRRF), police officers (acronym: HPOPS), and municipal employees (acronym: HMEPS).

Things to monitor

Remember, the first two things to monitor, with respect to the health of a pension plan, are the funded ratio – roughly how much of future payments are already covered by investments – and years to amortization, otherwise known as the time needed to pay down debts. I’ve previously said that an 80 percent funded ratio is considered ok, although closer to 100 percent would be preferred. For years to amortization, a 15 to 20 year time frame seems manageable, while 40 years to infinity invites state monitoring and restrictions.

So what do we worry about the Houston plans in particular when we see the funded ratio and the years to amortization?

Here are the two measurables on the three Houston pension plans:

HFRRF – 86.6 percent funded ratio, 30 years amortization

HMEPS – 54 percent funded ratio, 32 years amortization

HPOPS – 79.8 percent funded ratio, 23 years amortization

Honestly, using just those measurements, only the HMEPS funded ratio makes me worried. If you’re not frightened by the first two measurements of funded ratio and amortization – and when I look at them I don’t personally get panicked – the next thing to monitor gets trickier.

You see, the firefighters’ and municipal workers’ plans assume an 8.5% annual return on investments, while the police plan assumes an 8% return. Not only do all three assumptions seem too high, but the first two plans are complete outliers. In a survey done by the National Association of State Retirement Administrators in early 2016, only 1 out of 127 plans assumed an 8.5% return. So, Houston firefighters and muni workers have an aggressive – actually my preferred word would be unrealistic – set of assumptions.

Last Fall, the Chairman of the HFRRF Todd Clark defended their outlier return assumptions in the Wall Street Journal, saying “We strongly believe, and past history shows, we can continue to achieve the 8.5% long term.” Clark resigned in July. HFRRF Executive Director Ralph Marsh declined to comment on my questions about the assumed return, or others posed about their pension fund.

The last 20 years’ average pension returns were 7.47 percent, according to the Wall Street Journal.

As a finance guy, I wish I could intuitively explain to the non-finance reader the uncomfortable tingly feeling in my toes that I get about that math. The effects of being wrong by just 1 percent, compounded over decades in a pension plan, are huge. We can see some of the scary implications from a presentation done by the Houston plans for the Texas legislature in June.

In that presentation, they showed that if you shift the return assumptions on Houston’s police and municipal employees down by 1 percent, suddenly the police pension plan only has a 54.6 percent funded ratio, while the municipal employees plan goes to a 49 percent funded ratio. So, like, only half the money needed to pay out retirees is currently available in the plans. Ugh. The instrument control panel not only shows blinking green lights turning into red lights, but sparks are starting to shoot out of the dials. Danger Will Robinson!

Now you start to get a sense for why Moodys downgraded the City of Houston in March, and why the Chairman of the Pension Review Board is trying to sound the alarm on Houston pensions.

City Budget Constraints

You see, the next big problem is that fixing pension shortfalls begin to eat into city budgets, a process already underway in Houston.

Josh McGee, who serves as both the Vice President of the Laura and John Arnold Foundation – a Houston think-tank focused on public finance, as well as the Chairman of the Texas Pension Review Board – points to a worrisome trend for Houston’s city budget.

In 2001, required pension contributions made up just 6.7 percent of general fund revenue, or the amount of money in the city budget not otherwise allocated to specific purposes. By 2015, the required pension contributions have climbed to 19.2 percent of the general fund. The trend here, tracked by McGee, has been steadily upward.

McGee compares Houston’s situation today with Chicago’s situation a decade ago. In Chicago, the comparable pension payment to the general fund rose from 19 percent to a stunning, and devastating, 54 percent today.

That means city leaders can’t decide to pay for stuff in a city without dedicating half their discretionary budget to fill in holes in pension plans – money already owed to workers, for work already performed. You have to rob Peter to pay Paul. Chicago is in a terrible bind today, and McGee openly worries Houston will follow down that path without a course correction.

So what happens if these plans stay in trouble? Realistically, political leaders don’t just say “Whoops” and send a shrugging emoji to pensioners. They especially don’t do this with politically sensitive pensioners like police, fire and city employees.

No. Instead, they fund the plan, and then taxes go up. Or they fund the plan, and other discretionary city services go way down.

The only other fix is to significantly reduce benefits for future employees.

Either way, residents previously blissfully unaware of such boring actuarial minutia as funded ratios, amortization schedules and actuarial unfunded liabilities unhappily begin to care, deeply and late, about such problems.

A version of this post ran in the San Antonio Express-News and the Houston Chronicle.

Please see related posts

The Dallas Police and Fire Pension Mess

Pension Plan Heuristics

The Big Four Texas Pensions

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July 4, 2016

Wylys – What Were They Thinking?

I’m fascinated by the psychology of Dallas-based entrepreneur Sam Wyly, recently ordered to disgorge $1.1 Billion for maintaining an extensive offshore scheme that led to convictions and penalties for securities fraud and tax evasion.

I’m interested in knowing: What the heck was he thinking?

I mean, I gather Sam was motivated to not pay too much in taxes. And I’m sympathetic, to a point.

Mike’s First Immutable Law of Taxation is that “Every tax action causes a tax-avoidance reaction.” The government passes a tax law. We, the taxpayers, try to delay, defer, and minimize those taxes.

That’s not always a bad thing, since Individual Retirement Accounts (IRAs) for example are in part a tax avoidance reaction. Reducing our personal cigarette or gasoline consumption is another potentially positive response to increased taxes.

We should expect and even condone a degree of tax deferral and tax minimization. I would even agree that you have a duty to your own family and your potential future philanthropic agenda as you get wealthier to prudently pay to the government only what you owe, and not a penny more.

And then there’s the Wylys. I mean, come on, guys. I don’t mean to be overly moralistic about them. I’m puzzled by the unnecessary risks they took.

Self-sabotage

What makes me shake my head even is the needless self-sabotage involved. None of their tax evasion – if they’d sort of stopped to think about their true self-interest, properly understood – really helped them in the long run.

Picture yourself as Sam Wyly. You show an extraordinary and wide-ranging knack for building businesses and making money over the decades in computers, retail, restaurants, and insurance. You are rich beyond any reasonable expectation, especially considering where you started in life.

You are a Texas Miracle. A Man in Full. You and your brother Charles are the American Dream, personified.

Not only that, but you give generously, funding endowments to The University of Michigan, and Louisiana Tech. Your brother Charles funds a theater in the Dallas Arts Center.

This is not enough, apparently.

You listened in 1992 to a clever promoter of offshore schemes to minimize your tax bill in a variety of ways – reducing income taxes, capital gains taxes, future inheritance taxes, gift taxes – all the while shielding your financial empire from the prying eyes of US tax authorities.

The plan is a bit untested. All sides admit it is an “aggressive scheme” and will require an alert team of attorneys, family office managers, trustees, accountants, and heavy reporting requirements to stay on the safe side.

An independent tax expert in 1993 – after you’ve initiated the series of offshore trusts, corporations, and money transfers intended to obscure your assets – opines that the scheme as executed probably isn’t legal. Not deterred, you continue to create new offshore entities in 1996, neglecting to investigate the “grey areas” of the scheme and failing to file proper disclosures as recommended.

Maintaining the scheme requires you to engage in circular money transfers between onshore and offshore entities to hide the origin of your funds, to use made-up “friends” who create offshore trusts on your behalf, and to hide ownership of public shares behind shell corporations to evade securities laws on disclosures.

In 2003, ten years into the scheme, an independent, top-notch, offshore tax lawyer not only warns you that it’s all probably illegal, but even negotiates anonymously on your behalf with the IRS to find a solution to any penalties that might arise from your decade of operating an illegal offshore scheme.

This was your chance to make it right. No settlement is reached at that time. You continue for yet another decade to perpetuate the scheme, fail to file proper disclosures, ending up in cat-and-mouse litigation with the IRS.

The SEC finally wins a $300 million judgment in 2014 against you for federal securities fraud, as a result of your offshore accounts activity.

So that’s awkward. And is a teensy dent in your American Dream story. Undeterred – again, you’re a Wyly and presumably grit is your middle name – you declare bankruptcy in 2014 as a pre-negotiating tactic on the $300 million owed.

But things get worse. The IRS, unhappy at missing out on taxes for decades and very likely interested in making an example of your rise and fall, vows to sue you for back taxes and penalties.

The bankruptcy court in June 2016 declared $1.1 Billion in money now owed (80% of this is “penalties and interest” on the original taxes evaded) by Sam. This is not good.

My naïve thoughts

I feel like the Wylys made some poor choices here.

One of my personal uninformed theories is that if you have a lot of money or make a lot of money you should realize that the entire legal system – civil and criminal enforcement – is built to protect your money, private property, and personal safety.

I mean really, what does a destitute person have to gain from private property rights enforcement in the courts? A destitute person could arguably do better in a system of weak enforcement. So like, if you’re rich, then you really, really want a strong government to protect you from the destitute person who’s got nothing to lose if they decide some day to just basically take your stuff by force or fraud.

So one of my views is that if you have a lot to lose, then pay your damned taxes with extreme gratitude that the police and courts are there to protect what you have. But like I said, this is just my dumb theory.

Maybe no choice?

But then I wonder, psychologically, did they even have a choice? Were they wired to always seek their maximum advantage, to their own ultimate demise?

This is just armchair psychology stuff but part of me thinks that the same entrepreneurial drive that helped Sam and Charles Wyly conquer the business world also drove them to game the offshore tax system to the max, to their ultimate fraud, bankruptcy, and tax evasion convictions.

I hope naively that when I become a billionaire I’m going to pay my regular taxes right here onshore in the United States and just try to be happy.

Maybe that’s easy for me to say now, as I am not currently (temporarily, mind you) a billionaire. Also, while I’m pretty happy now, maybe the problem of having to pay tens of millions of dollars annually in taxes on my hard-earned money will really drive me crazy – like it must have the Wyly brothers – and I’ll decide to put everything at risk to avoid making those payments. Will I plunge desperately into a legal gray area, spending my final years giving court testimony, guilty of securities fraud, bankrupt, and liable for billions in taxes and penalties?

I hope to – some how, some way – have the opportunity to find out just how I’ll react.

A version of this post ran in the San Antonio Express News

Please see related post:

How To Evade Taxes Offshore

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June 28, 2016July 4, 2016

How To Evade Taxes – Offshore Wyly Style

Although no household names from the United States showed up in the “Panama Papers,”[1] – a trove of leaked client correspondence from a Panamanian law firm that helped people set up offshore accounts – a Texas bankruptcy court recently elevated Dallas entrepreneurs Sam and Charles Wyly as the most high-profile offshore-account tax evaders ever caught.

Last month the court ordered Sam to pay $1.4 Billion and Charles’ estate to pay $800 million. Just today the bankruptcy court updated Sam’s amount owed as $1.1 Billion.

I have often wondered what the point of offshore accounts really is. I don’t have any offshore accounts – alas – so have not had the opportunity to learn from my personal experience. So I studied the Wyly case out of curiosity about how very wealthy people use offshore accounts, and why.

Why offshore accounts?

In their simplest form, offshore accounts are legal. You could choose to set one up with the same goals in mind that might lead you to form a regular LLC or corporation – namely, to clarify where and when to pay your taxes, and to reduce your potential liability or vulnerability to lawsuits or attacks on your net worth.

If you intend to dodge your taxes or to cheat securities law, however, offshore accounts offer at least four distinct advantages, as I learned from the Wylys. Here’s how.

Avoid Income Taxes

A primary function of the Wyly’s offshore trusts set up in 1992 was to take in valuable stock options they owned, swap them for special annuities that allowed them to not pay income tax on their stock options that year, and then indefinitely postpone receiving income from the annuities.

The less income you have this year, the less you pay in taxes!

I gather from the court record that this all could have been cool with US tax authorities if, when the annuities paid out, the Wylys reported the income and paid taxes then. Tax deferral like this is often fine, as long as you color within the lines, carefully disclose what you’re doing, and pay everything eventually – sort of like a 401K retirement account, but on a much bigger scale.

But then…it gets murkier. The brothers kept deferring when the annuities would pay out. And the ownership of their assets kept getting split up between various accounts in convoluted ways that don’t appear to make economic sense, but do make sense if your intention is for the government to lose track of your money, so they’ll never pin a tax bill on you. So it seems offshore accounts are useful if you’re trying to play hide-the-ball with the IRS.

Minimize Estate taxes

The brothers set up a series of Trusts and corporations offshore – specifically on the Isle of Man, a little financial offshore haven between the UK and Ireland.

One of the points of a trust is to set aside dedicated funds and to clarify certain charitable intentions that may reduce your estate taxes. The Wylys named charitable institutions, as well as their children, as beneficiaries.

Over two decades, the brothers declined to properly disclose to the IRS money flows into and out of their trusts and offshore corporations. The estate-planning function – which could have been done with offshore trusts legitimately – appears to have been more about obscuring the extent of their wealth, which in the long run could have saved them and their children tremendous amounts of money on their estates. Naturally, the less observable money you have in your estate when you die, the less the IRS would expect to receive from your estate.

Evade securities laws

Even after reading 400+ pages of court documents, I can’t tell if this was a nefarious intention of the Wylys from the beginning, or not.

Here’s what happened. They move a lot of shares in public companies – including one they’d founded called Sterling Software – to offshore accounts. US securities laws require owners to disclose how much of a company you own, especially if ownership hits certain triggers, like owning 5 percent of any one company at any given time.

But the Wylys didn’t want to show the federal government how much they owned, and by splitting up ownership into multiple anonymous-seeming accounts, they tried to keep any individual account below the 5 percent disclosure trigger. The SEC prosecuted the Wylys for trading illegally using these offshore anonymous accounts, but ultimately could not prove their case.

But just evading disclosure – splitting up ownership into various accounts to keep under the 5 percent ownership trigger – is fraud in and of itself. If your goal is to minimize taxes – not trade on inside information as the federal government unsuccessfully prosecuted them for – you may still end up breaking securities laws around mandatory disclosures. And the Wylys did.

Avoid gift taxes

The Wylys kindly purchased valuable real estate – homes, horse farms, and office buildings – for their children, using money in their offshore accounts. They also purchased art and collector-quality jewelry for personal use using offshore trust money.

Here’s a pro tip. You can’t give more than $14,000 per year to anyone, including your children, without triggering a gift tax. But let’s say an offshore corporation owned indirectly by you does the real estate buying, and it’s unclear to US government authorities who the buyer is? Then you might be able to get away with it. (Unless the government figures it out, convicts you, and you owe around $2 Billion in penalties. But hey, we’re all adults making our own choices here.)

The Wylys argued in court that their foreign trusts simply invested in valuable real estate in the United States, and that the purchases of homes, offices, and horse farms for their children’s exclusive and rent-free lifetime use weren’t gifts, but rather long-term investments by the trusts. This isn’t real tax advice but, c’mon really, you can’t just do that.

Obviously you should not be reading any of this as a how-to – unless securities fraud, tax evasion and bankruptcy seem like life goals.

Next week I’ll write about the Wylys from a psychological perspective. Like, hello? What the heck were they thinking?

A version of this post appeared in the San Antonio Express News

[1] An excellent New York Times piece highlighted a few US citizens outed by the Panama Papers – including a hedge fund businessman, a real estate investor, and an author – but nobody I’d heard of previously.

Please see related post

Sam Wyly – What Was He Thinking?

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January 18, 2016April 5, 2016

Tax Avoidance – All The Feelings

One thing worse than paying our taxes is the idea that other people avoid paying their fair share of taxes.

On the subject of tax avoidance by other people, I can think of at least three principal feelings. As the kids say, I feel all the feelings.

Outright tax fraud

People everywhere on the political spectrum can get angry about outright tax fraud, whether it’s hiding income in offshore accounts to avoid income taxes or shielding inheritances from estate taxes.

A new book by Gabriel Zucman The Hidden Wealth of Nations estimates the size of offshore wealth at $7.6 trillion worldwide, or 8 percent of global wealth. In the US, Zucman estimates $35 billion in lost tax revenue per year due to hidden assets. Meanwhile, governments worldwide lose up to $200 billion in annual revenue from hidden tax havens, with a significant burden of this $200 Billion in fraud falling on developing countries’ governments.

Wealthy folks hold financial assets principally in Switzerland, Luxembourg, and known tax havens such as Cyprus or a myriad of islands in the Caribbean.

One exception to my outrage, I suppose, is petty tax fraud such as when my barista fails to report to the IRS each and every dollar she removes from the tip jar at the end of the day. In that sense the minor scale of her tax fraud diminishes my outrage, as well as the fact that the barista isn’t herself wealthy. Also she supplies my drug of choice. Still, fraud is fraud, and it’s never cool.

Clever tax avoidance

My feelings slide from “outrage” over to the milder “envy” when I read about some billionaires’ strategies to legally avoid taxes, such as the strategies explained recently in the New York Times. In an article titled: “For The Wealthiest, A Private Tax System That Saves Them Billions” the authors describe leading hedge fund founders whose investments in Bermuda-based insurance companies reduce their tax bills.

Their ability to guide tax legislation through Congress and to finance presidential campaigns does stick in my craw quite a bit, and should offend those of us who still hold out hope for our democracy. On the other hand, most of the specific clever tax avoidance that the article describes can be described as the benefits of simply owning a business – albeit in their cases, big ones.

Now, of course, you could decide to hate the fat cat hedge fund guys who simultaneously write the rules on creating income tax loopholes and then nimbly leap through those holes to the tune of billions in annual savings. I think generating that outrage is the main point of the New York Times article, and I don’t blame you too much for feeling that way.

Alternatively, you could decide not to hate the player and just to hate the game. By that I mean, understand that a major part of the ‘scandal’ exposed by the article is simply the trick of turning ordinary (high tax-rate) income into long-term (lower-tax rate) capital gains. The other trick – and this is really simple – is to invest in a business that appreciates tremendously in value over a long period of time but that only gets taxed when you sell it. And then don’t ever sell it. Like, to take an example I recently wrote about, buying a stock and holding it for thirty years, or for forever.

Look, I don’t intimately know all their tax tricks, but hedge funders investing in offshore insurance companies mostly just extend this year’s short-term income (a nearly 40 percent tax rate this year) into long-term capital gains (a 20 percent tax rate, eventually). It’s legal. It’s clever. I’m envious, but I’m not particularly angry.

This is basically how Warren Buffett famously pays a lower tax rate than his secretary. When you read about Buffett or Facebook’s Mark Zuckerberg merely claiming the proverbial $1 per year in salary, you really shouldn’t be impressed with their admirable lack of avarice. Rather, you should note their tax savvy. They make their money through (tax-advantaged) business ownership rather than through (tax-disadvantaged) wages.

It’s an open debate – actually it’s not, but maybe should be? – whether labor ought to be taxed at a higher rate than capital, as it is today. But those are the rules. And remember the Golden Rule you learned in Kindergarten, “He who has the gold, rules.” So save your hate for the player and just hate the game.

Imitation: Own a Business

By the way, if you personally want to start to save money on taxes like a baller, you need to own your own business.

I’m not your accountant, and you really shouldn’t take tax advice from some blogger you found online. But you should set up your own business – like today – if you want to reduce your personal tax bill.

Will you use a cellphone and monthly internet service for your business? What about a computer for record-keeping? Or perhaps a car with your business logo on it? If you are in the 25 percent income tax bracket, and those are legitimate business expenses, all of these will cost you 25 percent less, in after-tax terms.

If the business you own happens to pay you annual profits in dividends, you might enjoy favorable income tax treatment, when compared to taxes on ordinary wages.

If you can control the timing of when you actually get paid by the business you own, you may realize considerable income tax savings through timing your income from one year to the next. If your business makes an expensive investment this year that happens to reduce your annual profit, you may end up paying little to no taxes this year, even as your business grows.

So, my journey from outrage, to envy, to imitation can be summed up as:

Workers of the World, Unite! Start up your business today! You have nothing to lose but your chains (And your top tax rates!)

Unfortunately, as Marx and others discovered with the Communist Revolution, this is easier said then done.

Frankly it’s pretty difficult to find money for starting up your small business.

A version of this post ran in the San Antonio Express News.

Please see related posts:

Startup Finance – All The Terrible Ways

Getting Started – Entrepreneurship

Entrepreneurs: Pack Half the Stuff and Twice the Money

Entrepreneurship Part III – The Air, Taxes, Retirement

Entrepreneurs – Are you a touch funny in the head?

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