the Air Vent

Because the world needs another opinion

An American Primer on Taxes

Posted by Jeff Id on September 23, 2011

I’d like to write a few (hundred) words about taxes today.  This isn’t going to be some political rant, just an explanation for those who don’t own US businesses as to the difficulties that we currently face in creating jobs and an explanation of the new-age myth that companies and the wealthy are somehow undertaxed.  It is important that people understand these issues as too many of those I run into are buying into the current raise the taxes on the rich dogma.  No I am not an expert in taxes, but I’m not an expert in climate either and we can intelligently discuss that here all year long.  I do seem to be quite good at paying taxes though and I am lucky to have partners who are far more versed on these matters who keep me straight.

First, there are 3 main types of corporations in the US, LLC, S and C types (there are sub-variants as well for lawyers and medical I believe but this is beyond my knowledge), there are also non-profits, sole proprietorships and other nuances but the three primary taxable entities we need to worry about are listed here.  Of the three LLC and S never, ever, ever pay any taxes.   Not one penny.  This is because they are pass-through entities and any income they make is placed directly on the personal income statements of the owners.  C corps pay taxes according to a schedule like this and people like Warren Buffet who own giant C corps don’t report their corporate income or taxation on a personal return – thus, much of their tax rate is hidden.  Typically, the largest companies are C corps.  Each corporation type has its own advantages, we have an LLC and an S corp.  The S corp is a manufacturing company the LLC holds technology and does other contractual work.  Again, there are legal reasons for doing this but both of our current corporations are pass-through types.

So the second disclaimer of this article is that it doesn’t cover the most massive corporations like GE or Siemens who operate internationally and take advantage of the accounting shelters, political contribution quid pro quo that the ultra-powerful can take advantage of.   International tax law IS a key factor in what the US must change to improve the economy but the biggest companies are also the biggest donors and receivers from politicians.   We must fix these laws to survive as a country, again though, another blog should cover that for you.

Lets talk about families earning more than 250,000 per year or individuals earning more than 200,000.

The rich! ………… allegedly

So I like to ask people, “Do you personally know anyone making that much?”  Very often, the answer is no but sometimes people say yes. I know of several.  Lawyers, doctors, business owners those sorts of people.  But really, even the best lawyers and doctors have a hard time crossing the more extreme half million per year mark yet there are still plenty of those.  Of the doctors and lawyers, their income is actual money taken home in their pockets, unless they too own the businesses.

If you own a business, the tax story changes compared to a lawyer or doctor, especially if you own a manufacturing company.   If you buy equipment, like an injection molder $100,000 or a vacuum coating machine 600,000, or a sonic welder 30,000, this is an immediate cash outlay but you can’t expense it immediately, meaning that even though you pay 100% out of your pocket, you can’t subtract it from the cash you made that year.  I’m not an expert on how fast different things are depreciated, but it is like 5, 7 or 10 years depending on the asset.  Of course we pay big money for the real experts.   In other words, you make some money and spend 300,000 on equipment and you pay tax on income of 270,000 on the first year and you write off 30,000 on the tax for that year.  You get the whole value written off over time at 30K/year, but the point is that the whole amount you were able to make and expend looks like income this first year.  Further, the point for an S corporation is that it looks like personal income to the business owner.  Yay, a family making more than 250,000.

It is true that you do own the machine, but it is also true that you no longer have that cash you earned as profit to buy the equipment, so the immediate machine cash impact is typically over fifty percent higher than the money you paid for it.  Forty percent to the feds, five to the state, plus sales tax plus any incidental taxes, Michigan even charges personal property ownership taxes on top of the rest.  Sure, each year after that you get to deduct a fraction until all the money is back in your pocket as an expense against income.  The feds simply hold the money while you use the equipment to generate income, which is taxed.   They pay no interest for holding your initial payment of course so you’ve lost in the end but the point is, it costs a lot of money in taxes to add equipment in the US.  I think of it as a business-repressing negative (less than zero) interest loan to the US government.

Obama put some kind of one year plan in place to allow business to write off 250,000 in equipment purchases this year.  They call it a ‘subsidy’, but from my view it should be standard for all purchases, however, in business 250,000 doesn’t get you far.  That IS life folks.

Let’s keep this simple though.

In manufacturing in an S corp, sole proprietorship or LLC which makes up most of the businesses in the US.

  • the company pays no tax.  The company owners pay for the income of the company –  most people don’t know this.  Gas stations, stores, HVAC companies, machines shops, manufacturers often with hundreds of employes pay zero. Owners pay the tax on their personal returns.
  • Inventory increases are dollars on the shelf which cannot be expensed.   Inventory increases are INCOME!
  • Sizable equipment purchases can be expensed only over 7 plus years.   Actual cash outlay is not recognized by the government until years pass.
  • US labor which creates increased inventory in a growing company at the end of the year cannot be expensed.  Months of US labor becomes INCOME rather than expense!
  • Profits (corporate income) is passed through to the owners who pay at a very high rate.

So in our case, we are lucky to be a growing manufacturer well inside the top percentile of the US.   We get the advantage of paying enormous taxes on items sitting on our shelves waiting to sell.  We get the exposure of truly endless federal laws we must comply with.With all this anti-capitalist government financial pressure, the goal becomes minimizing inventory while delivering on time.   A difficult prospect for a company in a big market for a variety of reasons outside of the scope of this article.

Even if a small business owner paid themselves $1, there is a very good chance that they would be the family to fall inside the top tax brackets of the US.  If you own a business, that is your fate.  So despite my early promise not to turn this into a political rant, when Obama says: “Families earning over 250,000″,  yes he is targeting Wall Street families (easy targets), yes he hits some doctors and some lawyers, but MOSTLY, he is saying:  “Tax the business owners”.

He is saying, we need to raise taxes on the VAST majority of private “business” to pay for the federal overspending, in order to insure our future. — for extra credit, you work out whether taxation of private business to grow federal income makes sense long-term yourself.

Now personal top income taxes to the feds are at 40% while C corps ride at 35% plus extras.

So what does it mean when the media says things like the most wealthy don’t pay their fair share?   It takes a little more thinking but what the hell, conservative or liberal, god or gaia gave us a brain, so let’s not be wimps.

S corps, LLC’s and sole proprietorships pay zero tax directly but are taxed at the personal rates of the owners.   This means that they are not let off the hook on taxes in any way whatsoever any more than any individual.  They pay the company plus personal income tax as though they were individuals filing personal income tax forms.  In fact, they file many of the same forms.

C corps have advantages for tax level yet when profits are distributed, they are taxed at personal income levels.  Double tax –  no break there either.

What about capital gains tax?  An investor throws money at a company S, C or LLC with recognized potential is looking for a realized profit.  Say the investor takes a risk and throws in 500,000 and the company grows over two years such that the stock value doubles,  the investor sells the stock to a different investor for 1,000,000.  The tax paid is only 15% – capital gains tax – on the difference between the buy/sell — a measly 150,000.   The Warren Buffet special.   This is the rich dude, paid money to a non-bank viable company (or else they would have borrowed at 5%).  The value grew and the investor took a profit.  Banks don’t lend unless they already have assets to take  —- ever!  Today, in most cases, they won’t loan against business assets without additional personal assets on the line.

But wait!

If rich dude sells inside one year, he pays full income tax — 40 percent of the increased value — ouch!

If he sells after 1 year he pays only 15% of the increased value.

If it is an S corp, the income of the hugely profitable company in our example after one year, has ALSO been taxed at approximately 40% distributed to the wealthy shareholders.  The value of the company grows by the remainder.  One large tax has already been paid before the investor takes his profit and capital gains tax!  IOW, if it is a C, S or LLC corp, often the income of the hugely profitable company has already been taxed at approximately a 40% rate with the rest able to be distributed to the “wealthy” shareholders at rates determined by the type of corporation.

The 15%  is a second tax.

A double tax for the wealthy, not a single tax as some (too many recently) would opine.  The tax on investment that Obama recently wants to raise is the SECOND tax the corporation profit has experienced.  Everyone in the company has already paid full income (sized) tax on all the money earned.

So now, when you hear ‘tax the wealthy’, I hope you will consider how it sounds to my ears because I hear ——“Tax the Businesses”.   Does anyone in America really think that taxing business is the way out of the double dip recession?  Yes, the recession did happen again.  I warned of it two months ago because our industry sees it first.  I told you to expect bad news in the future.  The economy dropped twice and it is just a matter of time until people find out. Call me when you agree.  Better yet, save the phone tax and send an email.

As always in modern politics, tax the wealthy, has a true meaning entirely different from the stated message.

I am certain that many will have corrections/additions to the above, but please keep the GE and giant corporations out of the discussion.  I may even snip this time as this is an entirely different issue.

So as the seemingly benign discussion of increasing the progressive taxation of the wealthy continues on other threads here, does anyone really consider that expanding the ramp rate of payment vs income is good idea when income is company based?

This thread will be moderated for the MOOT giant corporation arguments.


264 Responses to “An American Primer on Taxes”

  1. kim said

    From each according to their abilities, to each according to their need. Oh, how sweet.
    ==============

  2. Matthew W said

    Under an S corp, inventory is income???????????
    What Einstein came up with that idea and why??

    I really don’t think that most people understand this point :”the company pays no tax. The company owners pay for the income of the company……..Owners pay the tax on their personal returns.”

    But then,there is no shortage of ignorance. (which is at least curable”

  3. Matthew W said

    Been drinking too much and I forgot to add a point.

    I would like anyone in the MSM to ask the President:

    “Mr . President, how will raising taxes on the “rich” create any jobs?”

  4. Serioso said

    Alas, you have made several errors. But allow me to deal with just one, and the one I consider most serious.Investors who buy a share of stock at $1 and sell it later at $10 (may I brag that I have had a few of these in my life) pay ONLY 15% tax on the $9 gain. The C corp that produced this gain need not have had ANY profits!!! The gain could well be simply a changed market perception of the value of my share. So your argument that capital gains are doubly taxed is invalid unless you can produce statistical evidence that shows this to be true. In my (very limited) experience it isn’t: The companies I invested in that grew the fastest had zero or negative profits during their growth phase, and hence paid no taxes at all (and had a loss-carry-forward later on),

    [snip] Sorry, No discussion of the biggest corporations on this thread. I’ve snipped nobody this year until now but this thread will be moderated harshly for off-topic detail as I’ve noted above. We need to discuss the reality of normal business rather than the extremes of the largest.

  5. Jeff Id said

    #4 Serioso,

    Stocks which gain value without profit are fine. Statistical significance is not required to justify the tax as many investors lose as well. Where would the company be without the investment?

    What I am more concerned with is the fact that banks won’t lend to private corporations without personal guarantees. Corporate protections mean that a company can go under without any person being responsible to pay a dime. Now companies can’t get money from banks at all, unless you put up your own assets to cover. If we tax investments more, what will real companies do to increase sales? Where will we go to get money?

    It forces slow growth by fiat.

  6. TimG said

    Jeff,

    I assume you structure your businesses the way you do because it is better for tax reasons.

    Doesn’t it follow that if taxes were raised these companies would switch to C types and millions of ‘rich’ americans would dissappear?

  7. John Vetterling said

    Jeff

    Seriously you need a better tax accountant. No one should be in the situation you describe.
    First, there is no such thing as an LLC under the tax code. LLCs are a creation of state law. The IRS allows LLCs to elect to be taxed as partnerships, S corps or C corps. Hence, an LLC who want to buy a significant asset should elect to be taxed as a C corp. Or, the more common form, is to create a separate holding company for the assets and use a lease purchase.

    S corps were never meant for businesses with significant depreciation assets. They were meant for professionals with mostly operating income and little assets. Those corps gained little from organizing as a C corp.

    Obama’s plan won’t work because many of those earning above $250 will just change their tax status and end up paying about the same in taxes. Only now they will be paying more to tax accountants. So we could consider it a stimulus package for CPAs.

  8. cementafriend said

    Jeff, looks like the US tax system has complications. I read your piece quickily to see how it compared with Australia. I could not follow your company types which seem to be different from Australia. Here we have only two types a) Public companies with more than 50 share holders – these are split into listed on a stock exchanges and unlisted, both have financial reporting requirements to a regulating body & b) private companies with less than 50 share holders down to one shareholder. The latter has private accounts but puts in a company tax return. Both types of companies are taxed at 30% and may (but do not have to) pay dividends to shareholders. Your LLC & S corps seem to be what we call other business entities. Here we have a) partnerships b) trusts & c) sole proprietor. The first two put in tax returns for the business but the net income (or loss) is distributed and then taxed in the hands of the individuals which various from 0% upto 48%. With the sole proprietor there is a business section in his/her tax return. For all business enties (including companies) there are tax concessions for small business with less than $2M turnover. I operated a private company for my engineering consulting business mainly to limit my liabilities in case someone sued me for wrong advice or poor operation. The company now runs a hospitality management business which is deliberatly breaking even. We have a trust for property which is rented to the business.

  9. j ferguson said

    Jeff,
    I am delighted that you finally did this. No one who hasn’t been subjected to this part of the world would ever know about it, much less appreciate how depressing it is, and you haven’t even begun to deal with regulatory harassment.

    thanks much for this. I hope it is widely read.

    this is not a derogatory remark aimed at employees, but after a number of years coping with the sorts of things you report, at dinner one evening with a competitor we respected (and liked) we concluded that the world broke down into employers and employees and the latter had little or no appreciation for “employer” problems – intellectual overhead among other worries, perhaps.

  10. Jeff Id said

    John,

    “Seriously you need a better tax accountant. No one should be in the situation you describe.”

    We have very high end accountants and tax attorneys. Our accountant used to be high up in a major firm handling taxes for little companies like Hertz but now works as the primary accountant for a sports-team owning billionaire. He buys and sells a company every week. Also, one of the primary partners is a tax attorney who works in business law.

    I’m fairly certain that the quality of our people is not a problem. ;) The quality of my descriptions may be but that is another matter.

  11. Matthew W said

    #10
    “Our accountant used to be high up in a major firm handling taxes for little companies like Hertz ……”

    Maybe a guest post??

  12. Chuck L said

    J Vetterling nailed it, “Obamas plan wont work because many of those earning above $250 will just change their tax status and end up paying about the same in taxes. Only now they will be paying more to tax accountants. So we could consider it a stimulus package for CPAs.”

    I would add that the “true” rich (not the oft put-upon small businessowner) would, as they always have, take advantage of their superior tax advisors and better information sources, and restructure their finances so less of their income and assets would be subject to higher tax rates, thus, reducing the amount of revenue the government receives. A flat tax or consumption tax would be fairer and likely raise more revenue although the US govenment in recent years has shown a remarkable propensity to spend more that the amount of revenue it receives but that is a topic for another post.

  13. Jeff Id said

    TimG,

    If you make profit in an S corp, you pay tax on it one time, then it can be distributed to the owners without a second tax. If you are a C corp, it pays tax yet if cash is distributed, you pay full income tax again. As John points out above, a high asset company may want to be a C type or a C type holding group with little profit, but that doesn’t avoid tax entirely either. Again, why are you paying tax for a purchase which is later depreciated back into your pocket anyway? It is a direct resistance to investment in equipment. Why are you paying tax on inventory sitting on your shelves. It isn’t cash either. They are just methods for the government to take money which have resistive impact on business investment.

    Suppose the government simply taxed a business on income only and left off the rest of the complexity. Sure companies who wanted to grow would try to show less profit by gaining assets. Assets, sounds like investment and jobs to me.

  14. Jeff Id said

    #11, It would probably cost me $1500.

  15. curious said

    Jeff – I’m pressed for time, so apologies I have only skimmed this thread, but can I check something re: your moulding machine example?

    “You get the whole value written off over time at 30K/year, but the point is that the whole amount you were able to make and expend looks like income this first year.”

    Are you saying from an accounting point of view you would experience this purchase as an income? I am slightly lost – to buy it wouldn’t you have required cash in hand at the bank to do so? Hence you would be converting a liquid asset to a fixed asset – which does not equal “income”? If OTOH you decided to lease the kit my understanding is that there are essentially two paths – operating lease and finance lease. The former allows you to have use of the asset and you are paying a tax deductable fee to do so whereas a finance lease is more like a mortgage whereby you will aquire the asset. Hence the treatment of WDA will vary accordingly. You seem to be arguing that 100% year one WDA should be the default? Are you mixing cashflow and profit and loss?

    Sorry the comment is a bit drive by – interesting topic as the use of WDAs is one of the ways Gov. seeks to direct/encourage investment. A spreadsheet showing your case would help – long time since I looked at this stuff and my rusty knowledge is UK based. Away for a while but will look in if poss.

  16. Jeff Id said

    Curious,

    I’m saying that our equipment investment is treated as cash until the equipment is depreciated. If we lease, or lease to own, the rules change as you have correctly stated. Actually, our inventory growth is more trouble than the equipment right now but both are issues. I don’t want to discuss our corporation specifically here though. We are in a very unique situation. Just the generalities of taxes on the unappreciated wealthy, who they ‘actually’ are and what they face. It is truly a myth that people making even a several million a year are undertaxed.

  17. curious said

    ok thanks – noted.

  18. Anonymous said

    I think S-corps are a little different. You actually pay yourself a salary, a reasonable salary, then you can distribute profits throughout the year. There are some tax advantages to doing it this way though I don’t know the details off-hand because my company (an LLC, the C is for Company in CO) elected to be treated as a proprietorship. We simply contract through the LLC and do so to gain the ability to write off travel and other expenses. S-corps also require you to pay FUTA/SUTA and worker’s compensation, though this allows you to “lay yourself off” and claim unemployment if the work dries up (not so in a proprietorship.)

    Fortunately, our LLC does not have any need for true assets. The only things either of us has ever purchased are software tools that count as expenses (we both write a lot of software.) I think there are some classes of assets that have an accelerated schedule for depreciation, such as workstations (computers) and the like. It seems there’s also a way to take the full deduction up front, but at some reduced valuation to avoid dragging things out on a depreciation schedule but I could easily be wrong on this.

    Were Warren Buffet’s company an S-corp I doubt he would get away with paying himself $100,000/year, btw. He does that to avoid paying heavy income taxes while making it sound like he’s some sort of saint for not earning much income. He wants to punish everyone to account for the fact that he’s essentially cheating. Go ahead and pay more, Warren, I won’t argue, just don’t tell me that I’m not paying my fair share.

    I recently took a permanent position anyway since there is not much contract work (that I like) in CO Springs. Most of it is in the Denver/Boulder area and I’m sick of the drive – 57 miles for my last contract on the south side of Denver, 110 miles for the previous contract in Longmont (I stayed there during the week, expensing my hotel and meal bills.)

    Mark

  19. Mark T said

    Utimately there is a limit to the overall amount of taxes the government can take from its working public. Finding new ways to extract blood from that rock won’t increase the overall revenue. It will merely change the public’s behavior. The Laffer curve is very real. I agree that the only legitimate (non discriminatory) way to tax is through consumption – those that spend more, pay more.

    Mark – previous post was me, too. IE9 forgot me again.

  20. Matthew W said

    # 14
    But it would be a business expense !!!

  21. R. Shearer said

    “Say the investor takes a risk and throws in 500,000 and the company grows over two years such that the stock value doubles, the investor sells the stock to a different investor for 1,000,000. The tax paid is only 15% – capital gains tax – on the difference between the buy/sell — a measly 150,000.”

    Wouldn’t that be a measly 75,000 (0.15*1,000,000-500,000)?

  22. cce said

    I’d like some justification for the belief that the “VAST majority” of private businesses make more than $250,000. About three quarters of business owners are the self employed, and only about about 4% of those are in the 33% or higher brackets.

    http://indus.sba.gov/idc/groups/public/documents/ma_boston/sba_036309.pdf

    Also, Obama is talking about replacing the Alternative Minimum Tax with the “Buffett Rule,” and I am pretty sure the AMT affects more business owners than a tax on those making more than $1 million. To my knowledge the mechanics of this haven’t been described, but I would think it would have to work in parallel to existing rules. Also, to my knowledge, no one has suggested implementing these tax increases while the economy is still weak.

  23. Joel Heinrich said

    Did you know that 70 % of the literature worldwide regarding taxation / tax laws is about German Tax Laws?

    We seem to have more types of companies: AG, GmbH, KG, OHG, GBR, GmbH & Co KG,…

    All with different types of taxation by city or state or the State. Oh and here you are ‘rich’ ( meaning that you have to pay the highest rates) if you earn more than some US$ 100k. So, yes, the US is still seen here as a kind of tax haven with a very ‘easy to understand’ taxation system.

    So, cheer up, it can always be more difficult. :-)

  24. Mark T said

    I’d like some justification for the belief that the “VAST majority” of private businesses make more than $250,000. About three quarters of business owners are the self employed, and only about about 4% of those are in the 33% or higher brackets.

    I agree. I think it should read “the VAST majority of people that are impacted by this are small business owners.” Certainly my business would never fall into this category.

    We made under $100k last year, and probably will only post $10k this year – both of us did the majority of our contracting on W2s through various contracting firms (which means we are actually employed by the contracting firm itself.) We’ll never get impacted that way now that I’m permanent at the new company. It is hard for a single engineer, my business partner, to make $250k in one year in Colorado strictly through independent contract work – maybe in CA. Realistically he’d have to charge over $150/hour, probably closer to $200. Not that such a rate is impossible, there just aren’t many companies in our area paying that rate so filling 2000 hours per year would be difficult.

    What’s interesting about all this is that high cost of living areas are hit disproportionally by such ideas. The tax system is not directly indexed on cost of living. CO Springs is cheap, Manhattan is not. There is a far greater percentage of folks in Manhattan going over the cutoff than there are here (even with increased deductions.) AMT has the same problem as well. Why anybody in their right minds would ever live, and particularly incorporate, in high cost of living areas is well beyond my meager understanding of life.

    Mark

  25. Jeff id said

    #21 you’re right about the tax calc I saw it last night but forgot

  26. So, just what are these ancilary benefits from a progressive tax? How do you measure it and where do you measure it?

  27. Bob said

    Good synopsis, Jeff.

    I regularly try to tell people that the 200K and up earner is usually owns some sort of business. Which brings on the idea of monetary stimulus.

    It has been shown that the best stimulus in a slow economy is lowering the tax rates for everybody. The reason for this is that it releases money immediately for the creation of jobs and economic assets. Plus, the government does not know which businesses are ready to hire, so targeting one segment is not efficient. By cutting all tax rates you guarantee an immediate monetary stimulus.

    Small business is the growth engine of the economy, and strangling that engine with high taxes and regulation is just not smart.

  28. Bob said

    Mark T said

    September 24, 2011 at 12:06 pm
    Utimately there is a limit to the overall amount of taxes the government can take from its working public.

    I agree completely, Mark. If we are on that part of the Laffer curve where tax revenues are going down with increasing tax rates, then lowering taxes is the magic bullet we are looking for to increase federal revenue, and stimulate the economy at the same time.

  29. Anonymous said

    All we know is that the last drop in taxes resulted in an increase in revenue. Well, that and increasing taxes during a recession is stupid than increasing government spending. Both wind up taking money out of the economy in order for the government to put it back to help recovery.

    Mark

  30. M. Simon said

    “Well, Charlie, what I’ve said is that I would look at raising the capital gains tax for purposes of fairness.”

    http://www.humanevents.com/article.php?id=44587

  31. cce said

    Effective tax rates today are low by historical standards (that is, since the end of WW2) and by international standards. The drop in Federal income and corporate tax revenue over the decades has been masked by increased revenue from the payroll tax.

    Federal tax revenue as a percent of GDP was 14.9% in 2009 and 2010, the lowest since 1950. That includes the payroll tax. Excluding the payroll tax, tax revenues were 10.3% and 10.6% for 2009 and 2010, the lowest since 1942. The exceptionally low numbers are due to the Bush tax cuts (extended by Obama), the Obama tax cuts, and most importantly, the economic downturn. So-called “on budget” revenue (ie non payroll) has been declining since the end of WW2 — the notable exception was during the late ’90s when revenue “surged” to levels typical of the late ’60s and early ’70s. Corporate taxes were 1% and 1.3% of GDP the last two years, roughly consistent with the downturns of the early ’00s and early ’80s. Corporate taxes made up about 5% of GDP in the years following WWII and declined until about 1980. Personal income tax has been about 8% since the end of WW2, except during the economic “booms” when they got as high as 10% (’90s). In 2009 and 2010 they were 6.5% and 6.2%, the lowest since 1950.

    http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=205

  32. TimG said

    #13 Jeff

    The double taxation issue is why Buffett is full of crap.

    In Canada there is a dividend tax credit that exactly offsets the corporate tax.
    This means if you are running a small business there is no difference in the net tax rate whether you take it out in dividends or personal income.

    But this means people who rely on dividend income pay a lot less tax than those earning a wage.
    So the demagogues on the left whine while they expoit the ignorance of crowds.

  33. Steve Fitzpatrick said

    Jeff,

    RE significant equipment purchases:

    You may do better with a long term lease/purchase (eg over 10 years) on major equipment purchases. Eliminates the need for up-front capital, though the total cost is higher.

    WRT paying taxes on inventory increases: I know your pain, but in reality, the investment in that inventory (whether raw materials, finished goods, or WIP) was taken out of operating profits…which are of course taxable. The unavailability of bank financing for increases in working capital is more the issue than taxes themselves, IMO. In Mr Obama wants to see employment increase quickly, he should figure out a way to make loans for working capital available to profitable small businesses; as things stand now, financing of working capital is essentially impossible, which is suffocating small business growth. Larger companies (the ones who are not growing) have lots of access to financing of working capital, but most don’t currently want or need it.

    WRT tax rates: Capital gains on investments is taxed at a very low rate (15%) which may have once made sense, but IMO, simply allows the mega-wealthy to pay very low tax rates. I think a better approach would be to index capital gains for inflation but treat all income, including capital gains equally in terms of taxes; maybe 28%-30% top rate, with a minimum of deductions/exemptions. It is just nuts for you and me to be paying higher net rates than Warren Buffett. The only suitable inheritance tax rate is 0%; the current scheme is repugnant; how many times must one pay taxes on the same income? The only (partial) justification for the inheritance tax is the very low rates currently paid on capital gains; take that away, and there is no justification for it at all.

  34. Steve Fitzpatrick said

    Cce,

    The rates on personal income (exclusive of Social security/Medicare) probably are low compared to post-WWII average rates; not sure why you choose to ignore those taxes, which have grown enormously as a percentage of GDP since WWII. IMO, the suggestion that taxes are now (overall) low is non-sense. I note that businesses (not individuals) pay more than half of all Social Security taxes. But the much larger problem is that government spending (at all levels) is at historic highs… about 40% of GDP (in the range of European ‘welfare states’), and MUCH higher than revenue. This is not sustainable.

  35. Kenneth Fritsch said

    Attempts to find fairer and better (more efficient and less painful to the politician) ways to tax only reinforces the argument of those that see the game as one of finding ways to finance bigger and more expensive government. The easiest way currently for those in favor of bigger government to finance their dreams is through deficit spending – with perhaps a view that that borrowing can be handled in the future through inflation or heavier taxation. Unfortunately what bigger government advocates fail to appreciate is the very negative effects that taxes have on the economy. They do not appreciate the fact that more taxes reduce the economic output and thus the base for tax revenue. At some point the amount of interest on debt will make the payments on interest on debt impossible. The higher taxes and consequencial smaller economic growth is a downward spiral towards bankruptcy.

    For those who see the problem of taxes, the argument should be how to make government smaller – and sooner not later.

  36. Jeff id said

    Steve,

    I finally got to a computer. The capital gains is a second tax, nobody gets off for free, except for the giants.

    You see other comments in this thread where people say the true rich get the breaks, scatology!! Only the top few which we are not discussing here.

    We rarely disagree, but capital gains of 30 percent would be insane.

  37. Anonymous said

    We rarely disagree, but capital gains of 30 percent would be insane.

    It provably restricts investment, which is key to economic growth.

    Mark

  38. steve fitzpatrick said

    Jeff,
    “The capital gains is a second tax”

    How so? It is a tax on profits from a buy/sell pair of transactions.

    I buy 1000 shares of XYZ stock for $25 per share. Three years later I sell that same XYZ stock for $50 per share, and make $25,000 profit. I buy a piece of land for $25,000, and some years later sell it for $50,000, and make $25,000 in profit. Please explain how tax is paid twice on the profit from either transaction?

  39. Jeff id said

    Becaause the Stupid c Corp paid 40% on their gains.

  40. steve fitzpatrick said

    Jeff,

    Sure, a C-corp pays taxes on their profits. Don’t get me wrong, the corporate profits should be taxed only once, not twice… having to pay personal income taxes on dividends, after the corporation pays taxes on those same profits, is just crazy. Still, I can’t see the direct connection with double taxation on capital gains you are seeing. What about the land investment example I gave; where is the double taxation there?

    The double taxation of C-corp profits is bad in many ways, including one that does connect to capital gains taxes: it distorts investment choices. A C-corp can distribute already taxed profits to shareholders, who will pay up to the maximum personal rate, yielding an effective corporate tax rate of >60%, or the corporation can hold onto the after-tax money (even just buying back outstanding shares) and build the share value, so that the stock price rises. Shareholders can then sell for a “long term capital gain” and pay only 15%, for an effective corporate rate of ~49% (instead of well over 60%). End the double taxation, and there is no reason for C-corporations to convert retained earnings into capital gains. I believe that would motivate companies to make more active investments, or distribute profits to shareholders (tax free), so that shareholders could find more productive uses for that money. As things stand now, the incentives for C-corps are all wrong…. if you want growth and jobs, that is. The incentives are now set to get share price increase only… no matter the cause for the increase. It is a significant economic distortion.

  41. Kenneth Fritsch said

    http://www.ntu.org/news-and-issues/taxes/eliminate-double-taxation-cap-gains-dividends.html

    “In one sweeping action, this bill would solve the problems caused by the Tax Code’s current treatment of capital gains and dividends. Even at the reduced rate of 15 percent, current capital gains and dividends tax policy punishes investments by imposing double-taxation. Because dollars that are invested had to first be earned, they have already been subject to taxation at the higher personal income tax rates. Taxing these dollars again if and when capital gains are realized only serves to deter productive, calculated risk-taking and reduce much-needed investment in our economy.”

    I get a kick out of so-called fiscal consertvatives arguing about which taxes are fairer or better and at what rates. You can rationalize any tax and any rate if you assume that bigger government must not be starved.

  42. Anonymous said

    Well, it goes without saying the government has to raise some money to pay for protecting our rights.

    Mark

  43. Kan said

    Steve F says:

    “What about the land investment example I gave; where is the double taxation there? ”

    Property taxes on the value of the property – not at the federal level of course (which was not stated as a requirement for exclusion).

    However, where it does get stupid is with the real estate investments and cap gains. Pandering to the real estate industry, if you re-invest in real estate with your gain within some time period (36 months I think), you just rollover the gain, thus deferring the cap gains tax. This distorts investment decisions adversely.

  44. Kan said

    Watch out for the Warren Buffet tax play. When he is speaking he is only speaking of his income tax (not others). I do not think his secretary has the gains he has. And he definitely is playing the AMT game.

    Has he opened his returns for us to believe him?

  45. Kan said

    Under Reagan the cap gains were taxed as ordinary income for awhile after1986. It was dropped to a lower rate (twice) in order to spur investments.

  46. cce said

    Steve,

    If you read my post you would know that I did not ignore the payroll tax.

    Also, I am not “suggesting” that taxes are low, I am stating a fact. They are low.

    Revenues from the payroll tax are at their lowest point since 1984. Revenues from the corporate tax are about half of what they usually are. Revenues from the income tax are at their lowest since 1950.

    Again, this is due to the Bush tax cuts, Obama tax cuts, and (most importantly) the economic downturn which has depressed income or put people out of work entirely. The end result is that the government is currently taking in 14.9% of GDP, the lowest since 1950.

    Also, the “unsustainable” part of government spending is Medicare and Medicaid. Everything else is either temporary (e.g. the surge in the “automatic stabilizers”) or are manageable with some minor tweaks (e.g. Social Security).

  47. j ferguson said

    When I was first “introduced” to depreciation schedules, my reaction was that the concept must have been the result of a conspiracy between the banks and the legislature. The government does not want to let you use all of your money to make the business go, or at least not all at once, and certainly not the part that was “rightfully theirs” and the banks want the vigorish. Same idea with taxing inventory.

    Does it make any sense that we (they?) have created a business environment that can only work with reasonably available credit, and that if credit is no longer “reasonably” available, other changes should be made pronto to rebalance – re-equalize – the system?

    Jeff, I assume you can continue to get vendor financed capital equipment, lease buildings and so forth, but when you need some cash to do something that doesn’t have anything to do with a big chunk of something or other, then without pledging your home, children, dogs and puppies, you can’t get any help.

  48. Kenneth Fritsch said

    Warren Buffett is like an idiot savant with business and economics. He shows little reality when it comes to economics and what capitalism is all about. If he truly thought that government should get a large portion of his income in order to grow bigger than why not tax his wealth – assuming there are no limits on what the government can take from an individual. Furthermore if the government can tax wealth, and I assume that would be ok with Buffett, then why does not he donate his wealth to the government instead of charities.

    I have given up mostly on reading Buffett’s silly pronouncements on government policy, but I would think a precursory analysis might show that a billionaire could make most of his income on capital gains and little on salary and wages. If he keeps his gains unrealized there are no taxes there no matter what the rate is. His wages/salary being only a small part of his increasing wealth would provide only a small portion of his wealth to the government. The only way to eat into that Buffett wealth would be through a wealth tax or if we wait for him to die a confiscatory inheritance tax. I would think that a good politician could find a wealth tax that was constitutional, confiscated most of Buffett’s wealth and did not significantly affect other millionaires/billionaires. That way we could relieve Buffett’s guilt without adversely affecting the economy.

    Buffett has always been all about the game of profits for his companies and I truly believe he has a difficult time thinking out of that box.

  49. Kenneth Fritsch said

    “Also, the “unsustainable” part of government spending is Medicare and Medicaid. Everything else is either temporary (e.g. the surge in the “automatic stabilizers”) or are manageable with some minor tweaks (e.g. Social Security).”

    Unfortunately many people believe that all that is needed is minor tweaking, and, of course, without any details about the tweaks.

  50. Mark T said

    The tweak necessary for sustaining SS is its elimination, IMO.

    Mark

  51. Jeff id said

    Jeff, I assume you can continue to get vendor financed capital equipment, lease buildings and so forth, but when you need some cash to do something that doesn’t have anything to do with a big chunk of something or other, then without pledging your home, children, dogs and puppies, you can’t get any help.

    This is exactly the case. They won’t even look at the books unless you have personal assets on the line and because of the size of money a company needs, only the most wealthy are truly able to borrow. A capital gains tax increase would be the final knife for a lot of business now.

    We aren’t looking for money ourselves, but I have discussed these issues at length with banks for other reasons.

  52. Jeff id said

    Kenneth,

    “If he keeps his gains unrealized there are no taxes there no matter what the rate is. ”

    Why aren’t people getting me. Taxes are still being paid by the gaining company at 50% using the billionaires money. He would have ‘gained’ more without the taxes.

    No free rides unless you are the biggest.

  53. Jeff id said

    I wrote 50% because of the other-than-federal taxes corporations are faced with.

  54. Jeff id said

    The taxless business or free rides for millionaires is a media created fallacy. It should come as no surprise that the IRS is actually quite good at collecting money.

  55. DeWitt Payne said

    Re: Steve Fitzpatrick (Sep 25 11:05),

    Capital gains on investments is taxed at a very low rate (15%) which may have once made sense, but IMO, simply allows the mega-wealthy to pay very low tax rates.

    1. There is no guarantee that an investment will increase in value. Do you allow immediate write-off of capital losses against ordinary      income? Because that option is highly limited under the present code.
    2. What do you have against the mega-wealthy?
    3. Tax capital gains at the same rate as ordinary income and investment will dry up because the risk/reward ratio will change adversely.

    A rate of 15% appears to be about the peak of the Laffer curve for the capital gains rate. Raising the rate will probably not increase revenue. Raising the rate for any other reason than increasing revenue is class warfare pure and simple. See here for example.

  56. Joshua said

    re: #55

    Dewitt:

    A rate of 15% appears to be about the peak of the Laffer curve for the capital gains rate. Raising the rate will probably not increase revenue.

    Raising the rate for any other reason than increasing revenue is class warfare pure and simple.

    I note that you language above is more qualified than you previous statement below:

    Every time the capital gains rate is raised above 20%, tax revenue decreases. Every time it’s been dropped below 20%, tax revenue increases.

    If you haven’t already done so, I suggest that you follow this link, and some of the follow-on links contained in that post.

    http://usbudget.blogspot.com/2010/11/do-capital-gains-tax-cuts-increase.html

  57. Chris in Ga said

    Cce – “Effective tax rates today are low by historical standards (that is, since the end of WW2) and by international standards.”

    Since we’re discussing individual tax, I stuck with marginal tax rates v, effective – though to tell the truth I don’t have a good feel for the difference. Since I prefer not to get tax data analysis from the Brookings Institution and the Urban Institute(i.e Tax Policy Center) …

    Let’s go to the CBO – From http://www.cbo.gov/doc.cfm?index=11976&zzz=41410

    One measure of the effect of taxes on the returns from working and saving is the marginal tax rate–the tax paid per dollar of extra earnings or dollar of extra income from savings. The highest marginal income tax rate (the tax rate that applies to the top income tax bracket) was 91 percent in the late 1950s and early 1960s and as high as 70 percent as recently as 1980, although a lower maximum rate applied to earnings in that year. Since 1988, the highest marginal income tax rate has ranged from 28 percent to 39.6 percent. For a representative family of four with median income, the marginal tax rate on earnings (combining the rates for both income and payroll taxes) during the period from 1955 to 1975 was around 20 percent. That rate climbed over the next 10 years as a result of rising payroll tax rates and inflation-driven increases in nominal incomes, which pushed median-income families into higher tax brackets. Following a reduction in income tax rates in 1986, the marginal tax rate for a representative median-income family has remained at about 30 percent.

    Just illustrating that the lowest marginal rates occurred between 1955 to 1975

  58. steve fitzpatrick said

    Jeff,

    “Why aren’t people getting me.”
    Because income from ongoing operations and capital gains are not the same thing. Suppose someone buys shares in a company that hasn’t made any money in years (or maybe never made much money!), and so not paid any income taxes. A year later, the company announces a ‘breakthrough’ in photodiode technology that may increase efficiency by 100% compared to the best available today, and the stock price doubles overnight. The investor sells his shares and pockets a 100% profit on the original purchase. Now since no taxes were paid on income, I do not see that the capital gain is somehow “off-set” by past paid corporate income taxes.

    IMO, income is income. The more incentives, deductions, exemptions, double taxation, and other distortions there are, the worse it is for capital efficiency. The best incentive is lower maximum tax rates, without all the bells and whistles.

    DeWitt,

    1. Of course not. If current rules for handling investment losses WRT ordinary income are not reasonable, then change those rules.

    2. Absolutely nothing.

    3. I doubt that. I think removing distortions and the multitude of ‘tax incentives’, combined with lower maximum rates, will greatly increase economic efficiency. People will always make investments based on their perceived maximum return; the current system rewards certain kinds of investments and punishes others. I just don’t think anyone is smart enough to select the ‘right’ economic distortions via the tax code.

    That said, as I noted above, the I think the main reason job growth is poor is because the profitable (small) companies that actually generate job growth have extremely limited access to working capital, due mainly to the banking mess. Provide access to working capital, and job growth will follow.

  59. Chris in Ga said

    And because this is a primer perhaps this slideshow will help a little – or I might have strayed too far OT?

    Trends in Federal Tax Revenues and Rates

    Trends in Federal Tax Revenues and Rates View more presentations from Congressional Budget Office

  60. DeWitt Payne said

    Re: Joshua (Sep 26 11:41),

    If you haven’t already done so, I suggest that you follow this link, and some of the follow-on links contained in that post.

    You mean like Entin’s article and Alan Reynold’s comment and article that support my position?

    Entin:

    The analysis finds that higher tax rates on capital income would discourage investment and result in a smaller capital stock than would exist if the rate remained at 15%.

    Reynolds:

    The Tax Policy Center estimates that McCain’s reduction in the corporate tax rate would reduce static revenues by $735 billion over ten years. This paper finds no evidence from the experience of other countries that reducing the corporate tax rate has ever been followed by any significant revenue loss.

  61. Joshua said

    DeWitt – do you just want to trade quotes? This discussion needs to be grounded in a real economy to have much value.

    The non-partisan Congressional Budget Office (CBO) and the Joint Committee on Taxation have estimated that extending the capital gains tax cut enacted in 2003 would cost $100 billion over the next decade. The Administration’s Office of Management and Budget included a similar estimate in the President’s budget.

    After reviewing numerous studies of how investors respond to capital gains tax cuts, CBO commented that “the best estimates of taxpayers’ response to changes in the capital gains rate do not suggest a large revenue increase from additional realizations of capital gains — and certainly not an increase large enough to offset the losses from a lower rate.”

    The Bush Administration Treasury Department examined the economic effects of extending the capital gains and dividend tax cuts. Even under the Treasury’s most optimistic scenario about the economic effects of these tax cuts, the tax cuts would not generate anywhere close to enough added economic growth to pay for themselves — and would thus lose money.

    Do you offer an explanation for this graph?

    Please note that the article with that graph was in direct response to the Entin article.

    Do you offer a counterargument to the following?:

    One reason is that preferential tax rates for capital gains encourage tax sheltering, by creating incentives for taxpayers to take often-convoluted steps to reclassify ordinary income as capital gains.

    And why are you now focusing on corporate taxes, as opposed to your categorical statement about the economic impact of capital gains tax rates?

  62. DeWitt Payne said

    Re: Joshua (Sep 26 14:37),

    The Congressional Budget Office isn’t anywhere near as non-partisan as they and you claim. They are not a reliable source. They use static analysis for scoring budgets. They always overestimate the revenue from a tax increase and the loss in revenue from a tax cut. Static analysis assumes that people won’t change their behavior when incentives change. This is blindingly obviously fallacious. In fact, if you define insanity as doing the same thing again and again expecting a different result, the CBO should be committed.

    I have a great deal of respect for Alan Reynolds. R. Davis, OTOH, is a complete unknown.

  63. DeWitt Payne said

    Re: Joshua (Sep 26 14:37),

    The corporate tax rate quote was a mistake. No excuse.

    It does, however, fit quite well with my criticism of the CBO budget scoring process. I must be psychic.

  64. kuhnkat said

    Joshua,

    first I would think we would all agree that virtually nothing happens in a vacuum. I am a firm believer in raising taxes and losing economic growth and revenue from those taxes. Then there is reality. We look at what happened under Presidents Johnson, who inherited JFK’s tax cuts, Reagan, and Bush II and we see increasing debt. Why would the debt go up if decreasing taxes typically generates more revenue than raising taxes??

    Because the economy does not just depend on the rate of Capital Gains taxes or all taxes. I think it is relatively uncontested that Government spending rocketed under all three of those presidents to the point that it comsumed all the benefits of the reduced taxes. In fact, the spending was so huge that the borrowing of the Federal Government also negatively impacted the economy in general.

    So, the answer to your chart is that it shows only a couple of pieces of the issue. For the most recent period that ugly bit about the enormous amount the government is borrowing is one of the largest contributors to the problems. The cost of money going up is having a negative impact on the entire economy, not just the government budgets. It is also a fact that the increasingly medieval torture chamber like regulations are also having a large effect on the profitability of companies and individuals by large increases in the cost of energy and the cost of meeting the regulatory environment. Yes, this includes at least the second Bush term.

    Increasing taxes on an economy that is already stressed too much will simply speed the offshoring and collapse.

  65. Kenneth Fritsch said

    “Kenneth,

    “If he keeps his gains unrealized there are no taxes there no matter what the rate is. ”

    Why aren’t people getting me. Taxes are still being paid by the gaining company at 50% using the billionaires money. He would have ‘gained’ more without the taxes.

    No free rides unless you are the biggest.

    Jeff ID, I think it is important in these discussions to understand what we are saying. My comment, that you quote, was in reference to Warren Buffett’s schtick on taxing the wealthy and how silly it is in light of even a simple analysis. I referenced a link earlier with an explanation that capital gains taxes can be called a double taxation since before the money was invested it had to be earned where it was eligible for a personal income tax. What you are saying here, I believe, is that an investor in a business, through direct ownership or through an equity position, in effect, has ownership in an entity that pays taxes on its profits which eventually (making profits that is) is required for that entity to increase in value and thus be eligible for capital gains taxes to the investor that might want to realize those capital gains. That could also be called double taxation.

    My further comments on these references to double taxations was to make the point that calling something double taxation is not going to deter the bigger government advocates from making government bigger and increasing taxes. They will, of course, attempt to call this taxation something different because of the bad connotation it imparts, but in the end the goal and strategy is to gain revenues (for bigger government) and these advocates do not really care whether you are double, triple or quadruple taxed. They do not care whether you are rich or poor, but rather what is the easiest route to more revenues for bigger government.
    Those naive discussions from Civics 101 where we get a view of some idealized democratic system of rational decision making written by an academic in an ivory tower who is attempting to make sense of what some cigar chomping politician is doing to grow government bigger really get silly, unrealistic and arbitrary and very fast for me. The debate becomes what is fairer tax and a tax easier to collect and never once what that tax is being used to support or its worthiness. It all assumes that we need the revenue without question and that it is only a matter of how we raise it.

    So you fiscal conservations can keep talking about fairer taxes and new and better tax schemes and keep getting your heads handed to you by those who are truly framing the issue. I suppose it might seem clever to talk about you and me not being taxed but rather the guy behind the tree, but the issue with bigger government advocates is to tax, you and me and the guy behind the tree and never once tell us why those taxes are required.

  66. Kenneth Fritsch said

    “That said, as I noted above, the I think the main reason job growth is poor is because the profitable (small) companies that actually generate job growth have extremely limited access to working capital, due mainly to the banking mess. Provide access to working capital, and job growth will follow.”

    Steve Fitzpatrick, could you suggest what is required for this to happen. You and Jeff Id have noted the difficulty in raising capital for business expansion from banks without using personal assets.

    If you have great faith in the success of your business and return on investments then why would you not want to use your personal assets as collateral for loans. You made reference to the financial state of banks as the reason for the banks not loaning without personal collateral. Would the banks loaning be any less tenuous with a personal collaterlized loan than a first-in-line in case of a corporate bankrutcy make it?

  67. steve fitzpatrick said

    Kenneth #65,
    “could you suggest what is required for this to happen.”

    Sure. It would take banks willing to look at a small company’s long-term history, and lend based on that history, primarily to finance working capital at reasonable interest rates. By reasonable, I mean somewhere above (but not outrageously above) mortgage rates. For lots of small to smallish companies, simply having access to capital (not even actually taking a loan, but simply having it available if needed short term) would make a huge difference in how aggressively the business could expand/hire.

    Some small business owners could indeed refinance their house, zero out their retirement accounts (with big tax penalties), run up credit cards, etc to free up some operating cash. A few actually do. But certainly not all, and maybe not most, have the assets needed. Besides, those actions immediately impact your credit score, not to mention putting your residence at immediate risk if there is any problem at all. Lots of people are loath to do it.

    During the boom 5 years ago some bank financing was available; now it is not. That makes a real difference. My company has generated pretty consistent profits for more than a decade; banks are not even interested in knowing the company financial history. Our bank won’t give my company a credit card with more than $3,000 credit…. in spite of an average checking account balance of over $200,000 for the last 5 years…. at the same bank! No company credit cards over a $3,000 limit is bank ‘policy’. It is just nuts.

  68. Jeff Id said

    Kenneth,I’ve finally gotten to a real computer and am checking in on the various comments more thoroughly at several blogs.

    “but the issue with bigger government advocates is to tax, you and me and the guy behind the tree and never once tell us why those taxes are required.”

    I agree that this issue IS bigger, but this small post was just to discuss the complete and utter fallacy that somehow the wealthy are not being taxed. I see your second question and think it may be ok to reveal a bit more of our situation. I really don’t want this to be about our company but the issue is critical enough that examples are important.

    First, we are a very-fast growing company. Taxes on inventory and equipment mean that we are in regular need of cash beyond what we have earned in the past. This need limits our future growth. Second, we started this company in my rented house with literally no money. Nuthin. Today we find ourselves with a lot of employees and in need of a larger 30,000 sq ft facility. Purchase 1-2 million. We pay enormous taxes because of our growth on items which we will later expense – get the money back. The government doesn’t get to keep the money but the tax burden is a hugely growth repressing factor. We would put more in our pockets today if we didn’t create any more jobs but were we to keep the money, we would invest it in more growth instantly. Think about that inversed incentive considering the economic outlook. It is actually a volatility creating tax policy as when people see a bleak future, they don’t want the double hit of taxes on inventory/equipment now.

    We have plenty of options, one could be investment from an outside source – back to capital gains tax. Another is SBA loans which requires the personal assets be signed over from all of the shareholders above 20% even though the buildings, receivables, inventory and everything are signed over to the banks. Some of of our shareholders are reasonably wealthy and others are not so much, therefore guaranteeing a huge investment is an unfair risk to the individuals with the $$. What’s more is that with the buildings, receivables, inventory and federal guarantees, there was already close to ZERO risk for the bank to make the SBA loan without the guarantees.

    In the end, we will probably just rent a building. Not a big deal, but all of the borrowing options available are completely unworkable for us. Two years ago the bank we used wouldn’t renew a revolving line of credit which we were borrowing and paying off to generate history and ‘accidentally’ weren’t using when it came time for renewal. We would have carried a balance at that time if we were concerned about a non-renewal. The loan is now the size of 1/10th of our average receivables and a small fraction of our cash account balance at the same bank, unless we also sign over our houses, cars, cats and kids too- obviously a useless LOC for us anyway because of the now miniscule size, but the decision has nothing to do with the financial health of our company. It is simply their NEW since 2008 bank policy. Unfortunately, all the banks now seem to have the same one.

    The lack of access to cash crushes small business growth opportunity and increasing the capital gains tax after effectively blocking access to banks would probably change our growth planning entirely. We are wise enough and strong enough to have a few individuals who are interested in investing but we don’t want the money now and simply have them waiting if needed. Investment cash is expensive but there are times when you have to make the call. Therefore, I’m fairly certain that capital gains tax increases would have a particularly massive negative impact on business in general given the current banking situation. Were I a conspiracy theorist as my detractors imagine, if the president wanted to kill capitalism, Obama’s new stated plans would do exactly the right things.

    Now that we have created jobs, have nicely crossed the ‘wealthy’ tax lines and are doing very well as a company, it is very important that I write and let people know that the typical ‘wealthy’ aren’t getting away with anything. It is a very rare CEO that is liberal these days, although some of the most wealthy and famous are. I think that is also worth some personal consideration for most people.

  69. Kan said

    I am not surprised that banks are not interested in loaning to anybody. Read Dodd-Frank for an explanation. Good luck – it has not been completely written yet. Dodd-Frank states that all rule making must have been completed by July 2011. To date very few rules have been finalized. Quiz question for the day – what happens when you miss a federal filing deadline – say with the IRS?

    (http://www.insurancetech.com/blogs/231002438)

    There are estimated to be 330 rule making provisions in Dodd-Frank. Remember a rule can contain 100’s to 1000’s of subclauses. In addition, there are also at least 5 new regulatory bodies to be created (for fun, google Consumer Financial Protection Bureau and Elizabeth Warren).

    (http://www.fiercefinance.com/special-reports/introducing-dodd-franks-new-regulatory-agencies)

    Jeff, SteveF, would you make any plans in your business if you knew a myriad of new rules were coming over the next year that will directly impact your business, and to date, have no knowledge of what they will be?

    What if the Federal Government told you that you could only sell your product for 1/2 current price (see card swipe fees)?

    Hoarding – the word for the times.

  70. Kan said

    I am not surprised that banks wont lend any money. For an explanation, read Dodd-Frank. Oh wait, you cant, because after only 2000 pages, it is not yet completed. See here for a monthly report on the progress.

    http://www.davispolk.com/Dodd-Frank-Rulemaking-Progress-Report/

    Dodd-Frank also creates 5 new federal regulatory agencies. http://www.fiercefinance.com/special-reports/introducing-dodd-franks-new-regulatory-agencies

    For fun, Goolge Consumer Financial Protection Bureau and Elizabeth Warren. Try planning ahead with this as your new overlord.

    Jeff, SteveF what would your business plans look like if the Federal Government has told you that, new rules governing every aspect of your business are coming in the next year but can not tell you what they will be?

    What if the Federal Government suddenly limited the price you charge for a product to 1/2 current list (see swipe fees)?

    Hoarding – the word of the times.

  71. Kan said

    Jeff – I just remembered you are moderating and that is why my first post did not go through. Please delete the second, repetitive one, and this one.

  72. Kan said

    Ummm, never mind – it must have been be the included links.

  73. Anonymous said

    Kan,

    It is probably stuck in the spam filter. I’ll get it out.

  74. Jeff Id said

    I don’t like moderated blogging typically but there was great potential for this thread to drift right to the GE’s rather than the standard of American business. In my world, there are a lot of CEO’s and small business owners who are well over the lines Obama calls rich and their businesses are really struggling. Adding load to them financially or increasing the cost of the only available capital is a very bad idea. I would even call it maximally bad.

  75. steve fitzpatrick said

    Jeff,
    “In the end, we will probably just rent a building. Not a big deal, but all of the borrowing options available are completely unworkable for us.”
    Some years back we faced a similar need for more space (in our case, we needed about 9,000 sq ft more space). After looking at all the purchase and rent options, we decided to try for a zoning variance for expansion at the existing location; it took the best part of a year, but the local area is relatively “business friendly”, so we were eventually able to expand at the existing location. Cut our investment about in half. We funded 75% of building construction out of after-tax profits. The remaining 25% funding was via a loan, which required (as you note) personal property of shareholders as collateral. But since the 25% wasn’t all that much money, we figured the personal risk was limited.

    Here is the weird thing: after investing in physical structure, and paying off the loan, the same bank would today ignore that investment, and refuse to make the same size loan today… without personal collateral worth much more than 100% of the loan value signed over. It is as if banks don’t believe that a small businesses can possibly hold any assets of value. Just weird.

  76. Jeff Id said

    Just weird.

    It’s extraordinarily weird. We also have some history paying off loans, have assets that far exceed our old LOC including highly liquid assets like receivables and ‘cash in the same bank’. There is absolutely no business model I could ever understand that wouldn’t make the loan. It’s a no-brainer and guaranteed profit for them. Perhaps the federal collateralization laws are limiting what they can actually loan but you would think a 10:1 ratio on receivables and even more on inventory assets would cover it.

  77. Joshua said

    There is absolutely no business model I could ever understand that wouldn’t make the loan. It’s a no-brainer and guaranteed profit for them.

    I would guess that it reflects an easily observed shift in how banks decide about lending – that entails ignoring the specifics of individual loans in favor of gambling on bets about larger returns that can be realized through heavy leveraging their existing assets to invest on a much larger scale.

    It also seems to me that business models have become, effectively, not particularly relevant to banks in the same way that they are less relevant than they used to be to large-scale investors. They are less inclined than they used to be, in basing investments on examining business plans and evaluating whether a company can deliver a good product at a good price. They are less inclined to lend money whereby businesses take on debt on the basis of a nuts and bolts business model. They are more inclined to lend money to companies who take on debt specifically for speculative purposes, such as taking advantage of debt for marginal tax advantages or issuing stock buybacks so as to increase share prices. Short term stock market gains trump long term returns from wise investment in a business model.

    And it seems that the financial crisis has not reduced this behavior significantly.

  78. Joshua said

    Related to my previous post – on a more positive note from an article just today:

    From June through August, $104 billion was withdrawn from equity funds worldwide, and investment in U.S. equity funds dropped by $61.3 billion during the same time period, according to Emerging Portfolio Fund Research Inc….Short-term Treasuries are the default option for investors who want to park their money somewhere safe. EPFR’s Brandt says emerging market bond funds have picked up some of the falloff…..Investors also are gravitating towards funds that specialize in dividend-paying stocks, a reflection of long-term pessimism.

    This, IMO, would be a good thing – stimulative for the economy, reducing unemployment, helping small businesses acquire financing. Unfortunately, if those phenomena occur on a widespread basis, the stock market will appear more attractive, and large-scale investors will go right back to investing in the leveraging of debt more or less only for the sake of ROI you can get from leveraging debt.

  79. Anonymous said

    How did you compute a 40% Fed income tax rate on a short-term capital gain of $500,000? I compute an effective tax rate of about 30% if self-employment taxes don’t have to be paid, and about 36% if they do (recall that SS taxes are only on the first $106K, and recall that on income the marginal tax rates and total taxes paid are not the same). Incidentally, the latter case is about the same effective tax rate one would pay (counting both income and SS/FICA) if they made $100K via a salary.

    Also, this was based only a quick read, but aren’t there some flaws in your S-corp double taxation example. The S-corp is, like an LLC, a pass-through entity, so that nothing is “left” in the company that could be taxed a second time? The owners of that firm might have paid, say, about 20-36% effective tax rates (depending on salaries and non-salary payouts) on annual profits from that successful S-corp operation (which are treated like their income), but nothing is left to be double taxed, is there? How was the first investor’s money double taxed? And, if the company has inherent value and an owner sells some shares, then they too will see a capital gain I guess on that stock value, but I don’t see where the double tax comes in?

    Finally, it is my understanding that a disregarded entity for tax purposes (such as an LLC) is a terrible choice of business structure if one has the significant equipment investment/depreciation situation you used in your example. For my [truly small] LLC I can expense the entire amount of my equipment purchases each year (one can expense equipment investments of up to about $24K I think, with no limit on other expenses). Your example seems to illustrate why that company would do much better as a regular corporation than as a disregarded tax entity LLC.

  80. Jeff Id said

    #79,

    First, there is an error in my calculation above. See the previous comments for documentation. I just now changed the capital gains tax to 15% which was the original intent. I don’t know where your 40% on capital gains comes from.

    Second, If you invest 1 million in an S corp in exchange for shares and the value of those shares increases to 2 million over some time period exceeding 1 year, you then sell the shares collecting a 1 million profit for your risk. You are taxed on that capital gain at 15%. However, in the meantime, you were also paying taxes on the profits of that company at what is likely to be a 40% individual rate so the capital gains is the second tax for your risk taken.

    Third, if you are a C corp, the corporation pays taxes. If it buys equipment, it also must be depreciated over time. Odd things like profitless holding companies owned by the parent can be used to reduce the impact. S corps cannot own C corps. I’m not an expert on how cash can be passed between C corporations but what I can tell you is your C corp pays 35 or 40% tax, and if you want to take money out of it, you pay an additional 35 – 40% personal tax for the privilege. Again, no break for the “wealthy” which is the point of this thread.

  81. Anonymous said

    Can you explain what you mean by labor not being expensable, and how labor used to create inventory creates inventory that is treated as taxable income? That does not seem to be accurate as you have described it. I don’t see how your S-corp or LLC can can have taxable income (profit) unless, well, unless you have a profit due to selling more goods or services than the labor and expenses required for you to provide those goods or services. I can certainly understand tight credit or limited capital creating severe cash flow problems while you build up an inventory (and with the delayed depreciation further hurting the cash flow if you used revenues to purchase that equipment), but that seems to mostly be a credit and capital issue, not a tax issue. If you are investing revenue from this year’s sales into creating inventory for next year’s sales, then you’d pay no taxes on that portion this year’s revenue, right? (Excluding equipment purchased with revenues, I guess.) The raw materials purchased (and labor paid) to create inventory are an expense, and there would be no profit until you actually sell the inventory (and at more than cost), correct? Are you suggesting that working cash raised via the personal contributions of owners or investors is treated as revenues? That is not correct, that would be a loan from the owners to the business (to themselves, really, as a pass-through entity), not revenue that could become taxable income. As for outside investors, with that I am now outside my own familiar territory, but that surely cannot be correct. There must be a mistake somewhere. Taxes are indeed a headache and a bit complicated, and no doubt in cases tax law can create odd crunches and wierd incentives, but I have not seen that they are nearly as illogical as you described.

  82. j ferguson said

    Jeff,
    This may be not be a worthwhile diversion, but in the end, i think we’re talking about how to get, or keep the wherewithal to maintain and/or grow a business. Your business apparently has investors in addition to you. They and doubtless you as well have some surge capacity in additional funds. There may be other investors you would invite to join you under the proper circumstances.

    But all of that would be to fund things you aren’t doing yet, or increase the scale of what you are doing.

    And clearly, the available surge would be reduced if some of the taxing schemes in contemplation came to pass.

    My question has to do with banking. You’ve noted above that your discussions with bankers have been mostly academic, not tied to any current need.

    If the liquidity, and availability was there, and you didn’t have to make unwarranted indentures to them, could you, or would you, fund your “expansion” using bank money?

    This may be too nosey a question, and if so, I apologize, but what i’m getting at is that we have people who wouldn’t know a business if it fell on them, proposing to increase the burden on folks like you and your investors while there are few other reasonable sources of money.

    I would be dollars to doughnuts that many of the 535 have no idea what the accessible loan capacity is in the US right now. I tend to think we are being lied to about it by the people who do know.

    I will say that in a personal episode requiring some family funding, the additional funding was forthcoming after we’d used all of our’s, and that was a condition – our’s first.. Maybe that is how the banks see it – lender of last resort, after the house, gun collection, children, dogs and puppies all are mortgaged, then they’ll talk to you.

  83. Jeff Id said

    #81, I wish you were right. Inventory is treated on an accrual basis. If you are small enough you don’t need to do this. The inventory is actually expensed when sold and the value of the inventory on the shelves must also include the value of the labor put into it. Otherwise, you are a naughty guy and need to be fined.

    “If you are investing revenue from this year’s sales into creating inventory for next year’s sales, then you’d pay no taxes on that portion this year’s revenue, right?”

    Nope, it’s all paid for with after tax profit. Inventory changes are effectively income changes. Reduce your inventory and write off the expense as it is sold, increase inventory and wait until you sell it to take the expense.

    “Are you suggesting that working cash raised via the personal contributions of owners or investors is treated as revenues?”

    Nope, that is an investment but you gain a share of the company and pay your shares worth of taxes on its profits no matter which form of corporation it is. Then if you sell your stock you ‘hopefully’ get to pay capital gains also.

  84. Anonymous said

    re #80, the 40% came from this statement of yours: “”But wait! If rich dude sells inside one year, he pays full income tax — 40 percent of the increased value — ouch!”

    yes, double taxation can arise from a regular corporation. for some businesses a C corp is better, for some it isn’t.

    on your second point, the $1M investment carried much risk, and the investor would pay 15% on realized gain from that investment. And on annual S-corp profits, which are personal income, income taxes would be paid. But the annual profits and the capital investment gain wouldn’t be the same dollars. So, so far, this is just like anyone else, nothing double taxed. Income taxes are paid on income and cap gains on investment gains. It sounds like capital investments and revenue-based income are being mingled incorrectly. Am I missing something still?

  85. Jeff Id said

    “If the liquidity, and availability was there, and you didn’t have to make unwarranted indentures to them, could you, or would you, fund your “expansion” using bank money?”

    This is becoming too much about our company but were money available at a reasonable rate, we would do more than we currently are and it would definitely create a lot of jobs. I’m fairly aggressive (not sure if that comes out in my writing ;) ) and our growth is already very fast but having the personnel, equipment and space we want is tricky during these times. Different banks have different policies but I’m told by our bank that they are spending all day making collection calls as business has gotten much worse in recent months. I wonder if they actually just don’t have the cash to loan. If that is the case, the whole industry is suffering worse than advertised.

  86. Jeff Id said

    #84, That’s right, there is a rule that you have to hold the capital for 1 year to pay capital gains instead of income tax. I believe this insures you take your hit for the company taxes on its growth. Again, someone else is probably better to answer that question though.

    On the company, it means that the investor isn’t paying at a 15% tax rate for their gains. If a company doubles in value, on average it has a large increase in income. This income is taxed at about a 40% rate no matter which type of company you are. This is money taken from the investors pocket as much as anyone’s. In a C corp, it doesn’t show up on your return so you can say, I only paid 15%. This is not the true tax rate typically although there are exceptions for profitless things like some dot com’s and it makes for confusing sophistry(and politics) for the public. The investor on a doubling company value would usually have made substantially more money without the income tax right? That tax did come from the investors pocket according to their percentages. The cap gains is the second tax.

    Because of the banking situation, increasing the capital gains even marginally, is a strong pressure to limit the only investment available right now for some companies.

  87. Anonymous said

    I have no experience with inventory issues. What you describe would certainly exacerbate cash flow issues. Sounds very odd to me.

    “The investor on a doubling company value would usually have made substantially more money without the income tax right?”

    I don’t think that is as clear as it sounds on the surface. The annual profits of the pass-through-type entity like an LLC are treated as income of the owners, the portion of revenues or other monies invested in company growth were not taxed (at least not generally, or not in the long run even in your example). The relationship between tax rates on the owner’s income and company growth doesn’t seem that simple.

  88. Jeff Id said

    #87 Why does that sound odd? It is actually very basic accounting. Look up accrual accounting.

    On the last issue. If an investor puts money in the company, they get a percentage right? This percentage ownership of the company is taxed if the investment is profitable. The money invested is intended to create growth and hopefully a return. Some investors want to have a percentage of the company and never sell. Some want to sell back the stock after X years for a multiple of the investment. In either case, during the period of the investment, the investor experiences additional taxes they would not have had on their money had it not been invested in a company. For instance, put it in a CD or savings account. The capital gain therefore is a second tax.

  89. Jeff Id said

    #87 Accrual accounting is the key to your confusion. Small companies often operate on cash basis, we are not allowed.

  90. Anonymous said

    ah, I didn’t realize everyone doesn’t have the choice between cash and accrual accounting. my novice mistake.

    on your last double or “additional” tax example, I think we are now down to a matter of opinion. you said the “percentage ownership is taxed if the investment is profitable”. Yes, if you own a share of a profitable pass-through entity, then the profit is personal income, you receive income from that ownership, and like anyone you will pay income taxes on income. If at some later point you are able to sell your ownership at a gain, you will also pay capital gains on that gain. That is additional tax only because that is additional income. That is not some extra or double tax.

  91. Serioso said

    Wait a minute. I’ve been following this discussion, but I am having trouble understanding some of the tax consequences. If I invest in a C corp — which is the only sort of corporation I can imagine investing in, unless the owner were a close personal friend or a family member — what I am interested in is (1) profits after tax (b) profit growth over time and (3) opportunities for profit growth in the future. The C corp may employ various strategies to minimize tax (R&D tax credit, etc.), but, frankly, I don’t care: taxes are simply another cost of doing business. Corporations can deduct essentially all costs of doing business, including fuel, transportation, heat, light, rental, etc (even clothing, but not usually food); individuals cannot. If a C Corp is run with a modicum of intelligence it need not show a profit unless it is doing exceptionally well. Inventory and capital expenses: Sure. You buy A, your value has gone up by A and your cash has decreased by A. When should you pay tax on the change? If the expense is capital equipment, you can write off tens of thousands of dollars in the first year, so, even though your cash is down by (say) $20,000 your net worth is up by zero and hence there are no taxable consequences. Ditto with the usual inventory: Office supplies and the like. I suppose WIP (with included labor cost) is different but I haven’t any personal experience with that.

    And let us not ignore the wonderful opportunities for cheating, C corp or S corp or sole practitioner. Do you need high speed internet for your business? It’s an expense. write it off, and the IRS won’t mind to much if you use the internet access in the off hours. Same thing with telephones, especially cell phones. And health insurance can be fully deducted (only the most stupid employers offer to pay less than 100% of health insurance premiums), and you may as well throw in 100% of dental and disability insurance and life insurance. Ownership has its advantages. An intelligent sole practitioner can manage to write off (as a business expense) a substantial portion of his annual expenditures — and the IRS won’t mind.

    Get real!

  92. Jeff Id said

    #90, If that company grows in value, then typically you have reinvested the ‘income’ back into the company to support that growth. I don’t know how to grow the value of a manufacturer or service company without more inventory, equipment, tooling or vehicles. You haven’t put it in your pocket, you have created jobs and opportunities for people in exchange for a growth in value. That means, you have invested further than your initial amount in the form of taxed income. The cap gains is what is left if you then sell that increased value company. The cap gains tax is just an extra tax for that increased value.

    As an example, if you were to have ZERO capital gains tax and the investor had zero taxes on a doubled value but a typical 40% tax on the money made by the company:

    Did the federal government collect more money than they would have without the investment? – Yes

    Did this money come out of the shareholders pockets? – Yes

    Did this money paid by the company create a load on business growth? – Yes

    So was the investment with a zero capital gains tax actually tax free? – Not even close.

    What opportunities would the company have with less taxation or greater ability to expense? – It is difficult to say but the original shareholders could have taken a smaller investment without the taxation. Invested money is very expensive money.

    #91, I’m not sure what to address there but there are no free rides with the IRS as you seem to believe.

  93. diogenes said

    Jeff at 92, typically if you sell a profitable company, the buyer will buy on a multiple of annual profits or some other value that includes what accountants call goodwill – eg a surplus over the balance sheet value, or to put it another way, a surplus over what the owner has invested and accumulated within the company.

    That is the real capital gain. Someone can buy your company and because of access to wider markets, cheaper finance etc can do more with your assets than you can.

  94. Jeff Id said

    #93, I agree with everything you have written but what does that have to do with being taxed?

  95. Kenneth Fritsch said

    Jeff and Steve, you have piqued my interest with your accounts of your personal experiences running small businesses and the “weird” reaction of banks in their aversion to loan to established small businesses in today’s economic climate.

    I have been collecting references to the problem as you have both presented it and I find many analyses that would agree that most banks have a general aversion to loaning currently to small businesses – no matter those businesses current financial standing. I will not bore you by listing those links here, but it appears that some of the published reasoning behind the banks hesitancy to loan to small businesses is (1) as Steve suggested, a need for the banks to reestablish their own capital, (2) banks concerns about getting into trouble with new banking regulations and regulators, and this implied from the bank regulators, (3) over reaction of the banks to new regulations.

    I have not to date seen a discussion concerning bank loans to larger companies and whether the banks are more willing to loan to those entities over a documented well-run and financially viable small enterprise and why that would be the case. It also appears that all businesses, in general, are requesting fewer banking loans and credit lines. We hear daily about the unusually large cash reserves that many larger companies are currently holding.

    All the preceding brings forth for me another aspect of this hesitancy to loan by banks to small businesses and for larger companies to hold cash and that is a matter that probably was the major reason that I never was involved in an ownership position of a small company – although I thought I was well suited for the other aspects of that position. That matter is simply: regardless of how well run a company is or how well its products are currently received, its future success can be in a large part determined by events and policies entirely out of control of the owners. Is part of the banks reaction to smaller businesses and larger companies holding cash a reaction attributable to this type of thinking and perhaps showing a lack of faith in the immediate to intermediate future for the economy?

    Warren Buffett, for all his investing genius and business acumen, was not able to avoid a big hit on his wealth in the current economic downturn.

  96. curious said

    Jeff – only skimming again but from your 68 FWIW I’d say beware the gearing monster. Someone I knew was a bright guy, hardworking and with a great product idea. He was a good business man and the company grew very fast. Turned down a very good offer for sale of the business whilst still pushing for growth as fast as possible. The cashflow was good but expansion rate meant the need for working capital was outstripping the rate he could reinvest in the business. Took on board some venture capital and had to give personal gtees. Cost of money was high but suddenly became a lot higher (Black Wednesday). Not only impacted his expenses but income too as everybody tightened belts. Net outcome was company ended up in the hands of venture capital bank. He would have been better off slowing the growth earlier and having done some future cashflow and business planning with some serious downside analysis in it. IMO we are in a cheap money era that has already gone beyond its limit. Not sure what it’ll take for the cost of money to go up – in the UK I think they will delay as long as possible as everyone is in hock but it can’t last forever. Your comment re: the business company you keep and the pressures on them makes it sound as if many people you know are operating without much in hand – IMO consolidation is not a dirty word. YMMV – UK based view, just my 10 pence worth.

    Kenneth – re: Warren Buffet: where could he have put his money?… I dare say he’ll ride these times out without going under :-)

  97. diogenes said

    following from 93…so what is your point? If you retain the compoany you pay tax on the income mgeneraqted. If you sell it, you pay tax on the excess nover book value – although in many countries you can wind that into your next company as reinvestment…

    So unless yuour company is gaining value without throwing out cash…eg Enron (because of frauds)….I am struggling to make out your point

  98. CDM said

    Jeff, I think #93’s point is that if the company has grown no more than the outside infusion of cash dumped into it, then has it really grown? Wasn’t it just propped up? If the company needs that much outside reinvestment of post-tax profits, was it really profitable? (I am not talking about lines of credit here, you were talking about owners infusing cash).

    I think you have described a situation that may be possible (thought not sustainable?) to illustrate a gut feeling of capital gains tax being a double tax, but I don’t think that scenario is usual. You suggested it was “usual” to reinvest post-tax money from profits into the s-corp/LLC, but that is not likely usual in the long run and certainly not optimal. It seems the more usual case is that “more inventory, equipment, tooling or vehicles” are purchased with pre-tax revenues. It would be odd to regularly do that with post tax dollars when you can do it with pre-tax dollars…it seems you’d do that only in a cash flow crunch. (But couldn’t that be a loan to the s-corp?) Even in your case, with inventory issues and slow deprecation creating tough tax situations in a given year, it will still be the case over multi-year spans that you were only taxed on real profits. If an s-corp or LLC buys deductable materials and equipment with post-tax dollars, then that is not a very good plan.

    I guess we can disagree on what is “usual”, but at the least, I’ll see your scenario and raise you one: in Company B, after an initial seed money investment, the company used much of the initial revenues it generated to purchase more or better equipment (and pay the owner/operator some salary along the way), which reduced profits in the short term, but increased them in the long run and led to a company more valuable than the initial seed money. That growth, those reinvesments, were done with pre-tax dollars (and the owner’s labor/genius). Income from the company over the years was taxed only once, and the gain from the resell of the bigger and more valuable company was also taxed only once, when the gain was realized.

  99. Jeff Id said

    CDM,

    You are not understanding. Companies gain artificial value in IPO’s, or stock sales this is true, but if they expect to maintain that value or increase that value then investment must be made in equipment, inventory and such. If there were an option to use ‘pre-tax’ dollars then companies use it, but these options are quite limited for a company of any real size. Twenty five thousand in expensed equipment would do nothing for most serious small business.

    “It would be odd to regularly do that with post tax dollars when you can do it with pre-tax dollars…”

    You are right that it would be odd. It isn’t odd though because you can’t.

    It is correct thought that over years/decades, we do get that tax money back but think of how a complicated tax law sucks massive value from a high growth real job creator, only to return it a decade later.

    “I guess we can disagree on what is “usual”” — I’ve seen a LOT of usual and the imaginary tax shelters for the rich are exactly what I said, imaginary. American business is heavily taxed and over-regulated. Income IS the value of the company, re-invested income has already been taxed once, which creates more value. The sale of the company is then taxed again based on this re-invested income.

    Double tax.

    Agian, if there is zero capital gains tax, can you truly say that the gaining investment experienced zero tax on resale?

    Did the government get more money from the investment?

    Would the investor have made more money without the government tax?

    Double tax.

  100. Jeff Id said

    Curious,

    “IMO we are in a cheap money era that has already gone beyond its limit.”

    Some get cheap money, not small business though.

  101. CDM said

    “Again, if there is zero capital gains tax, can you truly say that the gaining investment experienced zero tax on resale?”

    Yes. if the value increase in the shares you sold was greater than the cash you sunk into the company (which is what is required for their to be a taxable capital gain), then you only pay tax on the gain. You only pay tax on the the return ABOVE what you put into it, so the cash you put into it does not see a second tax, only the gain.

    Single tax.

  102. Jeff Id said

    CDM,

    Without the capital gains tax, on average across all invested companies, did the government collect more money for the investment?

  103. Jeff Id said

    It’s a bunch of sophistry on your part CDM IMO. I understand confusion, but the investor is taxed even if there is no capital gains. If the purpose of the investment is capital gains, the hurdles to those gains include increased operational tax paid because of your investment. It is a flat fact of business whether you are willing to grock it or not.

  104. Kan said

    Jeff #85 says – “If that is the case, the whole industry [banking] is suffering worse than advertised.”

    Yes they are not doing well. To give you an idea, in 2008 there were around 15,000 Banks and Credit Unions in the U.S. Some analysts are projecting that by 2015 there may be as few as 8,000 (I think this is overboard, but the situation is bad).

    Coupled with the current regulatory mess (I know first hand about this), nobody is doing much of anything.

  105. CDM said

    Jeff, then explain it, because you have yet to show me a case of double taxation in a pass-through entity like an s-corp. I am not sure you understand how the sale of an s-corp would be handled. Your invesments as an owner are (or should be) tracked… a balance kept….and upon a sale of the company, you would not be taxed on your “balance” returned to you, only on the gain. This is the same with any investment. I have no professional knowledge here (is the term shareholder basis?), and keeping track of that balance might be a headache in your case, but the basic idea is straightforward and logical.

  106. CDM said

    Jeff, please explain how the investor in an s-corp is taxed if there are no capital gains. Yes, they will pay individual income tax if the s-corp is profitable, but that is still not a double tax, just income tax on income. (yes, you did provide an example where profits are computed to be high in a buildup year and that only evens out over a few years, but in the end, still no double taxation).

  107. cce said

    Chris,

    “Marginal rates” are just that, rates. Taxes are government revenue. Between and including 1955 to 1975, the federal government collected taxes equal to 17.7% of GDP (lowest was 16.2% in 1959, highest was 19.7% in 1969). In 2009 and 2010, it collected 14.9%. If we limit the discussion to just the income tax, the figure was 7.9% then (lowest was 7.1% in 1965, highest was 9.2% in 1969), vs 6.5% and 6.2% today.

  108. kuhnkat said

    Cce,

    how sure are you of the GDP figure? I believe the way it was computed has changed over the years. Have you taken this into account?

  109. curious said

    100 – Who are your customers? What drives your sales? What are your sales vulnerable to? No need to reply – just saying that (availability of) cheap and easy money has effects beyond the direct expenses businesses see on their books. Might not be strong issue in your market.

  110. diogenes said

    The real point is that in many countries, the government is spending more money than it can collect in tax revenues. The government response is to raise taxes. But there simply is not enough money to tax to wipe out the deficit – all the proposals simply increase complexity and add to tax burdens without doing anything constructive to close the gap. It is not as if there are vast amounts of untaxed money lying around….the government is already sucking away at it all.

  111. Kan said

    cce – “Effective tax rates today are low by historical standards (that is, since the end of WW2) and by international standards.”

    You keep talking about tax rates, but then keep using tax revenue as a percentage of GDP as proof of this statement.

    These are not the same thing. All you have shown is that tax revenue reflects economic conditions – not tax rates.

  112. Jeff Id said

    CDM, — Jeff, please explain how the investor in an s-corp is taxed if there are no capital gains.

    The investor receives shares of the company, the company profits are directly inserted into the investors tax returns. In a company which is profitable such that the value of the stock can double, the investor pays tax according to the percentage owned of the company income. If there is a doubling of value, the company is almost always making a solid profit meaning the investor is paying a solid tax.

    Curious,

    You aren’t understanding me. The banks won’t even bother to ask those questions. They won’t look at the books or even our relatively giant account balance right in their own bank. They aren’t even interested in asking one thing, unless and sometimes even if you have personal assets to cover the debt. I have a neighbor in the industrial park who has gone to every bank he can find to find someone to invest in expanding the park. He’ll sign anything over because he knows he has a good opportunity. The banks just aren’t listening and it has nothing to do with his or our personal situation, because they won’t even look. They simply say no.

    I’m sure that were we interested enough, we may find a bank somewhere interested in loaning, but fortunately we don’t need to.

  113. CDM said

    Jeff on #112: Yes, indeed, that is what I said in the sentences after the part you quoted. Scorp owners pay income tax on annual profits (which are put on the owners indvidual tax returns, apportioned according to their share of ownership) and they will pay a capital gains tax on a realized value gain. but that still is not a double tax. We are all taxed on income and we are all taxed on gains, but we are not taxed on the investment. You seem to keep mingling the two (and, yes, if a company’s value has increased, it presumably does have profits and/or the anticipation of future profits), but you have yet to show a dollar that was taxed twice in an S-corp.

    I will now speculate some, at risk of it distracting from the black-and-white point above: If you are saying you didn’t pocket those annual profits, that they were all put back into the company, I think that is just reinvestment. You are “more in”. You decided (or had to) reinvest. Your ownership now has a higher “balance” …but when you sell the company, you pay cap gains tax only on the return above the investment you have in the company. Again, this situation is requiring a lot of cash and risk, but there still is no double taxation.

  114. CDM said

    Jeff: Again, I know little firsthand of this (I am an engineer, not a CPA), but it seems one commonly hears and reads that for rapidly growing companies, and maybe for manufacturing companies, that a C corp is better tax and operating structure than a pass through like a S Corp. Are you certain that has been thoroughly evaluated for your case? (Now, with the C Corp one can run into real double taxation, but apparantly it is still the better choice for some.) It seems taxes can be an impediment when a company that would be better off as a C corp tries to operate as an S-corp/LLC, but that is a different issue.

  115. Jeff Id said

    CDM,

    “Are you certain that has been thoroughly evaluated for your case? ”

    Yes. Very much so.

  116. [...] [...]

  117. Jeff Id said

    CDM,

    You are not understanding. First, for a company to gain value you have to increase its value. This increase comes from increased sales in particular which lead to increased profit. Those sales DO require increased investment to support them. Therefore profits ARE reinvested to support the increase. These ARE after tax profits. Your profits are taxed heavily.

    Gains in value result from those increased sales which the OWNERS have invested in. These GAINS are taxed already as stated in the previous sentence – heavily. If you chose to now sell your company at an increased value from your ALREADY taxed gains, you are TAXed again. A double tax on the same investment.

    Again, even if you had a zero tax on the investment, did the investor pay more tax than they would have?

    Did the investment generate more income for the government?

    It was a zero tax on capital gains, you can argue the investor didn’t pay enough but did the investor really pay zero tax on his investment?

    And finally, people keep asking if our accountant is good enough, he is the main accountant for a man who owns a professional sports team, multiple private jest, huge resorts, and buys and sells a company every week. In addition to that, one of our partners is a business tax lawyer in a major city. So yes this is the real world of real business, take it or leave it.

  118. CDM said

    “These GAINS are taxed already as stated in the previous sentence – heavily.”

    No. You are not accurately defining gains, value growth, and taxable gain. You are calling your investment into the company a gain, which is incorrect. The after-tax profits you are reinvesting is simply your investment (apparantly a deepening investment), and not part of a taxable gain when/if you later sell your share of ownership. (to perhaps put it too simply: you can subtract out your personal cumulative investment total from any future sale amount you receive and pay capital gains tax only on the gain above and beyond your invested “balance”.) You feel you put the money in play twice (maybe in a way you did), but it still never is taxed twice.

    Sure, the fact that you have paid income taxes on profit treated as income (the s-corp method) is reducing the leftover cash available to you for the demands of your reinvestment or any investment (and the income tax I pay on my salary is reducing the cash I have available for investing in your company, my company, gold, or the lottery), but that is still not a double tax.

    In a way, that last point reminds me of a restaurant, in a neighborhood with many successful restaurants, that goes under and the owner thinks “I could have made it if only I didn’t have to pay taxes”.

    “You are not understanding.”
    You have said that twice now. Often, one has to work and want to understand. I want to understand, your accountant likely does understand, but I am not sure you do.

    I don’t think you and I will make further progress. You have not described a double tax situation (it just “feels” like one to you, IMO), and we are now just repeating ourselves.

    Thanks for having replied to my posts.

  119. Jeff Id said

    “You are calling your investment into the company a gain, which is incorrect. ”

    No I am absolutely not saying that.

    “The after-tax profits you are reinvesting is simply your investment”

    No the after-tax profits are from the increased productivity of the company. This is increased in the examples above due in part to the investment from an outside source. If a company grows inventory itself, that is a re-investment but what choice do you have if you have more customers to service.

    “You feel you put the money in play twice (maybe in a way you did), but it still never is taxed twice.”

    There is no ‘feeling’ involved. It is a second tax on the growth of the company. The outside investment enables increased growth in the examples we’ve used. The company is taxed on its increased production of widgets or widget services, the shareholders pay tax on the increased production, and later when the investor wants to leave the company, the capital gains is the second tax. Why do you ‘feel’ so strongly that it isn’t a second tax? Just what makes that separate payment of more money to the government separate from the first? I’ve asked several times the questions about a zero capital gains situation, no replies so far. I assume that is because you realize the investor IS paying taxes he wouldn’t have paid had he kept the money himself. The capital gains tax is an additional tax on money already taxed once.

    “Sure, the fact that you have paid income taxes on profit treated as income (the s-corp method) is reducing the leftover cash available to you for the demands of your reinvestment”

    And an outside investor increased the ability of the company to grow. This increased the tax paid by the company over what would have happened without the investment. The investor pays his share of it. He literally writes checks with real dollars to the government as the company gains sales. Sales increases in part due to the investment. So for paying a company money, he gets the privilege of paying more taxes on his share of that money. Why aren’t those checks taxes on THE GROWTH OF his investment? Seems like the same thing to me. Dollars to the government for the same investment that wouldn’t occur without the investment.

  120. Kenneth Fritsch said

    “Marginal rates” are just that, rates. Taxes are government revenue. Between and including 1955 to 1975, the federal government collected taxes equal to 17.7% of GDP (lowest was 16.2% in 1959, highest was 19.7% in 1969). In 2009 and 2010, it collected 14.9%. If we limit the discussion to just the income tax, the figure was 7.9% then (lowest was 7.1% in 1965, highest was 9.2% in 1969), vs 6.5% and 6.2% today.

    Cce, you might want to look at the link below for all the government expenditures per GDP, i.e. local, state and federal. The percentage increases substantially over that for federal alone. A large expenditure with heavy borrowing/deficit can produce a current lower tax revenue but that simply lays that obligation onto the future and future generations. I think even with Keynesian accounting (we are all dead in the future) you have to account for deficit spending in terms of future considerations. The unfunded liabilities of the Ponzi like schemes of SS and Medicare also add to future expenditures far beyond what is allocated currently.

    There are plenty of other expenses covered by the private sector that are government induced and ever increasing, e.g. collecting the taxes and the cost of regulations.

    http://www.usgovernmentspending.com/total_spending_2011USbn

    To argue that current revenues (and during a financial downturn) are historical smaller (and could be increased) is to argue that past rates were not too high and that the sustainability of past conditions and obligations are the same as the current ones. Taxes have a net negative impact on the economy. The problem currently is not increased revenues and taxes, but rather pushing the size of government down to sustainable levels (and much further than that for my libertarian ideal).

    Finally in the link below we see another devious and increasing source of government spending and deficits that are kept off the books.

    http://www.heritage.org/Research/Reports/1985/02/Putting-Off-Budget-Federal-Spending-Back-on-the-Books

  121. CDM said

    ” I’ve asked several times the questions about a zero capital gains situation, no replies so far. I assume that is because you realize the investor IS paying taxes he wouldn’t have paid had he kept the money himself. The capital gains tax is an additional tax on money already taxed once. ”

    Certainly the capital gains tax payment is real extra dollars paid by the invididual (on new wealth which was created by the individual’s work and risk-taking—the source of your irritation, I think) and certainly it is real extra dollars collected by the gov’t. That was never in dispute. But the cap gains tax is only on the additional money gained using that investment, not on the money that has already been taxed. Yes, these are two different taxes…you have two single taxes on two different types of income, but no double taxes on this s-corp. (yes, the already-taxed money was used to create the additional gain, but that already taxed money part doesn’t get taxed a second time, only the additional gain.)

  122. Kenneth Fritsch said

    Jeff ID, I would guess that most posters here would agree with your main premise which I surmise to be that your company’s growth is impeded by the taxes that it is required to pay. People argue against your definition of double taxations not so much that they disagree that it impedes progress but rather that it has a bad connotation and thus by not calling it double taxation it can more readily be justified as a source for revenues for an ever expanding government. Most people have been convinced by the prevailing intelligentsia that any financial source and indication of well being is fair game for supplying revenues to a growing government. In actuality it becomes a more easily/readily tapped source of revenue because in a democracy there are more voters who are not in this taxed category.
    Other rationalizations for taxes are those connected to the sin taxation and probably affect the less well off more than others, but the sin part wins the day for those looking for more government revenues and some kind of rationalization. Real estate taxes can affect all income groups and the fact that the recent collapse in real estate values has not been associated with decreases in real estate taxes simply shows that government taps whatever sources are available for revenues. Sales taxes are of course regressive, but, on the other hand, they are readily collected by the merchant at little cost to the government and kind of hidden in the overall cost of the item purchased.

    I would suggest that the priority and progression of a big government spender is (a) legislate the spending without revealing the eventual cost or who pays for it and preferably with an emergency need for the spending, (b) rationalize deficit spending in order to lay the obligation on future generations while at the same time minimizing the concerns about those deficits by referring to minor tweaks in the future to “fix” the problem and finally (c) if absolutely required by popular demand, rationalize new and/or increased taxes as noted above.

  123. Jeff Id said

    CDM,

    So it is your opinion that it is a second tax on the investment but not a double tax?

  124. Jeff Id said

    Kenneth,

    I should mention that I don’t have a problem with capital gains taxes per se. I think they are a bad idea at times but there are far worse taxes. For instance, we haven’t even begun to discuss the inventory capitalization taxes whereby the time value of the people in the offices must be added to the inventory in an appropriate percentage, just to make sure that the government gets a bit more in their revolving (anti-growth) negative interest loan. It entails a lot of paperwork and do it wrong you get the big A (audit).

    The whole premise of this post was me getting pissed off that people think those making money get a free ride when it is complete and utter bullshit. Other capitalist countries like CHINA’s SEZs’ pay far less.

  125. CDM said

    it is one’s opinion on how much this separate tax is “reasonable” or “appropriate”, and likely somewhat an opinion or how badly it impedes investment, economic growth, etc., but it seems to be a fact that each type of income dollar in your scenario is being taxed only once.

  126. Jeff Id said

    CDM,

    Since the growth in sales is taxed and the growth in value is the same thing, I find them difficult to separate.

    Is there any possible way to be double taxed on the same money then?

    A C corp income gets taxed, then the owner gets taxed if the income is distributed – double or single?
    A sales tax on a candy which had a VAT.
    A VAT on a product before income tax?

    It seems to me that by this rationale we can justify as many layers of tax as we like.

  127. Jeff Id said

    Now I wonder,

    Assuming you are right an each layer is a single separately justified tax, is it accurate for a wealthy person who primarily makes income from investments into stock to say:

    He is paying less tax to the government than his secretary?
    Or is it true that the C corp assets he owns are actually taxed at a far higher rate and he is paying several times more than his secretary?

    Keep in mind the C corp taxes are not on his personal returns, but if they gain, they are profitable using his money.

  128. CDM said

    Not sure I have time to enter into a new debate (neglecting my own meager income too much this week as it is), and not sure I am informed enough either, but I’ll bite with at least one response.

    I assume you don’t dispute the basic calculation, that the effective rate on Buffet’s personal income is about 18% while his secretary’s could be about 25% (including effective income tax and FICA/SS taxes), or his self-employed plumber’s marginal rate might be on the order of 40% (say a marginal tax rate of 25% plus 15.5% SE tax…though the plumber’s total effective rate likely more like 25% to 35%). That is all straightforward.

    I have no idea how Buffet’s firm is set up or what sort of taxes it pays.

    I assume you don’t dispute the basic calc, rather, that you want to discuss whether the taxes paid by the companies Buffet invested in are also part of his “share” of taxes generated and taken by the gov’t? (Either through economic activity facilitated by his investments or by those corporate taxes having lessened his potential income and gains.) That seems a bit more philosophical…not my forte. (I could be a basic bean counter or tax-return cruncher, but not likely an economist.)

    Would it be a different illustration for you if this was not an “active” manager like Buffet and he didn’t have a firm? For example, what if this is just an individual with a large sum of cash who has a financial advisor put it in the market for them. The income derived from that investment is taxed at maybe about 15% to 20% (depending on scale relative to capped SE taxes and if they have to pay SE taxes at all), while their plumber again pays >30%. In this scenario, with the investor uninvolved in the investments (except for their at-risk capital of course), did this person indirectly pay lots of corporate taxes? To what effect? Even if they did, is their direct income tax rate of 15% a “fair” tax structure?

  129. CDM said

    Jeff, I just saw Post 126. Yes, of course, in a C corp you do end up with profit distributions that were taxed twice…double taxed.

  130. Jeff Id said

    I assume you don’t dispute the basic calculation, that the effective rate on Buffet’s personal income is about 18% while his secretary’s could be about 25% (including effective income tax and FICA/SS taxes), or his self-employed plumber’s marginal rate might be on the order of 40% (say a marginal tax rate of 25% plus 15.5% SE tax…though the plumber’s total effective rate likely more like 25% to 35%). That is all straightforward.

    See now, that’s where we knew you were gong. YES, I do and have disputed that. It is a flat lie. A dishonest, with intent, lie. His income is VERY heavily taxed in relation to his secretary.

    “I have no idea how Buffet’s firm is set up or what sort of taxes it pays.”

    I see that but to make it clear, it is a pile of companies of various structures that HE owns. You write “Buffet’s personal income” and ignore “Buffets personal firm’s income” which happens to generate “Buffets personal income”. Did his ‘firm’ not get taxed before he got ‘his income’????

    “That seems a bit more philosophical…not my forte.”

    Philsophical is scatological, it is HIS company which HE owns that pays HIS money to OUR govenrnment. Lies by the media and politicians about HIS payments to the government are the purpose of this post.

    “did this person indirectly pay lots of corporate taxes? ”

    YES and NO, one hell of a lot of taxes were paid, but since the person owned that portion of the company, there was NOTHING indirect about it. This conversation is smacking of gamesmanship. If you wish to believe against all facts that the wealthy don’t pay taxes in proportion to the poor, there is little I can do to stop you. What I can say though is that in my not-terribly-limited experience, it makes me shake my head.

  131. Jeff Id said

    CDM,

    I hope that doesn’t offend you actually. I’m just a little tired and stressed from running the business and am very tired of the fake ‘rich don’t pay enough’ crap on the news. I’m going to relax for a bit now.

  132. kuhnkat said

    #110, Diogenes,

    There certainly is a large pot of money that is NOT being taxed. I would direct your attention to all the tax free foundations and other groups. There are billions that are not touched and probably won’t be very soon, although they should be. Yes, I as a Christian include Churches and religious organizations as should be paying taxes along with the Tides, Heinz and all the other big ones (how about the Catholic Church?). If you are using secular currency in a created organization it should be under the same laws as everything else.

    Of course, you could tax evey penny that is moving and STILL not solve the problem. The problem was, is, and always will be that people divorced from the hard work of making the money will be too generous or frivoulous or criminal with the money of those who DO work for it.

  133. CDM said

    Jeff, as you noted, I made it clear I was not including corporate taxes paid by his firm and clearly expected you were thinking of the taxes his firm and its subsidiaries pay. It is no great revelation that the many companies he owns or partly owns pay a variety of significant taxes along the way, including corporate taxes on profits. Exactly how to tie that back into the most equitable and/or optimal tax system for the US is certainly beyond me today, and apparantly beyond clear consensus. But it is not based on ignorance or lies or some nefarious plot between the media and Buffet. It is a matter of perspective to some extent.

  134. cementafriend said

    Thanks Jeff for your information. It seems that the Australian tax situation is similiar but has different names. I read somewhere that in Australia about 30% of people pay no tax but they still complain about the 10-20% who pay 80% of the tax.
    Have you seen this Joke

    Joke About Taxes and Beer
    Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

    The first four men (the poorest) would pay nothing.
    The fifth would pay $1.
    The sixth would pay $3.
    The seventh would pay $7.
    The eighth would pay $12.
    The ninth would pay $18.
    The tenth man (the richest) would pay $59.
    So, that’s what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. “Since you are all such good customers,” he said, “I’m going to reduce the cost of your daily beer by $20.”

    Drinks for the ten now cost just $80
    The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men – the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share?’
    They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay! And so…

    The fifth man, like the first four, now paid nothing (100% savings).
    The sixth now paid $2 instead of $3 (33%savings).
    The seventh now paid $5 instead of $7 (28%savings).
    The eighth now paid $9 instead of $12 (25% savings).
    The ninth now paid $14 instead of $18 (22% savings).
    The tenth now paid $49 instead of $59 (16% savings).
    Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
    “I only got a dollar out of the $20,” declared the sixth man. He pointed to the tenth man, “but he got $10!”
    “Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too. It’s unfair that he got ten times more than I!”
    “That’s true!” shouted the seventh man. “Why should he get $10 back when I got only two? The wealthy get all the breaks!”
    “Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor!” The nine men surrounded the tenth and beat him up.
    The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!
    And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

    David R. Kamerschen, Ph.D.
    Professor of Economics, University of Georgia

  135. Jeff Id said

    CDM,

    I flatly don’t agree that it is a matter of perspective. It is a simple matter of fact that taxes on the wealthy are VERY high. All you need to do is remember that percentage of government taxes that the 1% pay. It’s a widely published number which you and everybody else including those you apparently see as the completely friendly no-motivation media should not ignore.

    I’m very tired of my tax level and Cementafriends ‘joke’ pretty well nails it.

  136. HaroldW said

    Cementafriend —
    I love the beer joke. But in the present U.S. environment, the reduction in the beer bill would more likely be distributed as follows, from the $20 to be returned:
    $2 credit given to each person, EXCEPT that this credit is phased out by income. Hence, the result is:
    1st through 6th get $2 back from the barman. Yes, this results in the first 5 being paid to drink.
    #7 gets $1 back (credit phase-out)
    #8 through #10 are above are above the threshold for credit. They get nothing back.
    So $13 has been returned to the drinkers. The other $7 is given to various private agencies to fund campaigns to stop drinking. [The relationship of said private agencies to campaign donations is not to be inquired into.]

  137. RB said

    A recession is now practically inevitable before the next election. It is going to be interesting to see how a Republican president deals with deficits that are only likely to soar under his watch with 10%+ unemployment.

  138. Mark T said

    If he’s smart, he’ll cut spending drastically. Unfortunately, the Keynesian mindset pervades most politicians, Republican and Democrat alike. They think taking money out of the economy in order to put it back in can somehow result in growth. Idiots.

    The problem I see is that we may end up with another case of complete control by one party, a super majority as it is termed. That’s the only way to get through the cuts that are necessary, but it ultimately leads to a blank check to push through anything the party wants, whether for the good of the people or not. Without a super majority, we’d never have gotten most of the major entitlements that are currently crippling our ability to compete economically.

    Mark

  139. CDM said

    Hi Jeff: I don’t much like for posts to end up being a trade of links, but I imagine you’ll like this article. It shares your idea (which I agree has merit) that Buffett was oversimplifying how taxes ultimately impact him, and it notes that (obviously) taxes were extracted at a variety of steps on the way to his personal return, etc.

    http://www.forbes.com/sites/timworstall/2011/08/17/if-warren-buffett-isnt-paying-the-corporate-income-tax-then-we-should-abolish-the-corporate-income-tax/

    I cite it because it backs up what was my layman’s conclusion that how to “view” or “account” for the impact of corporate taxes (especially in a large and public company) does not have a black-and-white answer. Apparantly there is a term for it: “tax incidence”. Buffett of course knows how much his firm paid in corporate taxes, but apparantly he views that tax incidence as having hit before him, or having hit him only indirectly. You do not agree, you have a different perspective. That is legit too. Buffett’s firm clearly paid a lot of taxes, but how much that negates the validity or honesty of Buffet’s editorial is up for legit debate.

  140. CDM said

    I also want to add that, based on how you described it, I acknolwedge that you are experiencing serious obstacles over how inventory build up, taxes, and depreciation are combining to hit your company hard and unevenly in certain years. That does sound very tough and worthy of your attack. I just am not familiar with those specific issues. In my simpler and more limited experiences, the small business tax situation appears to be more reasonable than in your situation.

  141. Anonymous said

    The capital gain tax on the sale of an LLC interest is not a double tax. The reason this is true is that all of the income previously reported and taxed is added to the “tax basis” of the LLC interest. That tax basis is subtracted from the sales proceeds in determining the taxable capital gain. Thus the capital gain tax is applied only to gain in excess of the prior income.

    I hope this clarifies the discussion between Jeff and CDM above.

  142. Ruhroh said

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  143. Jeff Id said

    “That tax basis is subtracted from the sales proceeds in determining the taxable capital gain. ”

    Which has little or nothing to do with the value of the company being taxed — so again I disagree with sophistry.

    ON ANOTHER TOPIC.

    I have asked and received permission to give a personal example of the undertaxed wealthy. This year, for my 2010 payments it took me two tries to fit my taxes on a personal check. I am not wealthy, one car, rented house. In 2012, I will have to have it done by a bank as both my primary partner and I will pay taxes equivalent to literally five or more times our GROSS take home cash.

    FIVE times our GROSS pay before tax.

    Since there are two of us, and accounting for the rest of the ownership, that amounts to 13 well paid employees worth of tax on a company with only 25. We were warned (by our inexperienced accountant) that there are serious rumblings about another increase for us for 2011 in the works as well.

    Go ahead, raise taxes on the “wealthy”, I promise it will solve all your problems.

  144. Jeff Id said

    Wow, quiet thread.

    I wonder if the Id might know what it is talking about?

    Naw.

  145. Jeff Id said

    It’s actually funny because we are fine. There is enough but when the lefties come by and talk about the ‘shelters’ and the ‘breaks’, they don’t have a clue about business. This is a maximally operated business getting coddled by the tax shelters of the US.

    The US population needs to take a hard look at its self.

  146. joshv said

    Jeff, I own an S Corp and am a partner in a much more successful LLC.

    Both have a similar problem – suppose we want to save up money to hire a new employee or invest in expensive equipment.

    Come march 15th, those retained profits get dumped on to my personal return and taxed at a pretty high marginal rate.

    But I wasn’t actually paid any money, the corporation saved the money to do something productive. No matter, I still have to pay taxes on it. So I have to come up with my own after tax money to pay taxes on corporate profits for the privilege of saving up money in my corporation. How odd.

    Sure, you can get around this by issuing a special bonus to cover the taxes on the retained earnings, but the bonus itself is taxed, and the bonus decreases your ability to retain earnings – very inefficient.

    The end result is that many small businesses like mine have the goal of zero profit at the end of the year. They pay out all excess earnings to the shareholders or partners, and don’t save a damned thing.

    I imagine this is the reason most larger companies use debt financing for large expenditures and expansion – it makes no sense to save. It’s better to borrow, interest rates are much much lower than tax rates. But these days small businesses, as you note, can’t get loans. So for us, it’s save up and pay ruinous tax rates on money that’s not been paid to you, or just don’t save.

  147. Jeff Id said

    Joshv,

    We do distributions out of the corporation now as the amount of taxes is absolutely staggering. The $$ of the distributions are of course taxed as income on our returns along with all the rest. You are right though that it does create significant financial pressure not to grow very fast so that you avoid the false prophets and keep the real ones :D.

  148. Serioso said

    I think I now understand the essence of the problem: If an S corp makes $100 and doesn’t distribute the profit to the shareholders, then the shareholders must pay (let’s say) $40 tax without receiving any cash from the S Corp. For this reason, S Corps usually try to distribute at least $40 (i.e. 40%) of the profits so that the shareholders are not adversely impacted. This distribution of cash limits the rate at which the S Corp can grow.

    That’s life. Hard to get away from it.

  149. Jeff Id said

    “That’s life. Hard to get away from it.”

    But the point is that small S corps are the ‘wealthy’ who are targeted for tax hikes. They are the VAST majority of business in the US on a dollar basis and the public is generally completely unaware of who ‘families making more than 250,000′ actually are or the fact that they are not keeping that money in their pocket.

  150. Serioso said

    It is surely true that the tax code as you have stated it penalizes owners of S corps who plow back their earnings in the interest of faster growth, but does not particularly penalize owners who keep all the earnings and let the business stagnate. But what about tax credits for R&D and for employment growth?

    [REPLY: No, S corps are penalized less than C corps. Read above for the math. I have given many examples already and a few dollars of credit cannot change the true result.]

  151. cce said

    [snip]

    This is my second snip this year. I’m sorry but giant corporations are not going to be the subject of this thread. This thread is about what makes America run and that is small’er’ business.

  152. cce said

    In comment 130, it was stated, “Lies by the media and politicians about [Buffetts] payments to the government are the purpose of this post.”

  153. Jeff Id said

    CCE,

    I really hate snipping people. Your thoughts are important and if you take the time to write something it bothers me to see it moderated. However, giant corporations have different rules than 99.99 percent of american businesses, which is the topic of the thread. We are the ones paying tax, Buffet uses his various excuses to claim he is paying little while hiding the rest.

    I think this topic is important enough that we need to leave it unpolluted by the sophistry of the media sales pitch. Perhaps people need to sign some giant piles of money over to get the true effect themselves. I just read about a psychiatrist who claimed a half million in salary in one year from the government, had his timecards reviewed and was forced to pay back 10K despite claiming hours that were literally physically impossible.

    I can’t imagine that much of my hard work, signed over at gunpoint and flushed down a toilet.

  154. cce said

    I will keep the Buffett stuff very brief. My point that was if you transfer his share of the corporate tax to Buffett, his overall rate of taxation is pretty much indistinguishable from than that of his secretary or the rest of his staff, who are, in fact, well paid. And the point that Buffett has made is not to raise the tax on those making $250,000 (that’s been Obama’s pledge — Buffett is against that), but on the tiny fraction of the population who are megarich (like him) and take advantage of all of those special rules.

    With regards to your anecdote, I’ll tell you one thing, that psychiatrist isn’t the first government employee to work for free (not sure what this has to do with taxation). And speaking of money “signed over at gunpoint and flushed down a toilet,” a $500,000 salary for a government psychiatrist?

    I’d also like some kind of documentation for the belief that S-Corps are responsible for the “VAST majority” of X, Y, or Z.

    According to the IRS, S-Corps had revenues of about $6 trillion in 2007 (last year before recession) which was about 43% of GDP that year. They had net income of about $400 billion, and paid $117 billion in taxes, or an effective rate of 29%. There were about 4 million returns, so the average taxable income from S-Corps was $100,000. There were 6.8 million shareholders, or average income of $59,000 per shareholder. They paid salaries and wages of $611 billion, so their average payroll was $153,000. They paid $224 billion in “compensation of officers,” or an average of $56,000.

    http://www.irs.gov/taxstats/article/0,,id=171033,00.html

    Of course, those are averages which are misleading, and don’t break down employment by the S-Corps based on income. We’d also need to know the amount of compensation to determine if those jobs were higher quality, than, say those created by big business.

  155. Jeff Id said

    Cce,

    You are providing your own documentation, something I like to encourage here. You have nailed 43% of GDP just from S corps. Now look at the other non-C classes taxed the same way. Doesn’t it make you wonder what percentage of those “families” earning over 250K/yr are actually business owners?

    Here is a paragraph from this IRS link which supports that the majority of business in the US is pass through.

    Corporate pre-tax profits, also known as net
    income (less deficit), decreased by 46.4 percent,
    from $1.84 trillion to $984.3 billion (Figure B). When
    excluding pass-through entities from the total, pretax
    profits decreased from $1.06 trillion to $388.7
    billion, a drop of 63.4 percent.

    Taking 1.06-.388 to be the pass through entities, you get 63% of all business profits in the US are pass through types. There were about 6 million business returns of which 4 million were S corps.

  156. Jeff Id said

    Here is another interesting quote from the same link:

    From the 5.8 million active corporations for Tax
    Year 2008, approximately 4.1 million were passthrough
    entities. These pass-through entities
    include: regulated investment companies (RICs), real
    estate investment trust (REITs) and S corporations
    [2]. These entities pay little or no Federal income tax
    at the corporate level. Instead, they are required by
    law to pass any profits or losses to their
    shareholders, where they are taxed at the individual
    rate. Pass-through entities showed a decrease in
    pretax profits of 23.2 percent or $180.4 billion during
    2008 (Figure C).

  157. CDM said

    Jeff, First, let me restate my understanding of your s-corp’s situation: Apparently there is a problematic timing difference (in reality and in in accounting and tax returns) between your revenues and deductible expenses and equipment investments (and complications with inventory build-up and taxes with which I have no familiarity), combined with a limitation on using outside lines of credit and a need to reinvest present earnings (to buy expensive equipment and build inventory, apparently without financing available) and that is creating current tax burdens and cash flow problems. The tax burden issue would, I would expect, average out a bit better over a few years (to only tax real profits), but regardless, for now, it creates a serious burden on the owners and obstacles to growth. I hope I understand that correctly.

    You are also talking about big picture issues, such as suggesting many businesses in the US are hampered like yours and stand to be further harmed if we increase income tax rates on that portion of a person’s personal income that falls above $250,000.

    I am wondering how common your case is. For example, let’s consider a plumbing business that chooses to operate as an S-corp. They can have 4 employees or 40, makes no difference for my illustration (only to the extent that the owner presumably has a better chance of larger profits with the larger firm). This biz can deduct all of their expenses such as fuel, pipes, employee salaries, etc., each year. They can deduct up to maybe $25K in tool and office equip purchases each year, and maybe their work trucks are financed over a few years, in way that roughly matches the depreciation schedule.

    Ok, their revenues and expenditures are presumably in much better “sync” than your case, thus profits computed for that S-Corp are “real”. In this case, the owner of this business will see a tax increase only if his take-home PROFITS exceed $250,000 (and, again, note the increased tax rate will be only on that portion of his personal income that exceeds $250,000.) It doesn’t matter if the company revenues are $2M or $500K; this plumbing business owner would see a tax increase only if he is achieving profits greater than $250,000 per year.

    I suggest this situation is the “intent” of the tax increase (an increase aka “going back to 1990’s tax rates on the upper brackets” or “letting the temporary tax cuts expire for the upper brackets”). I also wonder if this is not the more common S-corp situation. (C-corp taxes are a whole other topic).

  158. CDM said

    I also want to make a layman’s (i.e., I am not an accountant) observation about your s-corp. The equipment investments and inventory build-up cannot be the sole cause for your tax burden. What I mean is, your company must also be pulling in real revenues for there to be something taxable (however unfair that taxable amount may be due to the issues mentioned in the prior posts). For such a tax increase to affect you (the >$250K marginal rate increase), it seems your company revenues would have to exceed [currently available] deductions and expenses by $250K per year per owner. I don’t mean to focus on personal details, but this seems to be some missing context here. It sounds like you are undertaking a significant enterprise (e.g., an owner-financed purchase of a $600K piece of equipment?) which is, not surprisingly going, to have heavy capital demands and cash flow concerns while getting it off the ground.

    I might be the first to agree that tax code adjustments are needed for your situaion so that the tax code doesn’t handicap your venture (any more than taxes handicap everyone), but I am skeptical your case represents the “vast majority” of s-corps.

  159. Jeff Id said

    #158, The stated ‘intent’ of a tax increase has nothing to do with the result. I don’t beleive I have ever suggested that our situation is typical oor that it represents the ‘vast majority’ of companies. We actually have a near zero income holding company that keeps patents and proprietary software. It files a return but skews the ‘average’ numbers you calculated above.

    What I have suggested is that an increase of tax on the ‘wealthy families’ is a tax on business right when it is least needed. I can imagine no more destructive policy than increasing business tax further. We are aware of how to hold profits overseas as some of the large companies do and if the situation were to get worse, we might just do that. Companies are strained to their limit across the board right now. I know this because I get to meet many dozens of their owners each year.

    You seem to suffer under the belief that somehow 1990 taxes would be no big deal combined with an issue of high taxes being OK for a company making ‘real’ profits vs invested profits. My views are completely different. There are huge regulatory loads on businesses that didn’t exist in 1990. Crazy human resource law, environmentalist wacko law, layers of city and state taxes. In illinois they just raised our taxes by 60% from last year and we expect health care premiums to jump 30% from the ignorant Obamacare crap. Our ‘real’ pay rate is well over 50 percent already before dealing with the lazy leftist nutjob government workers. I once spent a day trying to get through the FDA to import a machine. It took hours of time and the end result was that the lady blocking the import was quoting a law that didn’t exist. I had to file a form giving the ‘reason for FDA compliance as — there isn’t any FDA rule for this product’. In exchange for my lost day, I got a lecture from this lady about how it is not their job to tell us the law and we should have studied up on it. IOW, I should have known to file the paper for the law that only existed in her head. What is really bad are the 60,000 USD bills for EPA studies for construction and bullcrap like some bird died in your drainage pond. We’re being sued too by some employee who claimed sexual harassment by another employee of the same sex, hostile work environment against two others, hipaa violations on another, permanent disability from a (we-don’t-even-know-what) work injury and now retaliatory termination. Fully, she accused 25% of the company of doing something wrong to her and she has free lawyers willing to go bottom feeding with her just to see if they can score a quick buck in a settlement. I am happy to note that I haven’t made the list of the accused — yet.

    The leftists are destroying this country and have no idea what we face to do business here. We can easily ship these jobs back overseas too.

    If you want to collect more money for the lazy government employees, we NEED less regulation, we NEED reduced tax burdens so that we compare with other countries, and we NEED restructured tax code in order to do it properly. If you let business keep their profits for investment, they will invest it in growth. Supply/demand guarantees that higher wages will result — the left doesn’t seem to realize that. In thier mind, it is always up to the government to force higher wages. Then we will end the second recession.

  160. CDM said

    I don’t dispute much of your last post. Those are real headaches you experience and no doubt a drain on business productivity. (Nearly all regs are drains. The awful cases you cite may be evils, but so are other ones that we might agree are necessary evils. But, I digress.)

    I wish you success. I think having manufacturing jobs within the US is EXTREMELY important.

    The following quote is what I have been questioning (well, this and semantics on the the correct use of the double tax label):
    “What I have suggested is that an increase of tax on the ‘wealthy families’ is a tax on business right when it is least needed.”

    See, I have yet to see how such an upper-bracket personal income tax increase is going to hit many businesses, except maybe in a case like yours which perhaps is a venture out of the norm (and even then it seems to hit your business only in certain years and arguably temporary, as it evens out over a few years). Now, we can still claim the tax increase is unfair or harmful, and it may be every bit as unfair if it only hits a few business situations (perhaps even more unfair and more damaging if it only hits owner-financed capital-intensive new growth like yours!). But, when debating just how bad of an idea it may be, I like to be accurate about how it might affect business.

    Is it going to hit the widget maker with $250,000 in sales? No. Is it going to hit the widget maker with $1M in sales? Maybe, if the owners are able to each NET $250K per year.
    (Again, if they are able to do that, is that tax increase unfair and “class warfare”? Maybe, but that’s another debate…which I think is the real debate to have, the debate which I think gets clouded by misunderstanding who the increase would hit.)

    I have had sincere interest in your scenario because one so often hears “it will hit lots of small businesses” and, by knowing only tiny bit about taxation in an S-Corp, I have not understood how that is possible. Yours was the first example I’ve seen make a case for it harming business growth in a certain situation, and I truly wanted to understand it. It has been a good exercise to think about.

  161. Neil said

    Hi Jeff,

    I have read through quite a bit of the thread. I see the problem from a different angle. People want to increase taxes to reduce the deficit. My question is always what are people prepared to give up out of government spending to reduce the deficit? The situation with taxing more for a reduction in the deficit is like finding you are spending more than your salary and then forcing your employer to give you a pay rise and then wondering why your buddy lost his job! If only this was possible! I am not American although I currently live here and pay USA taxes, but we have similar debates in New Zealand. Just yesterday I read a comment on a blog in NZ that will seem familiar to many here. There was the vague statement we need to tax the rich more (no definition of rich, but it will be someone earning more than the person commenting), followed by a response that 8% of tax payers are already paying 40% of taxes. The response to that was that they earn 80% of the income so they should be paying even more! The statistics themselves are slightly wrong, but the two missing parts are that in NZ about 40% of people with taxable income pay zero net taxes (infact some are negative tax payers) ,they are the lowest income people and they also consume a disproportionate amount of government services.

    The debate should be about how we create more rich people, not how should we redistribute what they (the rich and people generally) make/create. Re-distribution by govenment generally creates nothing, in fact there is usually a dead-weight loss associated with it due to transactions costs and government inefficiency. And we are seeing some real good examples about the inefficiency of government redistribution lately!

    As we tax the “rich” more we do two things , we reduce their incentives to create wealth and we increase their incentives to avoid taxes. Does not sound like a good idea to me.

    Unfortunately I think many countries are in for a bad time. Policy tends to move a bit like a pendulum and at the moment it is swinging anti-capitalism, anti-rich. The bad news is that I have lived through a country dragging itself away from interventionist policies and high rates of taxation and the transition was painful. The only reason it happened was that we had gone so far to the crazy left, that even the left saw it was nuts and they actually undertook to the pro-market reforms. The cost of the prior policies and transisiton was huge and the benefits, now almost twenty years later forgotten, so we set the policy heading back the other way.

    We collectively get what we ask for, unfortunately in a democracy, many of us did not ask for it.

    Neil

  162. Neil said

    Jeff, this should ring true for you!

    http://rogerkerr.wordpress.com/2011/10/04/giving-back-vs-creating-wealth/

    Neil

  163. cce said

    Jeff,

    I posted a link back in 22 with some statistics on small businesses, which would encompass more than just S-Corps. In 2007, there were 120.6 million non-farm private sector workers, and small businesses employeed 59.9 million of them. In other words, about half. There were 27.4 million small businesses that year, but only 6 million of them had employees. That is to say, 21.4 million are the self employed. Of those self employed, only 4.1% of them were in marginal brackets 33% or higher (about 880,0000 people). If we subtract the self employed from the total, we get 38.5 million employes amongst 6 million small businesses. So, the average small business with a payroll employees 6 or 7 people, which would include the owners. There’s probably a little wiggle room in these numbers because someone who is associated with more than one small business would be counted twice.

    In any case, 38.5 million is 32% of “non-farm private sector workers” which is . . . not a vast majority. What portion of these are employed by business owners who would see their taxes increase if we were to return to Clinton era rates?

  164. Jeff Id said

    Cce,

    First, S corps and pass through entities are not ‘small businesses’. They are businesses of a certain tax type.

    From your link: “Small businesses employ about half of U.S. workers.” The article I have written above is about the majority of businesses which are pass through entities — and not about small business. Also, I honestly wonder why would you subtract farm workers and present a conclusion about the small business in America? Is there some reason they don’t count?

    It must be noted that your averages are neglecting the fact that many businesses form multiple entities to hold technologies and hardware or are inactive. At one point, we owned 4 separate businesses.

    Most importantly, you are asking the question in reverse and have excluded farming for some reason.

    You asked: What portion of these [non-farm workers] are employed by business owners who would see their taxes increase if we were to return to Clinton era rates?

    The correct quesiton is: What percentage of those who would be affected by the Obama tax increase are pass-through business owners?

    I’m sure you will agree that the second question would present a far more important statistic

    “In any case, 38.5 million is 32% of “non-farm private sector workers” which is . . . not a vast majority. ”

    I’m confused. Are you claiming that farms are not private business, or that they do not experience pass through income? Or is it your claim that the majority of business in the US is not pass through? Everything seems all mixed up.

    Two percent of household families make more than 250,000 and there are 110million households so there are 2.2 million families making over 250K. Of those, how many made their money from a pass through entity? My guess is – over half.

  165. CDM said

    I was at such a good stopping point, and should quit while I am ahead (at least IMO!), but the last two posts have drawn me back in. I am curious (though I haven’t put much thought into it yet) why either of you are making a distinction about farm vs non-farm workers. How many farmers are netting incomes of $250,000 per year (and netting is a key word), and, if they are, does it matter if they are farmers vs. any other business?

    And does it matter if we are talking about a farmer, a widget maker, or a law or medical practice? They all have employees. Sure, the latter might not be viewed as “producers”, but that gets into another economics topic.

    One consideration in this overall topic (the topic being about potentially harmful economic effects of increasing the income tax rate on the portion of anyone’s personal income that is above $250K/yr) has been whether the tax affects, say, 50%, 10%, or 1% of business owners. But regardless of how many owners it affects, I keep coming back to this issue: It seems to be an article of faith that if you tax the personal income of a business owner that it will hurt the business activity. I don’t think that is as clear as everyone assumes. As gone over at length in prior posts, the employee salaries and business expenses are all “pre-tax” expenses. (With Jeff “sort of” providing a potential example to the contrary.)

    Certainly if you tax anyone’s income too much the incentive to work more will get diminished at some point (and it does seem business owners are taking on more risk than, say, the salaried guy, thus maybe they are more sensitive to such disincentives), but do you give up a business generating $300K in net personal income because the last $50K of that income will be taxed at 39% instead of 36%? (and keep in mind the first $50k, and even the first $250K, are still taxed at the same rate as everyone else in the country.) The fairness/unfairness of the progressive tax structure itself is another topic IMO; I am talking about harming business activity.

  166. CDM said

    To go out on a limb (I am sincerely hoping for objective and insightful critiques of this), maybe the higher tax on the highest portion of the personal profits encourages business owners to avoid incurring the higher income above $250K per year and instead invest that last $50K into their business, as sort of a pre-tax investment?

    A thought experiment: I have a pass-through entity (currently LLC, likely to change it to S-Corp taxation soon). Let’s say hiring a part-time assistant or buying some better engineering software costs $10K, but since that purchase is a deductible business expense, it reduces my take-home income only by about $6K (~40% total tax rate due to a marginal tax rate of~ 25% plus 15% in SE taxes). If this purchase/investment is going to pay for itself and make me more money, well, more money is more money, it seems I’ll do it either way. Or, if this employee or software is completely unneeded, surely I won’t waste my $6K. But what if I am unsure of the benefits (likely common) and on the fence? Maybe this investment won’t really increase revenues directly, but if it saves me a couple of hours a week for a couple of years, it starts to be worth it. In that case, the fact that I gain the help for $6K out of my pocket (and not $10K) actually seems like an incentive to make that hire/investment? I don’t think I’ve seen this scenario examined before—-what is my logical flaw here?

    Now, I can easily imagine if I am netting only $80K per year then I have to take a serious look at how much after-tax take-home income I need to meet personal demands (feed the family) or meet goals (save up for retirement or that better house). In that case, any income tax does interfere with my funds available for investment (similar to Jeff’s example, but arguably everyone’s income tax reduces their investment cash on hand.) And maybe I have similar goals even if I am netting $300K per year (who can decide what “enough” is), but it seems to me that at that higher level I am going to be more inclined to “shelter” that income in the business into something that makes my business life easier, such as that new software or new assistant. The upper-bracket personal income tax increase seems to encourage business-owner investment in this scenario. Again, I truly would be happy for someone to point out logical flaws in this.

  167. Jeff Id said

    CDM,

    This is the kind of discussion I expected when I started this thread. I assert that it doesn’t matter if the business is a ‘farm’ or ‘widget’ or ‘service’ company, they all pay taxes and hire workers. Taking their money causes them to have less.

    “It seems to be an article of faith that if you tax the personal income of a business owner that it will hurt the business activity.”

    I’m trying to stay nicely calm but “An article of faith?”, Wow. This is very strange thinking. Here’s a little example of faith for you — Illionois raised our income tax 60 % or a measly 2% of total ‘PERSONAL’ income and directly took one worker from our company. One employee’s salary — gone from this years operation simply by ‘PERSONAL income tax’. Where are we supposed to get that money from? Is it not a real check I personally sign? I have to say, it sure feels real. One person doesn’t have a job in our tiny town because of this.

    I am surprised that you thought you were ‘ahead’ in your previous comments. I took that to mean that some point I’m making is unsubstantiated. While my wife (and many here) will tell you, I am often wrong, a business is simply numbers. If you take positive numbers from a business, it creates less. How could a business create more if the stuff it operates on is bled off? Not logical IMO.

    To go out on a limb (I am sincerely hoping for objective and insightful critiques of this), maybe the higher tax on the highest portion of the personal profits encourages business owners to avoid incurring the higher income above $250K per year and instead invest that last $50K into their business, as sort of a pre-tax investment?

    A very healthy business making 250K/yr in profits is usually at a minimum 1.5 million in sales. For a family to make that much from a business so small, it would likely be a sole proprietorship. This excludes lawyers or some consultants as they operate at an entirely different level of infrastructure need – In my past, I worked as a consultant. In total, I’ve never owned a substantial business which performed that profitably at that very low level of sales but they probably exist. What is factually incorrect is that you are postulating that there is some imaginary ‘shelter’ for a company of that size to suddenly and without a previously intended need for investment, to ‘hide’ fifty thousand in income.

    Equipment and inventory are often depreciated items so no shelter there. Oddly enough, despite the half dozen businesses I’ve owned, this has never even been suggested in board or executive meetings. Because of he sure-to-ensue embarrassment, I would not want to be the guy who made the suggestion either. Recently, Obama has given some extra incentives for companies to purchase equipment that you need a little earlier by allowing instant depreciation/expense. Unfortunately, the rules say that the equipment MUST be new and US made despite the huge market glut of used stuff from already bankrupt “rich” companies and therefore, as is often the case with government, all is not what it seems. Businesses spend money when we need to ONLY, and we invest in our best possible interests ALWAYS and from our best understanding, to the maximum benefit level – ALWAYS. I like business for that reason because it is simple to understand what the other guy wants.

    A very healthy business lives on a small fraction of the money left from your sales. If you can make 25% earnings before interest, taxes and depreciation you are doing very well. If you raise taxes on that tiny remaining bit, you steal investment directly from the heart of the company. Money which was available for either re-investment, tooling, advertisement, or even the awful payoff to the owners for the enormous risk a business he/she personally takes.

    “If this purchase/investment is going to pay for itself and make me more money, well, more money is more money, it seems I’ll do it either way.”

    What if you have ten investments and the increased tax means you only have enough left to pay for nine? The examples you give are too small to matter for the numbers we’re dealing with. Are you suggesting — Oh, if there is so much money that you can make ten investments, you don’t need to worry. Pay your share?

    When you say you will do it either way, you are ignoring the reality of serious business, there is NEVER enough money to do everything you want. A percentage lost, is a percentage less.

    This is an approximate example from my history where I was a minor shareholder. If you have a small company with even 50 employees, the cash in and out is pretty fun to watch. Two million in payroll, 600Kish sales/ month, over 1 million in inventory. Not a perfect company. Every new customer was a victory, every new check is a positive feedback. Profits one month could be huge and losses the next could potentially be even bigger. The fast growing company managed to profit about 0.8 million in a year on 6-7 million in sales. A five percent Obama hike would be $40,000 which equaled 1.5 low level production jobs or a nice little piece of equipment to help us be more efficient. Is there some way we could have sheltered the measly $0.8 million from Obama’s liberal clutches?

    Nope.

    Perhaps if we took the money and threw it into some (in our case giant) software we don’t really need now as you postulate above? Nope, even large software investment must be depreciated over 3 years. Therefore there are no magic shelters and you must pay 40% tax now and you will receive the breaks later. But in our distant past case, the money had already been re-invested into inventory and equipment required for our growth and survival. Growth (job creation) was intentionally limited by the board to make payments.

    This is real business in America today.

    Please tax us more, it is simply an ‘article of faith’ (damn that was hard to read) that it makes any difference at all. Don’t worry, we’ll still hire everyone who wants a job because WE ARE VERY STUPID AND GREEDY!! haha.
    —————————

    Last paragraph:

    And maybe I have similar goals even if I am netting $300K per year (who can decide what “enough” is), but it seems to me that at that higher level I am going to be more inclined to “shelter” that income in the business into something that makes my business life easier, such as that new software or new assistant. The upper-bracket personal income tax increase seems to encourage business-owner investment in this scenario. Again, I truly would be happy for someone to point out logical flaws in this.

    I have already pointed out the logical flaws above but you say (who can decide what “enough” is) is a clear sign of a steep political bias. Still, you are not understanding. A corporate income of 300,000 is a very small business. Sure there are smaller ones, but many private pass-through companies experience this kind of revenue. A substantial portion of that MUST be re-invested just to maintain the status quo by improving whatever you deliver because that is what your competition did. If you fail to match, you fail as a company. An additional amount of that profit must be invested for growth to attempt to surpass the competition or else you will experience corporate entropy – slow disassociation of customers. So when you are taking tax percentages, of that allegedly giant 300K profit, the owner typically takes home little BUT the new tax comes from his share 100%. These are not small expenses and they must be both paid and taxed.

    As a final note, yes the tax will eventually be passed on but in many industries, a penny can make the difference between a sale or go home. The company with the biggest pockets can suffer the loss from a sudden tax increase for a time to strangle the little guy. Therefore, the little guy with the better widget, must grow big enough pockets quickly or the boss man will show them the door. I’ve seen that personally plenty of times as well.

    If you are lucky enough and happen to maintain just the right balance of investment/cash for long enough, you might even get a savings equal to a low level federal pension. A few even go farther.

    Not many though.

  168. Neil said

    I am and have been a direct report to the CEO of a multi-billion sales and value company for almost 15 years. I am currently a director of a “little” start-up that we have funded with US$250m . I only say that because taxes matter to everyone. The challenges Jeff talks about apply to small and big companies. As we sit as senior executives and board members we never have enough capital to persue all of the opportunities we have. So many times opportunities have gone because tax makes them unattractive.

    I of course dont face the challenges in quite the same personal manner as Jeff, and yes we can weather changes better, but increasing and decreasing taxes matters. A 2% increase in tax comes from where? It comes from what is left over after everything else has been paid for, it is coming from the hopefully economic profit that the shareholders risked their capital to acheive.

    The “pie” of economic surplus is in the short run fixed, so when the government decides to increase its share what do I do as a manager? Firstly I look to recoup the cost to get the after tax returns to the shareholder up again, so I look to cut costs. Secondly some projects which may have been marginal already, will look even worse, so I reduce investment, which is just as well as I now have reduced after tax cashflow to pay for stuff. Third, the incentive to look at my tax structuring just increased, so I might have another look at that, including countries I operate in.

    I said it earlier in this thread and I will repeat it here. Tax and reditribution does not create anything (generally and for teh bulk of goverment spending). Taxing to solve a deficit maybe a short term political solution, especially if you can wrap it up as taxing the rich. But what/who is rich? I can understand people feeling upset about a hedge fund manager, speculator or Bill Gates making huge amounts of money, but then surely the solution if you dont like that is to try and become one yourself or something else that makes money and adds value to the economy and society? If you dont want to acheive the same success as Bill Gates etc then all you are really indulging in is the politics of envy. I know it is not fair that some people get ahead and others dont, but I am afraid that is just tough. I have huge empathy for people who don’t have the same opportunities and I am more than happy to see that addressed through spending on education, but at the same time I look at what governments spend our money on and I am sad.

    The only long run solution to a persistent deficit is a reduction in government spending.

  169. Jeff Id said

    Thanks Neil. There are quite a few lurking businessmen on this blog. I think it has been a good thread for teaching people about the reality of doing business in America. We have a coming election in which we will likely be faced with poop or garbage, but the reality is that we need to have a general improvement in business climate if we expect to continue to succeed instead of get worse as a country. There are just too many extra hurdles to face these days.

    It would be informative for the readership to hear some of your environmental stories. e.g. costs for breaking ground/cleanup.

  170. CDM said

    I agree your examples apply to the s-corp where the after-tax owner income (i.e., taxed profits of the s-corp) must be retained to be reinvested for growth, and you assert that such reinvestment of owner income is the norm for a growing company. I have no doubt what you describe is common, but how predominant it is, I am not yet sure. What if we also point to business examples that make their growth/reinvestments primarily from revenues and not through the reinvestment of after-tax owner income? (And, what if these equipment purchases were financed through outside line of credit instead of owner-income reinvestment, such that equipment payments are more in sync with the depreciation schedule? That would seem to change the cash flow dynamics of the delayed depreciation effect on taxes you cite. You are back to only being taxed on real profits, not on monies used to grow the company.)

    And, sorry to repeat something you’ve already answered with apparent certitude, but it is common tax advice that a business that expects to regularly retain some earnings might find it advantageous to organize as a c-corp instead of s-corp. Why is the c-corp not more favorable in your case? (Perhaps lowering the c-corp tax rates would make the c-corp option more attractive to you. It seems that lowering corporate tax rates would spur business activity better than a personal income tax cut…that is an argument I could get behind more easily.)

  171. CDM said

    You cite a case in which:
    “the fast growing company managed to profit about 0.8 million in a year on 6-7 million in sales. A five percent Obama hike would be $40,000 which equaled 1.5 low level production jobs or a nice little piece of equipment to help us be more efficient.”

    Aren’t your numbers off? If this is an S-corp with a single owner and $800K in profit, a 5% increase on personal income above $250K/yr, would be an increase of $27,500, not $40K. ($800K – 1 owner x $250K)*0.05 = $27.5K. If this S-corp has 3 equal owners, then the additional tax is $2,500. With 4 equal owners, no tax increase. If my calcs are correct, does that change your opinion on how widespread might be the effects of such an upper-bracket tax increase?

    My own political biases, whether steep or not, are not about a simple-minded “tax the rich” position. I agree that there is potential to harm some (or perhaps many) businesses and therefore it should be carefully considered. (Maybe tie it to a decrease in c-corp taxes and give businesses a chance to reorganize?) But, it seems extremely common for people with different baises to get the numbers in their examples wrong, as I think you might have with that $40K example, and as you did (at least on a technical point) on the “double tax” posts many posts back.

    When I see the specific examples given by politicians or other steep-biased people to have significant technical errors, a red flag goes up for me. Why provide exaggerated examples of harm, if there are accurate examples of harm that could be cited? (yeah, I know why people do it, for impact, but then such examples beg for closer analysis.)

  172. Jeff Id said

    “What if we also point to business examples that make their growth/reinvestments primarily from revenues and not through the reinvestment of after-tax owner income?”

    For the vast majority of business, there is NO difference. None. Please consider what you are being told.

    “And, what if these equipment purchases were financed through outside line of credit instead of owner-income reinvestment, such that equipment payments are more in sync with the depreciation schedule?”

    You pay less tax up front, if it is an ownership contract, you get both an asset and liability. If it is a rent-only contract you get just the liability and the expense but don’t own the equipment. Either way, you pay for it out of after-tax income so there are still no breaks.

    “and as you did (at least on a technical point) on the “double tax” posts many posts back. “

    Our big-shot accountants, lawyers, partners and I, all disagree with you. You are incorrect in your interpretation. If there were a 15% tax only on the capital gains of an untaxed company, then I would agree, but since the gains were after tax gains, you are wrong.

    “And, sorry to repeat something you’ve already answered with apparent certitude, but it is common tax advice that a business that expects to regularly retain some earnings might find it advantageous to organize as a c-corp instead of s-corp.”

    There aren’t many advantages to being a C corp. You get double taxed on any income, once at the corporate level and once when you take it home at personal income level. Big companies do it for various reasons – like over 100 shareholders, the ability to own other companies and they utilize tax laws to hold profits off shore. This is not the point of this thread though. So NO it would be completely inappropriate for a company retaining earnings to reorganize as a C corp without having other reasons. In either case, there are no tax breaks -unless you are huge.

    “Aren’t your numbers off? If this is an S-corp with a single owner and $800K in profit, a 5% increase on personal income above $250K/yr, would be an increase of $27,500, not $40K. ($800K – 1 owner x $250K)*0.05 = $27.5K. If this S-corp has 3 equal owners, then the additional tax is $2,500. With 4 equal owners, no tax increase. ”

    I’m confused. If there is one owner and his company made 800K, he pays 100% of 800K at 40%ish for taxes. If you pay 5% more, you pay 5% of 800K.

    “. If my calcs are correct, does that change your opinion on how widespread might be the effects of such an upper-bracket tax increase?”

    NO, your numbers are too small and few companies have four equal owners for obvious reasons. If you had 4 shareholders at a company of that size, it would be with the intent of getting larger.

    “I agree that there is potential to harm some (or perhaps many) businesses and therefore it should be carefully considered.”

    Again, many of us have considered it already and it should not be considered at all. It’s quite literally insane in our current operating condition, unless you intend economic recession. I actually think the recession may be the point when I see the leftists sticking their hands out in front of the New York banks. Every economic collapse leads to the same thing, the poor believe they deserve more from those who have earned it. Why wouldn’t the democrats want the situation our economy is in? One election is a battle, not the game.

    “Perhaps lowering the c-corp tax rates would make the c-corp option more attractive to you. It seems that lowering corporate tax rates would spur business activity better than a personal income tax cut…that is an argument I could get behind more easily.”

    Why just C corp, are not S corps real business? We just discovered that ‘personal’ income taxes are actually business owners, we also discovered that vast majority of business in the US is pass-through, and we discovered that a huge fraction of the alleged wealthy are simply reporting company income rather than personal take-home income on their returns. I realize that those of a political mind set that the wealthy take too much find these facts hard to swallow, but they are still facts. Next year, when I’m writing a check to the federal government for many times my take-home pay on money this company earned, I will remember this conversation. Trust me, I won’t be hoping for ways to pay more.

  173. CDM said

    “I’m confused. If there is one owner and his company made 800K, he pays 100% of 800K at 40%ish for taxes. If you pay 5% more, you pay 5% of 800K.”

    yes, you are.

  174. CDM said

    re post 173, sorry to have been snide there, but considering your response, there is no question you are confused on computing taxes. the marginal tax rates apply to income intervals, not totals. That is very basic stuff. you should review the difference between marginal tax rates and effective tax rate rates, look at the current tax brackets and proposed changes, and then revisit your $40K example.

    there is plenty of room for disagreement between us, but the capital gains “double” taxation for an s-corp is not one. You are correct IF it is a matter of interpretation (i.e., it “feels” double taxed or is indirectly double taxed), but the retained investments can be subtracted from the taxable capital gains, thus no double tax. These are not layers of taxes (an analogy you used earlier) on one stream of income, these are two separate taxes on two different streams of income (however interrelated those streams are in your examples). You and I are again repeating ourselves, so a good time to stop. Thanks again for taking time to respond. I’ve learned a few things.

  175. Jeff Id said

    “. the marginal tax rates apply to income intervals, not totals”

    CDM, I’m not confused on how taxes are computed, you have discovered the reason why I put the ISH in the number 40%. If you have 800K of S corp. income, most of that is well inside the top bracket and the exact percentage doesn’t matter to my point. I’m quite good at paying taxes.

  176. CDM said

    “If you pay 5% more, you pay 5% of 800K.”
    No, that is a mistake. You have made similar mistakes repeatedly in this thread.

    “I’m quite good at paying taxes.”
    well maybe better at paying them than computing them. In the personal example you provided, you’d have paid between $12,500 to $40,000 more than you would have actually owed (1.5 equivalent employees lost!). More the point—and this is important—instead of you having provided a personal example of how such an upper-bracket marginal tax rate increase would have affected you as an owner of a business, you have instead provided an example of how it would not have affected these business owners at all if it is an s-corp with more then 3 partners. And that is one of my points: the extent/depth of the negative effects from such an increase seem to get misunderstood.

    to calm things back down a bit: you acknowledged that some businesses have a much different infrastructure need. I guess that is the viewpoint I am coming from—the consluting firm, professional partnership, etc. I think most of what I have suggested applies well to those types of businesses. You are focusing on businesses with signficant capital and reinvestment needs, which supports [some of] your arguments. I think that is [part of] the source of our failure to agree on much. In concert with your example, you propose that the most significant economic activity comes from the business types you describe. Maybe so. Yours are likely much outnumbered by smaller firms, service firms, etc., but I’ll agree your examples are extremely important businesses, perhaps far more important. I don’t disagree with you on that.

  177. Jeff Id said

    “. In the personal example you provided, you’d have paid between $12,500 to $40,000 more than you would have actually owed ”

    Five percent of 800,000 is still five percent of 800,000 distributed out of the company or paid from personal savings. I have no idea what else you are talking about and can’t see any errors at all. In the multiple partner examples you suggest, many times minor partners in S corps are over the 40% range from their ‘real’ jobs/companies, which is how they got to be minor partners in the first place. One issue you may be missing is that S corps MUST distribute equally to partners by law or you lose your S election. So if you wish the company to cover the taxes of a wealthy partner, you MUST distribute at 40% of profits to cover taxes. You can opt to make the shareholder pay it out of their own pocket which is essentially a forced investment but most I’ve dealt with don’t do that. So take 800,000 * 0.4 and you are pretty darned close to what you need to cover tax.

  178. CDM said

    this doesn’t neagte your argument…I am just sharpening the pencil….but, actually, on $800K of personal income to one married individual, the effective Fed tax rate is about 31% without SE taxes, and 33% with it. (yes, the marginal rate is about 35%, but effective rate lower even at that range). If we increase the marginal rate on the highest bracket (currently that portion of income above around $380K) by 5%, then, yes, the marginal rate goes from 35% to 40%, and the effective rate on $800K rises from 31% to 33% (with no SE taxes, or 33% to 35% with them.). Again, that was for one owner. If we spread it around multiple s-corp owners (who, say, have avg incomes), then there might be no increase to them from this upper bracket increase. (Yes, for the single owner, that is darn close to 40% as you said, and state taxes do get you to 40%, but I thought I’d clarify this anyway.)

    Your last paragraph was an important addition. You are saying these S-Corp venture co-owners have invidiual incomes well into the top bracket from their other jobs and companies, to the extent that a 5% increase on the top bracket hits them all at close to a 5% on profits from this S-corp they co-own, essentially no matter how small are those s-corp profits and/or how many owners. Wow. OK, you got me there. So, for your argument to hold true, we have two conditions: (a) they are reinvesting the profits back into the venture and (b) the owners are all far into the higher personal income brackets.

    You might still be 100% right that the increase hurts the business venture regardless of the income level of the owners (and thus it hurts those who want to work there, hurts the economy), but try selling that case to the average voter, with all that extra context included. That is a far cry from the typical example invoked by politicans talking to the shallow media of it hurting the local “small business owner”.

  179. CDM said

    Here is a new fun[gible] question: For these s-corp venture owners, who have other taxable incomes above $250K (your example), what if they are investing some of that other income into shares of GE, Apple, a mutual fund, co-ownership of a local new restaurant, bricks of gold, land, etc. Are any of those investments different from the money that got reinvested into their S-corp venture?

    I think you can agree that retained s-corp profits are essentially the same as the owners having been “paid out” (as co-owners, profits distributed in proportion to their ownership/investment level) but then asked to immediately invest some or all of that back into the venture. (Yes, the cash never changed bank accts, but your ownership “basis”/balance increased.) I am curious if that is or is not different to you? In this case it seems any personal income tax increase reduces their after-tax income, regardless of source, which reduces their after-tax income available to invest in anything, regardless of what investment. (Again, as co-owners they have already made one investment, but are now investing further into the venture.)

    Or, what if this s-corp had little net profits one year, but still asked the owners to invest further into it to fund some growth?

    In either case, would you want business owners of this type to pay less income taxes than, say, the consulting engineer who invests in Apple, the solo law practice lawyer who invests in real estate, etc?

    This is not gamesmanship, I think we are onto something. (I also have a feeling a good economist could have distilled this long exchange in one step!)

  180. Jeff Id said

    “So, for your argument to hold true, we have two conditions: (a) they are reinvesting the profits back into the venture and (b) the owners are all far into the higher personal income brackets.”

    They are investing their income into another venture and yes you can expect them to be guys like lawyers, doctors, CPA’s, businessmen and the like.

    “You might still be 100% right that the increase hurts the business venture regardless of the income level of the owners (and thus it hurts those who want to work there, hurts the economy), but try selling that case to the average voter, with all that extra context included. ”

    That’s why the post is simple enough to understand. I try to remind people of the inconvenient facts of science, politics and business. People claim we have no AGW and it is not possible, I argue against that as vehemently as those who claim extreme AGW is known. I’m wrong sometimes and right sometimes. Unfortunately, in business, I’m experienced and less likely to be wrong although learning is a regular part of the experience.

  181. Jeff Id said

    First, you made me look at the tables and I agree that you are right, my 40ish number is too high according to income tax rate. The reason that I say 40ish without concern, is because the actual rate is much higher and I notice a lot of real expenses which cannot be expensed. Half a meal for a sales dinner is 35ish percent deductible but the entire dinner is paid.

    “(Yes, for the single owner, that is darn close to 40% as you said, and state taxes do get you to 40%, but I thought I’d clarify this anyway.)”

    You are almost correct with your calculations but don’t forget that we pay the other half of FICA, the five percent of state tax, property taxes on business buildings are much higher millage than homes in many areas, end user taxes on equipment and various fees. By the end, we are well over 50% true tax and we live on the rest even though it is all termed ‘INCOME’.

    “I think you can agree that retained s-corp profits are essentially the same as the owners having been “paid out””

    See, that is the implication you are supposed to experience (feel) but many of the ‘profits’ are actually expenses which are still taxed. If you have to retool to remain competitive, this is something which must be invested with no real choice. Any break? Nope, pay your taxes on this “paid out” income.

    As a business owner, if you want, you can request that some of the distribution be re-invested for stock basis, but this is obviously a ‘my hand is out’ situation in which people want to negotiate for value of stock. You don’t do this every year for simple tax purposes. Asking/paying people for business money is never easy or cheap.

    “Or, what if this s-corp had little net profits one year, but still asked the owners to invest further into it to fund some growth?”

    Investors are free to say no or ask – what do I get? Again, this is the reason capital gains becomes critical. If your obviously last resort source of cash is the very expensive investment from the individual, you really don’t want the government limiting their hoped for profit with a second tax. You only ask these nice people when you are forced by your financial situation, because their capitalist motive is quite clear.

    “In either case, would you want business owners of this type to pay less income taxes than, say, the consulting engineer who invests in Apple, the solo law practice lawyer who invests in real estate, etc?”

    The business owners don’t pay less taxes. They pay far more. I would love to see any instance ‘other than the giants’ or the heavily subsidized BS green companies where the opposite was true.

    As far as an economist resolving differences, I’ve actually enjoyed the conversation despite my occasionally grumpy tone. It is a fact of life that the public doesn’t understand what they ‘believe’ and our differences in understanding have exposed some of the realities that true job creators face. I’m very tired of the anti-capitalist bias in the media, but when I’m ten years older and with a little luck, I’m still going to be tired of it. Today, I discovered our UPS bills are finally big enough to make their unions react to our needs.

    I wish I knew at 18 what I know today and will probably say the same at fifty about forty two.

  182. RB said

    When the CBO looked at U.S. tax policy in comparison with other countries, they concluded that U.S. tax policy favors taking on debt as opposed to shareholder-financed investment – summarized on page xi. While taxes and regulations traditionally top small business complaints in the NFIB survey, the single most important issue as reported by them is now poor sales.

  183. Serioso said

    Jeff, I’m afraid I feel that I’ve had a little sand thrown in my eyes. You said “don’t forget that we pay the other half of FICA” but at the level of income you are talking about there is NO FICA. Are you talking about the FICA tax you pay your salaried employees? That’s universally regarded as a tax paid by the employee, as any self-employed person will attest. And then there’s your remark about having to pay part of your sales dinner. But of course! The rest of us don’t get to deduct ANY portion of the cost of our meals — ever. So please keep your complaints about taxes to the real issues.

  184. Jeff Id said

    Are you talking about the FICA tax you pay your salaried employees? — yes.

    “That’s universally regarded as a tax paid by the employee, as any self-employed person will attest.” —

    Then why do I write the check. Is it not income?

    “And then there’s your remark about having to pay part of your sales dinner. ” — my favorite comment on the thread. Serioso honestly believes that ‘write off’ means that 100% of the cost is covered. I love it when our production workers explain to me the same thing. Just write it off!! Sure, I’ll take my 40% of the total cost off of my taxes, but for meals for clients, they are only half of that – 20 percent with a ceiling. It is almost not a value worth accounting for because accounting costs money.

    “The rest of us don’t get to deduct ANY portion of the cost of our meals. ”

    You also aren’t taking clients out for business. doh!. How silly can we be? The meal doesn’t even cost as much as a tiny piece of machined metal on the smallest manufacturing equipment. The net tax discount doesn’t cover a box of screws.

    Love the left folks, they need help.

  185. Serioso said

    “Then why do I write the check. Is it not income?” I still feel you are throwing sand. The person who writes the check is an artifact of the law; you’d pay the employee more if he had to write the check — as you do with any independent contractor who has to pay both halves of FICA. Your half of the FICA tax is, in reality, a tax on the employee.

    As for the limitation on deduction for meals, it is, IMHO, perfectly reasonable as an attempt to prevent the deduction of ordinary living expenses. People and corporations are taxed in entirely different ways (which makes a mockery of the idea that “corporations are persons”, but never mind). Corporations can deduct every necessary expense (at least over time); people cannot. Meals are not considered a necessary expense as far as the corporation is concerned. If corporations could deduct the personal expenses of their employees and owners then I, as the owner of a corporation, could deduct every expense of my own, including the upkeep on my yacht. Tax law is not entirely stupid.

  186. Serioso said

    And as for the comment “Love the left folks, they need help.”, let me assure you that I am in fact the owner of a business. Not left. I think of myself as intelligent. I await the data that show you are the same.

    Sorry about the tone. But I thought your last comments were disrespectful, as was mine just now. Let’s lower the tone.

  187. Jeff Id said

    Serioso,

    You won’t hurt my feelings. It wasn’t me bringing up the fact that a homeowner can’t expense any meals. Considering that home owners aren’t having dinner with clients, and how small the deduction is, how silly is it to mention that? While I have pointed out that expenses for growing inventory and equipment are taxed until resold, I have also given hard examples of how the growing job-creating company is disadvantaged by tax law. As far as corporations and individuals being taxed differently, corporate income is included as personal income and increases in taxation for families making over 250K are actually increases in corporate tax. Obama actually puts that hike right in a bill allegedly to create jobs. A more insane policy is hard to imagine but when politics trumps common sense, this is the norm.

    “Your half of the FICA tax is, in reality, a tax on the employee.”

    Thinking of it that way, so is my income tax. If we had more income, we would pay the employees more. We would in fact be forced to by competition with other companies and growth. Property tax, gas tax, electricity tax, phone tax, environmental fees, it is all just a tax on the employees. The money all comes from the same pot, pot is more full, more jobs, more pay, pot is less full less jobs less pay. This thread is so that people realize that the 250K family is often times a business income with a single money pot.

  188. JeffID, have to admire your willingness to teach. But you should know of the virgins and the sex story. The real issue is how do we measure the claims, whether fairness, jobs, or whatever. In business, we not only have to do it for such things as boards and stockholders, but have regulatory agencies making sure we followed the methodology and accounting correctly. If such methodology and accounting, cannot be done for fairness, job creation, or cost, then why bother? It is another cost that slows real employment (production of real goods and services) for more job stealing jobs (jobs that are not real goods or services).

  189. steve fitzpatrick said

    Jeff,
    “Obama actually puts that hike right in a bill allegedly to create jobs.”
    I agree that is pretty funny for inclusion in a jobs bill.

    But I don’t expect Mr. Obama to be any more direct/honest in the pursuit of his ideological goals than other politicians. In this specific case, it is clear than the last thing Mr. Obama wants is a reduction in entitlement spending, even while he is aware entitlement programs are for certain unsustainable in the long term in their present form. The tax increase on income over 1 million is just a way to fund his jobs bill without having to reduce entitlement spending. The truth is that politicians on the left (indeed, most people on the left) consider all personal income, and all accumulated wealth that comes from personal income and personal effort, to be in reality the product of the “beneficial conditions” society has provided, not the product of an individual’s effort. As such, all income is morally the property of the public, and so subject to public confiscation to the extent deemed appropriate to meet society’s ‘needs’. If you ask someone on the left to specify a just maximum (never to be exceeded) rate of tax, you will rarely, if ever (I have tried) get a straight answer…. the usual reply is “it depends on.. ” Which is to say, any level of tax can be justified based on the circumstances; the product of your labor does not really belong to you.

    It is warmed-over Marxism, sugar coated to make it more palatable, but philosophically identical.

  190. Serioso said

    Jeff, in re 187, first paragraph: It was you, not me, who first raised the question of the deductability of meals (in the first paragraph of 181). But you are correct in saying this is a rather tiny issue.

    And in 184 you wrote “Then why do I write the check. Is it not income?” in regard to the fact that your company writes the check to the IRS that covers your share of FICA. True, but you also write the check that covers tax withholding and the employee share of FICA. Just because you write the check doesn’t mean it’s a tax on YOU.

    As far as I can tell, your claim that your total tax payment is over 50% is simply not true. You are counting taxes paid by others, including your employees.

  191. Jeff Id said

    It’s funny, I like to tell my partner across the hall – I wonder why I’m wrong today. :D Blogland is goofy.

    For 2011 my taxes will be 4 or 5 times my takehome. In 2010, it took two tries to fit it on the check. We do send 50% of our income straight back to the govt. so I really don’t care how you justify which tax is for what. It is what it is.

  192. kuhnkat said

    Serioso, #186,

    You imply that leftists are not business owners. Please research Armand Hammer. As an agent for the Soviets I do believe that he is imminently qualified as a leftist and more. He was also a millionaire, philanthropist, founded Occidental Oil, and owned Al Gore’s dad, the first Senator Gore, as one of many investments.

    I would also point out that Bill Gates, Buffet, and numerous other very rich big business types own businessses and do, based on who they give money to primarily, support leftists and their causes. I have never talked to one of these people off the record so cannot speak as to their motivations, only observe their actions.

  193. kuhnkat said

    Steve #189,

    Thanks for the reminder!!

  194. Jeff Id said

    “You imply that leftists are not business owners. ”

    They are rare in typical US business. Giant companies seem to tend that way though. hmm… No data for the claim, it is just my impression.

  195. Serioso said

    Just for the record, I did NOT mean to imply anything about the politics of small business owners. I was merely responding to Jeff’s impression or implication that I am myself a leftist.

  196. Joel said

    Apparently the Taxes and Beer Joke is Internet folklore.

    http://davidk.myweb.uga.edu/

    “Complete vitae available online. Contrary to Internet folklore, Dr. Kamerschen is NOT the author of “Tax Cuts: A Simple Lesson in Economics” or “Bar Stool Economics” or anything similar to that. Additionally, he does NOT know who wrote it and he has no opinion on its merits.”

    Too bad :)

  197. cce said

    Jeff, Re: 164 (sorry for the delay)

    1) It’s clear that you are talking about “small businesses” both from the post and the comments. e.g. “Even if a small business owner paid themselves $1, there is a very good chance that they would be the family to fall inside the top tax brackets of the US. If you own a business, that is your fate.” “This thread is about what makes America run and that is small’er’ business.” “But the point is that small S corps are the ‘wealthy’ who are targeted for tax hikes.” The number of “pass through” entities that are very large companies are very small. Form 2553 is what you need to become an S Corp is literally called “Election by a Small Business Corporation,” even though a small number of them are not “small busineses.”

    2) I did not subtract farm workers. The document that I linked subtracted farm workers. My guess is that because agriculture is mostly immune to the business cycle, that is why it is usually left out of discussions about employment.

    3) I have already noted that those numbers could double count people associated with more than one business. It’s also likely that people can be shareholders of multiple businesses with no payroll. But none of this makes any difference to my point. The document gave a more relevant statistic. It says that there were “15.5 million individuals whose primary occupation was self-employment” in 2008. But that was 2008, not 2007. Does it matter? No. Whether the “real” number is 6, 7, 8, 9, or 10 jobs per small business (with a payroll), the average small business is “small” — super small if you include the self employed.

    4) From the article, there were 18,311 “large” businesses in 2007. There were 4 million S-Corps alone. If every one of those 18,311 “large businesses” were S Corps, that would mean 99.5% of S-Corps are small businesses. If you want to throw in other types of “pass through” entities, be my guest. It just shrinks the numbers to more ridiculous levels. There is no way to squeeze “vast majorities” from these numbers, other than to say that the “vast majority” of “pass through” entities are small businesses, and the “vast majority” of them have less than 10 employees.

    5) If you own a small business/S-Corp/”pass through entity” or whatever, it is extremely unlikely that you will pay higher taxes, because such business owners overwhelmingly do not make the kinds of money necessary to see their taxes increase.

    If you want to talk about the composition of those 2.2 million people, you’ll see a lot of executives, and doctors, and lawyers. Probably a lot of S-Corp shareholders. But I highly doubt that they are responsible for the “vast majority” of anything other than portion of the population who have seen their wealth explode, unlike the vast majority of working Americans who have seen their wages stagnate for decades.

  198. cce said

    This is what Milton Friedman said about the portion of the payroll tax paid by the employer:

    [The total tax for social security] includes what is euphemistically called “a contribution by the employer.” Again, this is mislabeling. It is no contribution by the employer: it is a compulsory tax and it isn’t paid by the employer; it is, in effect, paid by the wage earner. It is part of his wages that is sent to Washington instead of going to him. The form, the name, doesn’t change the substance.

  199. Jeff Id said

    Cce,

    If you send checks for 50% of your income to the government instead of vendors, employees or your self, then you have sent 50% of your income to the government. Spin how it got there any way you want, but it ain’t here, it’s there.

  200. Jeff Id said

    I can’t let this go

    “But I highly doubt that they are responsible for the “vast majority” of anything other than portion of the population who have seen their wealth explode, unlike the vast majority of working Americans who have seen their wages stagnate for decades.”

    Class warfare lies are popular these days, I’d like to congratulate you on buying into them hook, line and sinker. One thing the business owners have seen explode is the net percentage of federal tax they pay – which is gigantic. I’ve presented a link to a federal document above which supports my statements that pass through entities represent the vast majority of business. In fact, since putting the link up, I’ve realized that sole proprietorship’s are not on the list.

    Pass through companies are often small business, but you have to realize that these small businesses often go over the alleged ‘wealthy’ line even though they have taken only a small fraction of the $$ home. They can and do have hundreds of employees at times. This is what Obama is truly suggesting raising tax on and these are the policies which will make the poor truly poor. If you want more jobs and better wages, we need to be allowed to compete and re-invest our alleged ‘wealth’ into our companies. Right now, 50% of my efforts to build a business from nothing go straight to the government.

  201. Mark F said

    Jeff:
    Possesives – if it belongs to Fred, it is Fred’s.
    If it belongs to families, it is families’ similarly Kohls, it is Kohls’
    If it is two or more of something, without any ownership, no apostrophe. Just plural, no apostrophe.
    Plural with ownership, or otherwise ending in “s”, put the apos. after the s.

  202. Jeff Id said

    Mark,

    Thanks for the lesson. I tend to type quickly so there is a difference between knowing the rules and taking the time to follow them. I would much rather spend my time with math on this blog, but it has been a year since I’ve done anything fun. No time to play.

  203. CDM said

    “Class warfare lies are popular these days, I’d like to congratulate you on buying into them hook, line and sinker.”

    Jeff: I’ve enjoyed following this tax thread because: (a) you have some first-hand experiences in a scale and type of business in which I don’t have experience (my own is so simple and small it is not even close to comparable…though I have still learned some basic principles of s-corp taxation which helped me ask the right questions), (b) you no doubt have some analytical prowess and also presumably want tax/economic analysis to be as objective as you want climate science to be, and (c) some of my more interesting friends are also grumpy republicans. (ha…your word). It is much more enlightening to talk to those with different perspectives…especially if they are intellectually honest. (I should probably also admit another reason is that I often suspect people who are stinging from large tax payments of overstating how new taxes will impact them, so I was eager to dive into your personal example you were giving.) I am very new to your blog, but my reaction to some of your replies has been that you are not completely objective on taxes/economics and that I’d like to see you put as much care into tax and economic analyisis as you apparantly put into climate science.

    The point of that long prologue: I am curious about your quote above, in response to Post 197 Economic numbers, wealth stats, etc., are subject to lots of different ways to view them and thus there is not always one black-and-white way to present them, but, nevertheless, I think we could find some fairly objective numbers documenting that working-class wages have been flat to declining over the last 30 years while upper-crust wealth has grown considerably. (And by “working class” I mean a wide range, especially blue collar folks but even some working professionals. And by upper-CRUST I don’t mean even affluent professionals, I mean that much talked about “1%”.) Do you know of data that suggests something contrary to the observation that wealth within the US has become more concentrated in the last 30 years?

  204. Serioso said

    Please, Jeff, at 199, pay more attention to what Cce said at 198. Just because you write a check to the IRS doesn’t mean the money comes out of your hide. I fear you are counting the money you withhold from your employees’ paychecks as taxes that you pay.

    RELPLY: The withheld FICA money is a separate issue entirely. You are getting your taxes mixed up. I could put that in also, but I didn’t. We’ve both said our piece on this, don’t you think?

  205. Neil said

    #203 no warranty on this but have a look at this:

    http://www.stateofworkingamerica.org/pages/interactive#/?start=1947&end=1973

    Plus I suggest you download the source data and have a look at the spreadsheets. I only just googled this so hence why I take no ownership of its quality etc.

    Neil

  206. Jeff Id said

    “I am very new to your blog, but my reaction to some of your replies has been that you are not completely objective on taxes/economics and that I’d like to see you put as much care into tax and economic analyisis as you apparantly put into climate science.”

    I think you need to reconsider my objectivity, I do write the checks and do know exactly what is expected of business these days. It is my belief that the left-leaning media has polluted the public mind about business so much that people think the problem is that the rich should be taxed more. Everything is reversed in today’s thought processes about how wealth is created. If we manage to succeed in business, shouldn’t we get the reward? The hurdles to start a business from nothing are far higher than they were 20 years ago and instead of lowering the hurdles, people are sitting on Wall St demanding to raise them. It is time for America to wake up and realize that this sort of thinking will lead us very quickly to a cuba style implosion. If you want money for yourself and your kids, whether you own a small business or work for a large one, the taxation and liability hurdles of owning a larger business must be reduced. The fat cats don’t want the competition, the politicians want the power, the confused leftists just want to take the successful people’s money. In the midst of it, the very thing they all want, “money from business”, is being hammered left and right.

    “I think we could find some fairly objective numbers documenting that working-class wages have been flat to declining over the last 30 years while upper-crust wealth has grown considerably.”

    Well, you could say the ‘upper crust’ has grown, but I would tell you that much of the upper crust has vanished. Bankrupt. I’ve seen a lot of it. If employees get less, it is because the jobs are being outsourced to more cost effective solutions. Our current payroll is about 1 million, we could save 500K by outsourcing these jobs. If you want the jobs in the US, you need to have a lower more competitive wage than in the past five years, the alternative is use other labor. China comes with less liability, less cost, less headaches, less EPA, less regulation. You may ask why we do it then, but I don’t want to answer that publicly. Instead of realizing that the reason workers are being paid less, is because they are now competing with a global workforce, people are blaming the business owners who were quite literally financially forced to outsource.

    I know of boat companies who won’t manufacture in certain states due to asinine rules about volitile chemicals. I know of truck manufacturers who import all of their wood from across the globe because it is cheaper and they face less documentation hurdles. I know of very large S companies which shut their doors suddenly when the pressures of labor made them non-competitive with off shore product. I know of a very large german manufacturer who won’t put an office in the US because of the insane harassment laws here. I know of a company which replaced it’s very high efficiency sodium lighting with allegedly higher efficiency florescent lighting for the tax breaks. Too much forced bullcrap redistribution, and the true output of the country is reduced.

    You really shouldn’t blame my objectivity, you should blame the political and legal situation businesses are in. If we were to eliminate much of the regulation and taxation we are currently faced with in business, America would absolutely boom. Competition for workers would drive up salaries, global corporations who won’t manufacture here now will balance our higher labor costs against shipping costs and new jobs will be created. Friendly tax law for C corps would bring huge office buildings and many high-paying jobs. We might even make enough money to actually pay those overblown federal pensions.

  207. RB said

    Do you know of data that suggests something contrary to the observation that wealth within the US has become more concentrated in the last 30 years?
    I suspect you meant something different, but there seems to be a misuse of the terms “income inequality” and “wealth inequality” here.

    Saez points to evidence that wealth disparity has not increased much in the last few decades and describes some causes for the rise in income inequality here . One criticism of the famous Piketty-Saez graph is regarding the influence of tax policy and wealth-shielding on reported incomes. One can view both Alan Reynolds’ criticisms and Emmanuel Saez’ response disputing the same here .

  208. CDM said

    Thanks Neil. Looks interesting. I’ll try to take some time to digest it.

    RB: yes, I was being sloppy and not distinguishing between income and wealth. If I recall correctly, for the stats I was thinking of, should have said most working-class incomes have remained relatively flat while the very highest incomes have grown quite a bit. It seems that would translate to wealth disparity as well, but that might be too simple a take on it. I’ll take a look at your links. Thanks.

  209. CDM said

    Jeff: This is just shallow speculation (I don’t have specific “facts” or stats in mind) and I am drifting on topics, but maybe we still are talking about different groups and maybe even have similar concerns. What if thousands of “millionaire” business owners are vanishing and being replaced by a small number of near-billionaires? Is that the healthiest economic dynamic for the US? This is not envy or seeking the proverbial handout. Rather, I am asking, doesn’t that situation actually hurt your and my chances of becoming one of those “millionaire” business owners/producers? It is worthwhile asking if this shift is a result of unlevel overseas competition, US consumerism vs production, consequences of tax code changes over the last 30 years, or all of the above, etc.

    “If we manage to succeed in business, shouldn’t we get the reward?”
    of course. I think few people dispute that. but arguments for a progressive tax structure are far more complicated than that, of course.

    “The hurdles to start a business from nothing are far higher than they were 20 years ago ”
    I am curious about that. Due to free trade and a global economy and global workforce? I could believe that. From new regs and taxes? Hmmm. The US added a lot of regs in the 70’s and 80’s, but did we areally add that many in the last 20 years? We had new taxes in 1993, but cuts in 2001 and 2003, and by some measures some of the lowest rates of taxation today than in the last 50 years? Did we enact many new regs and taxes 1994-2006? 2006-2008? 2008-now? I have no doubt you could cite several specific examples of new regs, but overall have they grown in 20 years? I agree you have hurdles, but are they really higher today than 20 years ago?

  210. Jeff Id said

    “did we areally add that many in the last 20 years”

    Yes. 20 years ago you couldn’t be sued when an employee said ‘bitch’ to nobody in particular. I’ve heard an example recently where a passerby collected a free attorney and $75,000 when the comment wasn’t directed at anyone and the discussion didn’t relate to the ‘offended’ person who was just passing by. Often, it is the zero-tolerance practice of the law which adds cost. The amount of environmental regulation has become FAR worse, as have the social justice practices. We’re currently being sued by an employee for what appears to be nothing in the hopes of a permanent disability claim. The employee has a free attorney, our insurance company has theirs, the standard for a bogus claim is settlement for a smaller amount to avoid attorney fees which often tacked onto the company premium. Again, we have little control of the settlement. The employee is hoping for a lifetime salary for not working. We have no choice except to wait and watch. In fact HIPAA medical laws are so insanely written that we can’t even see the unreported employee injury claim. So we’re being sued for something, we don’t know what, by a bottom-feeding attorney who hopes to collect at least a settlement even though everyone on both sides is 99.99 percent certain that nothing happened. That isn’t what the Jury will be allowed to hear. Fortunately, it won’t hurt us much, except for time, distraction and an increased payroll for a full time HR manager. Just imagine what that experience is like for a company which focuses on providing work for Americans these days when we can export the jobs and save money with a phone call.

    Again, zero tolerance anything in the justice system is completely bogus (blame whichever party you want), however the politicization of imagined injury for money has become a huge business. The employee’s boyfriend was successful in his disability claim earlier this year. I have no idea how it will turn out but we can’t control it. I consider the whole mess another inappropriate government money load on business, you can feel free to categorize it how you like.

  211. Jeff Id said

    The past practice of law – is law. As law grows and the intolerance grows, the result is a huge growth in cost for business which is completely unrecognized by the public. So much of this BS can be avoided by a return to capitalism and keep what you earn principles. We have layers and layers of tax law. In today’s situation, the laws are so deep that a company like us can negotiate with govt for breaks. We get incentives which may cut local taxes in half for some time, in exchange for job creation. They give the money knowing full well that they will get it back. But what a huge opportunity for business to contribute to elected officials, get extra savings, and be rewarded by government employees who will use your story to pad their record. Wouldn’t it be better if expenses were expenses and income was income. People pay at the personal level equally. We all have equal opportunity to do more instead of the govt choosing winners. If corporations were taxed less and individuals were taxed more, America would gain a LOT of global corporation business – which does nothing but promote global freedom. If we wait to become the second (or twentieth) largest economy, it will be a less effective policy than now.

  212. Jeff Id said

    By individuals taxed more, I mean a flatter tax with a similar net but everyone paying. The concept of over 4% being too poor to pay tax is insane. Right now America is approaching 50% not paying tax. If you don’t pay net tax, you don’t vote IMO. Disability is a different beast but if you work and don’t pay tax, NO vote for you.

    If I were dictator in cheif, things would be different but people would always have jobs and food.

  213. Serioso said

    Jeff, you seem to have a blind spot when it comes to FICA taxes. You say ” Right now America is approaching 50% not paying tax.” I’m not quite sure what you mean by “America” here: Employed persons, perhaps? Or including children and the retired? But IF you mean employed persons, you are absolutely wrong. EVERY employed person making over $600 annually pays taxes (or at least is legally required to, which is not quite the same thing). And, if you will refer again to comment #198, that tax is in excess of 10%, higher even than Cain’s 9-9-9.

    As for your no-tax no-vote comment, it demeans you.

  214. RB said

    CDM,
    The chart for the wealth share of the top 1% as constructed by Saez and Kopczuk can be seen in Figure 5 here .

  215. Jeff Id said

    #213, I’m sure you won’t mind if I disagree? Actually, I’ll clarify the FICA issue. The employer ‘contributes’ half, the employee has half withheld. Our half comes right off our books and is a payment to the government. Not to the YMCA, not to the local McDonalds, not to pizza palace, to the government.

    You have again given away your politics btw. I simply don’t agree that people who have no skin in the game should get to vote. If they have no contribution by accident or by fate, that is one thing, but no contribution through effort is another entirely. No pay, no vote.

  216. Serioso said

    Jeff:

    Well, you are right that I have given away my politics. I stand with those who believe that every adult human being is entitled to vote. I guess that is better than 99% — maybe 99.9!

    You have given away your politics as well. With whom do You stand? Ugh! Painful to observe. I am beginning to suspect you ain’t too sharp on global warming, either!

  217. Jeff Id said

    The no tax no vote policy may sound extreme to the first time reader. Consider though that in our country, people have discovered that voting correctly brings them free money. We have massive resources, massive business which can be sucked dry of cash for decades before collapse. Small businesses vanish under the sun-lamp of doom but citizens can suck from the straw of life for extended periods.

    No tax no vote simply means that if voting is important enough to you, you need to be a net payer, not a net taker. A net taker has an entirely corrupted incentive for a vote. In my opinion, it demeans those who don’t agree with the policy. When the incentive is 100% toward taking money from the government, the voter can no longer be considered a valid contribution to society. The only case where it is not true is in the example of a truly disadvantaged person who deserves a true vote.

    To fail to recognize the problem these non-taxpayers present, is foolish.

  218. Jeff Id said

    Serioso,

    You shouldn’t trust anyone about global warming except yourself but my opinion is not in bad company.

    “When the people find they can vote themselves money; that will herald the end of the republic.” Benjamin Franklin

  219. Jeff Id said

    You know, I don’t even think no-tax no vote works. There has to be a way to stop the non-productive public from sucking the life out of the economy. Something which gives them the understanding that if they and two freinds aren’t working, start a business!! How about – get a job. We’re having discussions of extending US unemployment for 3 years. People are intentionally not looking for work, I’ve seen many examples. The same people are voting for liberals who want to continue the policies.

    I don’t have the answers but I do know that the feedback from the voter to the politician under our current system is positive.

  220. Anonymous said

    Funny you should raise no-tax no-vote. It is a concept I have floated with friends for a long time. I have a slightly modified version to stop people being too offended, which is everyone gets a minimum of one vote plus one extra for every dollar of tax paid during the prior say 4 years (to stop people paying tax once per election cycle). If progressive taxation is fair, then progressive voting should be too.

  221. Neil said

    that was me at #220. This voting approach should appeal to people who beleive that rich people dont pay tax, therefore they wont get a vote. I think they will all be in for a shock when they realise how few people are paying most of the tax. As the tax payers reduce their burden and shift it to others then we will find that the ability to vote either tax reductions or governement distributions will trend towards some economy equilibruim.

    An alternative and potentially better solution is the the size of government is reduced and the incentive to work is enhanced.

  222. CDM said

    Jeff, going back to Post 210, I imagine most people would agree that lawsuit abuse is a great wrong. I’d support some form of tort reform, and perhaps tougher evaluations/qualifications for disability, penalties for frivolous lawsuits, etc. But it isn’t obvious to me how that is due to new gov’t regs in the last 20 years? (And, an amusing perspective: is asking politicians to enact tort reform measures the same as asking the gov’t to develop and impose new regulations on a given sector in order to help address a problem created by that sector?)

  223. RB said

    Apparently they used to call it the “poll tax”.

  224. RB said

    Sources of federal tax revenue : payroll taxes are fairly comparable with income tax coming in at 6% of GDP compared with the 8% of GDP from income tax.

  225. RB said

    At the state level, the largest portion is apparently ad valorem taxes, i.e., sales and property taxes ‘guesstimated’ as 35% with actual income tax at 24% of total tax revenues.

  226. RB said

    Some more relevant statistics to add to the above, this time from the White House:

    1. … In fact, the top 1 percent of all Americans only pay 4.1 percent of the nation’s payroll taxes.
    2. … the top 10 percent of American earners now earns 42 percent of the nation’s income, and when correctly calculated, pay about 50 percent of the federal income and payroll tax burden – not much larger than their share of earnings.

  227. Carrick said

    RB: 2. … the top 10 percent of American earners now earns 42 percent of the nation’s income, and when correctly calculated, pay about 50 percent of the federal income and payroll tax burden – not much larger than their share of earnings.

    You don’t find it curious that the White House number disagree with other sources?

    I don’t… politics (lying) as usual.

  228. Carrick said

    I’m sure if you parse the words carefully enough, they are true, though still misleading. Omission of part of the truth designed to give a false impression is still a form of lie.

    I think the “trick” they used to “hide the incline” was only talk about payroll taxes.

    Typically wealthy people don’t primarily earn that much of their living from payroll taxes.

    It’s a fact that the top 1% earners pay 30% of their income as taxes, 50% more than the average over all incomes and nearly 8 times as much as the lowest quartile pays, as a percentage.

    These numbers are from the CBO.

  229. RB said

    Carrick,
    I am happy to get independent data – but as you say there is no “disagreement with other sources.” While the data I quoted referred to the top decile’s share of federal taxes, the CBO data addresses the top quintile. The specific portions address the issue being discussed of disenfranchising a large portion of the population for non-payment of taxes when they do in fact pay taxes whether or not one agrees with the portion of total taxes that they do contribute to. Aside from that, the White House seems to be addressing the omission of part of the truth about how almost everybody pays some federal taxes in the form of payroll taxes.

  230. Carrick said

    RB, they give the top 1% too, not just the quintiles. Look at table 2 page 7. The conclusions from that table are 180° from the arguments of the White House, so no, I wouldn’t say there is “no disagreement”. Complete mirrored opposites.

    Your source is the politically motivated White House numbers (seriously, imagine them not being), but it does give pause to consider your own objectivity for their cooked numbers to be the primary source of your “information.”

    By the way, if we want to use the White House criterion for “correctly calculated” tax rates, namely “payroll taxes”, you have to go to the third quintile before the average household pays any net payroll taxes, and even then, the tax rate goes up with income level, which doesn’t suggest we’re being “overly soft” on the highest income earners. (From the notes it is clear payroll and income taxes as used in this table are synonymous.)

    The omission of the truth by the White House is the omission of the taxes paid versus share of liability (again table 2 page 7):

    The top 1% pays 28% of the total taxes from a 16% share of the total income. The first quintile pays just a 0.8% share on about 5% share of the total income. You have to go to the fifth quintile before the amount paid exceeds the percentage earned.

    Given that, there is no way this is not deceptive:

    In fact, the top 1 percent of all Americans only pay 4.1 percent of the nation’s payroll taxes

    They’re paying a twice the rate of the rest of the population in total taxes.

    Funny how that little bit got left out, isn’t it?

    Lies by omission indeed.

  231. Jeff Id said

    Not only is the top 1% number by the whitehouse inaccurate, it is a flat lie. The top 1% also consists of a lot of C corp owners, and these C corps are taxed at a 35% rate to start. The S corp owners which make the cut pay very high income tax on the S corp itself. If you sell your C corp, you pay 15% ADDITIONAL tax which goes directly on the income statement of the owners. The other 35% tax which the company OWNED by the rich dude pays, is on a different return.

    There are NO breaks for the wealthy (excepting again, the largest multinational companies who can play games to make profits appear overseas where they are more appropriately taxed) and claims to the contrary are propaganda and lies. People who wish to believe the opposite are not people I can help.

  232. RB said

    Carrick,
    I couldn’t care less to defend the White House. Perhaps my argument about how everybody is entitled to vote on the basis of paying federal taxes would have been better served without that pointer. In any case, you point to the CBO saying that the top 1% pay 28% of total taxes and this is what the White House says:
    In fact, the top 1 percent of all Americans only pay 4.1 percent of the nation’s payroll taxes. Overall, they pay about one-quarter of federal income and payroll taxes.

  233. Jeff Id said

    “In fact, the top 1 percent of all Americans only pay 4.1 percent of the nation’s payroll taxes. Overall, they pay about one-quarter of federal income and payroll taxes. ” – And this number leaves off any tax on C corps they own.

  234. RB said

    I don’t know if this addresses Jeff #231, but there are similar updated 2009 numbers here for which the corporate income tax is also apparently considered for recipients of capital income.

  235. Carrick said

    RB:

    I couldn’t care less to defend the White House

    a) Well you are.
    b) you appear to be using from a political organization as a primary data source.
    c) What they said was accurate. What they left out is what gave it the political spin they desired. Common trick of politicians, it makes it easy for people who “couldn’t care less to defend them” to defend them.
    d) taxpolicycenter is a partisan organization, that’s why I didn’t use it just as I didn’t use heritage foundation numbers.

  236. Jeff Id said

    The only way that the whitehouse can report that millionaires pay 23% is because they are including capital gains income. This is false propaganda and is a direct lie as the gains are the result of an increased value of a heavily taxed company. Again, the huge multinationals have methods of avoiding tax so this blanket statement has exceptions. The link in 234 fails to include income from companies as owners income and fails further to represent the undertaxed in that the top 20% of households make only 93K so the write offs take down the income on your return yet not on their percentages. Home interest payments which are not taxed, are considered a fraction of their actual income. Compare a person making 95,000 with an S corp owner making a million and taking home a tenth of that, and you will quickly see that there aren’t any credits for the S corp owner. Millionaires are not allowed much in the way of writeoffs or credits. Also the flat rate on non-capital gains income is far higher than these sources report. The truth is that over 50% of the money generated by the millionaire club goes straight back to the government in one form or another. Anything else is pure bovine scatology for the purpose of class warfare.

  237. Mark T said

    In fact, the top 1 percent of all Americans only pay 4.1 percent of the nation’s payroll taxes. Overall, they pay about one-quarter of federal income and payroll taxes.

    “Payroll tax” is the FICA + employer match. Of course they only pay 4.1% of it. It cuts off at $106,800. The only reason they don’t pay only 1% is because not everybody makes more than $106,800. It is, by any definition, a tax on the poor.

    What a joke that anybody could be fooled by such weasel words.

    Mark

  238. RB said

    Carrick,
    I wanted to find numbers that show that if you include payroll taxes, the percentage of the population that pays taxes is well distributed. I suppose I should not have used the first link to pop up. In any case, taxpolicycenter also claims to use the same methodology as the CBO. Whether the tax rate is “fair” or not, except for the bottom quintile composed of the elderly or the very poor (yeah, I should be less lazy and see if somebody other than the white house can attest to that), everybody else pays taxes and this denial of voting rights on the basis of federal taxes doesn’t work. Further, constitutional experts may be able to say whether this libertarian proposal to exclude voters on the basis of payment of taxes is in violation of the 24th amendment of the U.S. constitution, or not.

  239. Carrick said

    RB, fair enough. I’ll point out though that until you get to the fifth quintile, as a percentage, people pay less tax than the amount they earn, and if you just want to look at “payroll tax”, with the bottom 40% earners actually on average get money back (they pay NEGATIVE income taxes). Whether that is fair or not, is for somebody other than me to figure out. I just prefer the facts get stated without the requisite spin added.

    MarkT, I think they meant personal income tax (taxes on what you earn) not FICA. I’m not sure why the choice of “payroll tax” was used, other than to obfuscate. But this still is deceptive, because it doesn’t include passive income.

  240. Carrick said

    Sorry for obfuscating even more… I meant “taxes on your wages”.

  241. RB said

    Carrick,
    I don’t know what you mean by “just want to look at payroll tax” but I believe the bottom 40% gets a tax refund on their income tax arising from the earned income tax credit and the partially refundable child tax credit. While we are in the process of stating facts, we might as well also put it out there that prior to 1974, 19% did not pay taxes but this was expanded subsequently to 25% by Ford/Reagan through the earned income tax credit as the Republican alternative to raising minimum wages and rose to 36% with the Bush tax cuts prior to the events following the economic downturn.

  242. Carrick said

    RB, I mean tax on federal wages, not including FICA and state income tax.

  243. Carrick said

    Er federal tax on wages…..

  244. Mark T said

    Carrick… Maybe, but the 4% # is about right for payroll tax, which is what FICA (and maybe Medicare/Medicaid) is typically called.

    Silly either way.

    Mark

  245. RB said

    That’s right, FICA (Social Security + Medicare) is the payroll tax.. so I can now finally understand Carrick’s confusion here: “… you have to go to the third quintile before the average household pays any net payroll taxes, ..” I believe he might have been mixing up payroll tax, total federal tax and what we know as income tax.

  246. Carrick said

    I’m not even sure what the point is, if you are just talking about FICA contributions. The wikipedia seems to suggest there’s more than one meaning, neither having anything to do with FICA>

    I also got about 4% assuming it was income tax on wages, assuming I did the math right, but then again my eyes are crossed at the moment (lets just say it’s been a busy week and I’m ready for some downtime.)

    This is why I generally go to the source instead of reading some political hack’s write-up intended to convey “emotional truth” rather than “factual truth.”

  247. Jeff Id said

    “This is why I generally go to the source instead of reading some political hack’s write-up intended to convey “emotional truth” rather than “factual truth.””

    I wish more people did. I didn’t know anything about taxes 15 years ago. Just fill out the form and turn it in. Owning several reasonable sized businesses has exposed me to an entirely different perspective. Just filing the taxes is an amazing process. We generate about two inches of paper to file for the partners and two companies. Our portion of the payroll tax amounts to 75K for this year. Some people say that is not our money, it is employee money because the employee earned it, but it all came out of the same bucket as the rest of the tax and it is 75K less than we had before and it doesn’t count on the employee’s income so the argument is sophistry. The employee’s checks had an equivalent amount withheld for fica so the total to the federal government was 150K. Since the feds are also horrible about keeping money in the right lockbox, I think of it as though we bought the fin of a tomahawk.

  248. Jeff Id said

    My percentages are not accurate in 247, the total amount of 150 is close though.

  249. RB said

    Well OK, this is what the source says briefly regarding payroll tax. It is also the definition used by my first “primary data source” in #224 which also provides information on other components of payroll taxes. People may not like what the White House chose to highlight, but I believe their usage of the terms payroll tax and income tax and federal taxes (i.e., net) is consistent with usage by the CBO, so I fail to see the mirrored opposite claims identified in #230. Sophistry appears to be a matter of interpretation since the CBO assumes that the employer portion of the FICA counts as employer income as well (see notes for the same table).

  250. Jeff Id said

    In 234 the link leads to this quote:

    A key insight from economics is that taxes are not always borne by the individual or business that writes the check to the IRS. Sometimes taxes are shifted. For example, most economists believe that the employer portion of payroll taxes translate into lower wages and are thus ultimately borne by workers. There is not a consensus, however, on the economic incidence of other taxes, such as the corporate income tax.

    Sophistry and games IMO. The whitehouse claims that the 1 percenters pay 23% of their income to the feds. The only way to state the number this low is by including the income from capital gains as their general income. This capital gains income is typically already taxed and returned on a different form at 35% by a company which gained value. Therefore the only way to increase the 23% millionaire number to match those who don’t have significant investments is to tax capital gains more or place something like a 90% tax on other income. It’s all games and lies. The IRS is VERY good at getting its share and the imagined hideouts for the wealthy do not exist. Claims that they pay a lower percentage are false. An increase in capital gains tax right now would be economic suicide for an economy which is already way overburdened with tax and regulation.

  251. Jeff Id said

    Here’s a link with numbers more in line with my experiences.

    http://www.foxnews.com/politics/2011/10/15/republicans-unveil-their-buffett-rule-allowing-americans-to-pay-more-to-uncle/

  252. RB said

    Jeff,
    The numbers you link to are consistent with the numbers as I described in #232.

  253. Jeff Id said

    The top quintile from your link is at 23% but this includes families making 90K. The top percent in my link is at 29 and that includes the top tenths paying a bunch of capital gains tax at 50%. This is only the federal income tax and if you don’t make your profits by capital gains, the tax on income is higher than 29. Then there is employment tax, property tax, state tax, import tax, electricity tax, etc… We even get the special privilege of paying an inventory capitalization tax. Over 50 percent goes right back to the government in one form or another already. My partner and I will be paying tax in multiples of our takehome next year. Not percentages, but multiples. It isn’t sane considering what business could do were we not shackled to stupid tax laws.

  254. CDM said

    Jeff, I just checked in after being absent a while so I’ll pound out a quick flurry of comments to keep you honest (that last remark was said in humor, btw):

    “This capital gains income is typically already taxed and returned on a different form at 35% by a company which gained value.”

    again, that is simply not correct. You do have that word “typically” in there, which gives you some wiggle room, and you have presented some perspectives and interesting examples that support your perspective, but as a strictly mathematical exercise, the capital gains are not taxed twice…they are taxed once…currently at 15%. (c-corp distributions being the clear exception on the “double tax” question.)

    Regarding post 251…those tax rates sound likely accurate, but I have to point out the crassness of such a response from the GOP Senator. (Why not make everyone’s taxes voluntary? Or speed limits, or…)

    You had some post far back about you being the one who writes the check for your business’s half of employee SS/FICA. True. However, you also write the check to the gov’t for the employees’ half, while showing it having been withheld from their paycheck, subtracted out from some agreed-upon pay rate. So, who is paying their half of the SS/FICA taxes? Are you paying that too since you wrote the check? (that is rhetorical…you already know my answer that tax incidence is not a black-and-white topic.)

  255. CDM said

    btw, I just saw your post 247…I was speaking of earlier posts…which is why my last post seems a bit redundant. I should read more, post less.

  256. Jeff Id said

    CDM,

    If you own stock in a C corp and a cash distribution is made, the distribution transfers a portion of the value of the C corp to the owners pocket which is then taxed as income. You say this is a double tax but consider what it means if an owner of shares of this already taxed company, transfers the value of (sells) that stock back to the company in a buyback for some net gain by the shareholder. The gain in value means that the company has typically not distributed all of its earnings, they have been invested in growth – not everything in stock is speculation, real numbers are involved. So the stock owner’s profit is taxed at 15% even though the increase in cash you receive is increase in after-tax value taken from the books of same company. Wouldn’t the shareholder have profited more without the first tax? Doesn’t the second (cap gains) tax just represent a tax on an increased value (income) of an organization which is already taxed on its income?

    I have a hard time seeing the difference, perhaps you could elaborate on my example.

  257. CDM said

    I’ll have to give that some thought—likely another day. In the c-corp case, your buyback example is sounding very plausible on first blush, due to the corporation being a taxed entity.

    Incidentally, I would be open-minded about reducing double taxation of c-corps in an effort to promote US economic activity, maybe by greatly reducing corporate taxes (such as raising the brackets) and instead shifting those taxes to progressive individual income tax rates on dividends and gains, but that topic is out of my scope today.

    I do harbor a feeling that you give short shrift to just how much company reinvestment can be done without being taxable on the c-corp level (also, of course owners employed by the c-corp can pay themselves a salary), but I have no specifics to offer on that today.

    As I’ve noted, most of my [potentially limited] understanding applies only to low-capital pass-through organizations. The ins and outs (and desirability) of c-corp organization with respect to taxation has never been very clear to me, though of course many small companies still do organize that way. I know the basics, and can see it being desirable in some circumstances, such as when the taxable corporate net income can be kept minimal (which can be true in small firms, not just large firms with creative tax avoidance options), and I know it is a legal requirement in some cases to be a c-corp, but I really can’t comment on c-corps, expecially not complex ones.

  258. CDM said

    (btw, referring to earlier posts: I am glad you don’t deduct credibility points for typos or bad grammar in blog posts. I don’t either.)

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