Fairness and the Tax Code

I'm sure you've all heard the story about the group of friends that paid their dinner bill like their taxes. 4 people ate free, and the rest split it up ($100 bill) - $1, $3, $7, $12, $18, $59. They get $20 off, and can't divide up the savings without making everyone angry. I guess it was meant to say "give the rich a break, of course their going to save more money with a tax break, they pay more."

I think it paints the wrong picture of our tax code. I've heard it referred to as, "it can either be fair or simple, not both." To most who label it as unfair, they don't take into account all taxes -- they pick and choose the taxes they think are unfair, and single out the biggest variances. Let's look at the 10 people eating dinner:

The 4 people eating for free (the poverty level) -- this implies that some pay no tax, when that is entirely false. The income tax threshold for a single person is roughly $9,350. This can vary, as they may qualify for credits, and receive public assistance to offset some of that. They have no investment income. Of course, they pay 7.65% tax for FICA and Medicare (their employer wouldn't pay their portion without them - we'll add that too) - $1,430.55. I would venture to guarantee that they spend half their take home on taxable (sales tax) items. Let's just say another 6% of half their income, or $280.50. You can probably assume that 2% of their rent goes toward property taxes (let's say rent is 30% of salary - $56.10. So each of those 4 people are paying roughly $1767.15 in tax, and making as much as $10,065.28 (grossed up for employer match) -- or approx 17.6% in taxes.

Now look at Joe Schmoe middle class (the guy who paid $7). He makes 50k, owns a 150k home, all his investments are tax deferred (401k, IRA). He itemizes $12,500 in tax/interest, $1,500 in property tax (1%). His income tax would be approx $4,660. He spends 35% of his income on taxable items (6% sales tax) -- or spends $17,500 and pays $1,050 in tax. His FICA/medicare would be $7,650. His total taxes are $14,860 - with total income of $53,825 (grossed up for employer match) or 27.6%.

Now the high-roller -- let's just say he makes 400kin income, lives in a 750k home, and has investment income (1/2 dividend, 1/2 interest) of 100k. He itemizes ~ $65,000 in taxes/interest. He is going to pay approx $98,431 tax on his income, an additional FICA/medicare of $47,956.8. He will have tax on his investment income of $25,000. We'll assume that he pays 2% property tax on amounts greater than 150k, and 1% on first 150k -- or $13,500. Let's say that they spend 25% of their employment income on taxable items (sales tax) -- or $100,000, and the sales tax rate is 6% ($6,000 in tax). To sum it all up, $536,356.80 in income (grossed up by employer FICA + investment income), and a total of $190,887 in taxes (35.5%).

So to those who talk about the vast inequities I say, "Balderdash!" the poverty level is still paying about 18%, middle class 30%, and wealthy 35%. Sounds more fair than anyone wants to admit.

Walmart - What do they really do for the economy?

I just read Brian Cuban's blog post on Walmart (http://tinyurl.com/ya2odmk), and it brought me back to the same old discussion. Does Walmart add or take away from the economy?

I read (scratch that - "listened to...") Sam Walton's book, "Made in America" (http://bit.ly/6pDx4b) quite a few years ago, when travelling frequently. His ideas were not new, he was just a very astute business man. Instead of pricing for what people will pay, he always priced for the lowest price he could sell it for -- no "loss leaders" no gimmicks, just low prices. Several other "big box" stores offered discount items. Less quality in the name of low price - K-Mart, for example. For eons, grocery stores have offered "store brands" for a cheaper alternative. For those of us that have tried "store brand" soda, when we really wanted a "Coke" know that they are not the same, they are just cheaper. While K-Mart generally concentrated on big markets, Walmart moved into smaller towns. I was living in Moscow Idaho (population ~ 20k + 8k university students) when they opened, and I saw a few of the business that went under because of Walmart. There was the typical outrage-mostly from the same people that are outraged by all big business. I actually knew someone who worked at one of the stores, and later went to work for Walmart. Actually she still works for Walmart - some 15yrs later.

When she worked for the "mom & pop" store, she made minimum wage. Even less than that, actually, as she was subject to a state minimum wage that was less than the federal minimum wage because the business employed fewer than 10 people (or close - I can't remember). She didn't have health coverage, or retirement. The "mom & pop" had its good aspects -- poor pay or not, they were a close knit family -- they had Christmas parties at the owner's house, and knew the families of all employees. Straight out of "A Wonderful Life" less the afore mentioned really bad wages, and lack of health care or retirement packages. The sad part was that the "Mom & Pops" didn't pay better, offer healthcare or retirement not because they were hoarding money for themselves, but because they couldn't afford to. They had no secret formula to riches that Walmart took from them, they had a small store, made enough money to get by, and it required a few minimum wage employees so they didn't have to work every waking hour at the store - that's it.

Walmart had the advantage of economies of scale. Purchasing power, group rate healthcare plans allowed them to sell the same things much cheaper, and offer better benefits. They could stream line their delivery to minimize shipping charges, negotiate contracts that allowed them to return any unsold items (if they got bad products). They could also sell lesser quality items, similar to the items that the "mom & pop" were selling much cheaper (this is where the China items came to play). All in all, Walmart actually had a plan, and stuck to it. The only plan most "mom & pops" have is to open a store & sell things. Walmart not only wanted to sell things, their plan involved what to sell, how to sell, how to get what to sell, how to get what not in the who now -- understand?

There is no denying the purchasing power that was given to the nation's "poor" by Walmart. The question is "Does it really hurt the local economy to buy from China (as opposed to American vendors)?"

How could it hurt the local economy? Those mom & pop shops were not buying anything from the local economies - they were buying from distributors who were buying from wherever the products were produced. Look on the back of the tongue of your Nikes, or the tags on your shirts/pants and see if they say "Made in America." More likely "Hencho in Mexico," China, Tawain, or Vietnam The employees now have health care, and retirement (available - most minimum wage employees do not take advantage of what is offered). The huge monstrosities are now a great source of property tax revenue for the local economies without the local face (that local assessors felt guilty about sticking it to). The increased sales offer more sales tax revenue. Not to mention the local services that they require (landscaping, snow removal, utilities, etc).

Fundamentally, if you want to support "Buy American", you can find them at Walmart. You just won't buy them if you buy the cheapest things on the shelf. I'm just waiting for Walmart to start offering health care (insert Dr. Nick reference from the Simpsons)...I'm sure I want the best doctor, when I have a major illness, but when I need my prescription renewed for allergies, or an anti inflammatory for an injured knee (other than ibuprofen) -- I'm sick of paying for a $180 office visit, when Dr. Nick would suffice.

Executive Compensation - or Comp In General

Here’s an interesting essay about executive pay at Bear Stearns and Lehman, written by several Harvard Law Professors (Lucian A. Bebchuk, Alma Cohen, and Holger Spamann) -- The Wages of Failure

I wonder about all pay – not just executive pay. I work for a fairly large company as a tax manager (and have my own small practice on the side-hence this blog). It is an agricultural manufacturing facility, structured as a cooperative, to allow ownership by the growers. In lemans terms, we have a couple thousand owners, and their individual activity determines their share of the profits/losses.

These “owners” do not manage the manufacturing facilities. We have a CEO, and 4 senior VPs. Each individual location (three active factories, two inactive/processing factories and several warehousing facilities scattered in several states) has a management structure. We are big enough to be publicly traded, and in fact were, until an investor bought us off the marked and delisted us (quite a while ago). Our growers, then bought the company from that investor (sort of – they are still owners, technically, until the long-term sale is complete). Our corporate HQ has a management structure. All in all, I would estimate at least 100 manager and above level employees.

Their pay is (for the most part) fully deductible. With exception of two employees (CEO & a SR VP), all are under the lowest of our nexus state deductibility thresholds (300k) – and they aren’t over by much, and I would say a vast majority of managers are in the 60-80k range.

Some would attribute this to being cheap, or not making money. While both of these aspects have their merit, I believe the culprit belongs to the transparency to our owners (the growers), and our Board of Directors (who are active and paid minimally ~ the Chairman made 12k last year, most directors made 5-6k). This is something that (in my opinion) that needs to be a major issue of reform for publicly traded companies, investment houses, banks, etc.

Why stop at executives? Why are ANY compensation figures off limits? As the owner of a stock certificate, you (and several million of your closest friends) are the owner of a company. All compensation information should be available for you to review. Can I be the first to say that I want to know financials and compensation information for everyone that handles my money and investments.

A wise corporate buyer once told me that “buyers” should be the highest paid individuals in the company (retail), as if they can’t negotiate their own salary effectively, how do you expect them to negotiate the best deals with vendors? While humorous (and self-serving), the element of truth is that everyone contributes a good to the company, and determining their worth is very difficult.

In the public accounting world, we live to a higher standard. While safeguarding independence, (auditors) have to not only have independence, they have to look like they are independent. This is to prevent auditors from altering their opinion, because of their own financial stake. While there is much debate on the merits of it, what it amounts to is accountants (Managers and above) can’t own stock in companies that are audited by their firm. If they work on an audit, and they quit and are hired by the company they audited – they cannot work on anything related to the financial statements for a year. So if you’re a tax manager at KPMG, and your wife buys Albertson’s (Supervalue) stock, you’re likely in violation of independence guidelines – even if you do not work on any Albertson’s jobs. Yet CEOs and senior executives of the same companies (who are direct participants in management decisions of the company) can buy and sell their own stock freely? While stock options, and sales by corporate officers are disclosed in notes – they aren’t really regulated. Bear Stearns and Lehman, for the benefit of 10 people, reduced the equity of the companies by 2.5 billion through equity sales and bonuses from 2000-2008. The company I work for has total compensation of around 65 million. This is for ~ 1200 employees. This would fund the entire compensation of 5 companies this size for 8 years. To pull a childish reference, I call bull$hit. How can anyone with a logical mind think that pay of that magnitude could be good for a company?

Having Your Children Work For Your Business

Small Businesses:
Having Your Children Work for Your Business:
Before you start paying your children to work at your business there are some questions that need answered.
Do you pay your children allowances (or some equivalent)? If so, how much? Are you saving for their college (or requiring them to save)? What's your highest marginal tax rate? i.e. if you are a C-Corp, what is the corp's tax rate, if S-Corp, or LLC-- what is your personal marginal rate(highest rate)?

Your children do not have to file a dependent tax return unless they have earned income more than $5,700, or unearned income greater $950. They are exempt from withholding (for federal income taxes) if they earn more than $950.

One easy way to plan for your children's education is to employ them, and force them to save the money for college. This is fully deductible as wages for the company, and unless your child makes more than $5,700 in earned income for 2009 (unearned income, such as investment income, is much less, so you have to be careful there), they do not have to file an income tax return. You are exempt from FICA withholding, if they are under 18 yrs old and you're a sole proprietor. You are not exempt if you are a Corp or S-Corp, and a Partnership or LLC is only exempt if you and your spouse are the only owners (ouch!). There is a way you can do it if you have a C-Corp or S-Corp and you are actually a sole proprietor, you just have to create a smllc, and pay them through it -- not too tough.

I'm interested, you say, but how do I work this voodoo? I know if I pay my kids, they'll blow it all on pizza, music & video games.

You pay your kids as you would any other employee, but you have a payroll deduction to the savings account (say a Coverdell ESA). These are after tax deductions (up to $2000/yr), but there is no tax paid on appreciation (much like a Roth). So out of the $5700 have 2,000 directed to their Coverdell. You can increase their effective income by another $5000 as well, if you want to start planning their retirement (401k). As long as their W-2 doesn't say more than $5,700, they do not have to file (unless they have unearned income).

We all give our kids allowances, or some equivalent. This is just a way to make it work for them. Instead of giving them $50/week and asking them to save $25 for college -- why not pay them $60, deduct $20 for their Coverdell, and $20 for a Roth. Your out of pocket would be $60, but your child would be saving for college, retirement and you would increase your payroll deduction by $3120 (saved yourself ~ $7-800 in income tax) for money that you were already handing out or saving.

To maximize, let's say you pay them 2k for their Coverdell, and the remainder for their Roth (less what you were going to give them for an allowance). If they are 10, and they save 2k a year for college, and put 3700 a year for a roth -- every year until college -- retire at 66, you just gave them $2 million to retire with (8% annual yield) tax free, assuming they don't put in another dime, and about 5k/year for four years of college. If they are 5 now, it's ~ 3.6 million for retirement, and 10k a year for school (all tax free).

There are limitations to this. You want to pay your children for work they actually perform. It has to be something they can easily do. The IRS or Department of Labor can (and will) look into this if you are paying them, and you should be able to verify their work with timecards, or some other form of verification. You also have to be aware of labor laws. If they are a toddler, there is not much they can do, legally, is there? There is one easy way around both issues -- pay them for "modeling"

Models/actors are exempt from certain child labor laws (hence some TV families have infants and toddlers). If you put your children on your business card, all business advertisements, tv ads, etc -- you can hire them to be models for your advertisements, and on a regular basis, take more pictures, video, etc.

send me an e-mail, or give me a call and I can help you structure your labor so it works for you.

-Al W. Middleton, CPA

(208)724-3762

ctdmonet@gmail.com

Regulating Tax Preparers

I'm often reminded when I prepare an amended return, why preparers should be licensed. Granted, as a selling point, I always point out that the returns I prepare are prepared by a CPA, when that is not always the case.



A few months ago Fox News pointed out this: http://www.foxnews.com/story/0,2933,548827,00.html?test=latestnews



They try to use it as trying to label ACORN as teaching the Pimp how to lie to the IRS, but the underlying fact is that the staffer had no idea of the implecations of preparing a false return.



Last season, I prepared a schedule c, amended return for a client with a home business. It was amended because his mortgage broker had told him "If you file your return and don't show the expenses for your (successful) home business, it will show much more income, and you can finance a better house....." as he was buying a house at the time. He did what the "advisor" recommended (and paid a hefty tax payment) by filing his taxes online -- doing it himself. All to save my fee, and to buy a house that his income/debt ratio said he couldn't afford.



It's a wonder we're having a mortgage crisis with brokers like that, but it also brings into question -- Are people qualified to prepare their own returns --- even with turbo tax or tax act? This person obviously didn't know the implecations of filing a false return, nor did he read the fine print when signing his mortgage (if he bought a house). By signing, he was verifying the information in the application was accurate, to the best of his knowledge. Is it criminal?



I have no problem holding preparers accountable for their own error, but if I commit a crime, such as preparing a false return for the purpose of lying about your income? not knowing the law is no excuse.

Time Value of Money - Real Gain/Loss

A while ago, someone came to me with some product, guaranteed to pay off my mortgage in 7 years, while not effecting my spending or raising my payment. They also said they could pay off credit cards lickety split as well, but that will add time to the 7yr estimate..




As a CPA, I am curious of any scheme that says (basically) "we can do a better job than you at managing your money," so I asked the tough questions. Naturally, my sales person was a sales person and not the crafter of the formula (had absolutely no idea how it worked). While I couldn't get actual amortization tables from her as to how it worked (mathwise), I could get information from physical data. It involved setting up (essentially) a home equity line against your home, and paying your bills from the line.




After analysing the data, excelling out a payment module I figured out she was right, and that it would work. It just requires a lot of work and discipline that most people don't have.




This is how to do it:


Now -- make a budget of how you are spending your money right now. You'd better make it accurate, because you can't really change it if it is going to work. You will have the illusion of more cash flow, but you won't actually be making more money.




Now comes the tricky part in this economy -- get a Home Equity Line Of Credit - or HELOC. I think the ideal HELOC would be a refinanced full HELOC (1st mtg), but it can be used from a normal HELOC, it just might take a little longer, as the interest rate is not usually as low. Be careful, as this account can't have restrictions as to how many payments are made, and checks written. Starting with your highest interest credit, roll it into your HELOC. If you don't have any credit cards, write a check to your mortgage holder. You don't want to use all your HELOC, leave a little room for interest posting, etc.

Now, deposit your paycheck into the HELOC when you get paid, and pay your bills out of the HELOC when you pay your bills -- that simple. When you have room for another bill on your HELOC (car, house) - pay it off. It will work - now I will tell you why it works.




Currently, your checking account probably doesn't give you interest. If you use a credit union, or savings account you might get a little, but generally not much at all. By depositing your paycheck into the HELOC, you are accomplishing two things: 1. it is in effect a payment. You will not have to make an additional payment on your HELOC for the month. and 2. You are receiving interest for the time your money is not being used (by paying down the principal). This interest will in effect increase your cash flow. The lack of payments on whatever bill was transferred into the HELOC, and the HELOC itself increases your cash flow. All the increased cash flow goes to paying down the HELOC (PROVIDED YOU DO NOT INCREASE YOUR SPENDING WITH THIS NEW FOUND CASH)



If you want to put in the work, you can do it yourself. I think the salesperson was just selling the 1st mtg HELOC, and the software to accomplish the most efficient way of doing it -- your choice!

Purchase or Lease Vehicle - Decision Guide

Given this "Cash for Clunkers" program, there has been much debate that there is no better time than the present to get a new vehicle for your business. While you are taking advantage of this new program, you still have to make smart money decisions for your business. How exactly should you do it?
To make the decisions, you need to know several things. How many miles/year do you estimate the car will need? How much of that is personal? What kind of car are you looking for? How much do you plan on spending? What is the purpose of buying the vehicle -- what will it be used for?
Should I have my business buy the vehicle, or should I buy the vehicle? Granted there are limitations as to financing, business history, and the like so I'm going to assume that that is not the limitation. Everything is bought with cash in a perfect world anyway. We may determine a monthly value, but that is just the cost of money -- not necessarily a payment. Let's just look at a couple of types of cars, for example: A high mileage compact and a luxury sedan

Example 1: Toyota Prius (you're trying to take full advantage of the credit). MSRP of 22k, invoice of $20,900. Let's assume you negotiate half the difference between invoice & MSRP -- $21,450 less clunker rebate of $4,500 is $16,950 + 1017 tax (6%) + 100 title/lic. -- let's just say $18k. If you take a 60 mo amortization, 18k @ 6% is around $350/month value.
If the company buys the vehicle, they get a bonus depreciation deduction of 50% = $9,034, and a regular depreciation of the rest (20%) = $1,807. The total of these two is $10,841 -- just barely under the IRS' maximum deduction for listed vehicles (in 2008) of $10,960 -- woohoo!. What does that mean for your business? You bought a vehicle for $18k, and you can deduct $10,841 from your taxable income this year. These are all prorated by business use -- if you use the car only 80% for business, take 80% of everything (approx $8673 deduction). I'm assuming your employer pays for 80% of your gas, and all the mtc (15k miles a year, 50mpg, 2.49/gal $600 + $200 mtc). Company deducts a total of $8,873.
If you buy the vehicle -- assume same purchase price, no depreciation. You pay for gas/mtc, your company reimburses you for mileage ($0.55/mi). You pay 18k, and an additional 800 for fuel/mtc. Your company reimburses you (this is a deduction for the company, and not income to you -- pay attention!) $6,600 for mileage.
You could also lease the vehicle. Let's assume the same $350/mo. You don't pay anything, the company pays $5k ($4,200 in lease payments, $800 fuel/mtc). Depending on lease term, and applicable taxes you could pay another$1k in sales tax/lic. Let's assume worst case, $100 lic, $1017 sales tax (6%), for total out of the company's coffer of $6,117. With a lease, you may have some included in income as a fringe benefit. For a $22k car (FMV, not actual cost), it is $38 for the first year up to $164 for 5th & later years -- so minimal.

Example 2: Mercedes C300 4Matic AWD - loaded (don't give a hoot about the credit). MSRP of 47k, invoice of $45,500. Let's assume you negotiate half the difference between invoice & MSRP -- $46,250; (doesn't qualify for clunker rebate); + $2,775 tax (6%) + 100 title/lic. -- let's just say $49k. If you take a 60 mo amortization, 49k @ 6% is around $950/month value.If the company buys the vehicle, they get a bonus depreciation deduction of 50% = $24,500, and a regular depreciation of the rest (20%) = $4,900. The total of these two is $29,400 -- just barely over the IRS' maximum deduction for listed vehicles (in 2008) of $10,960 -- oops! What does that mean for your business? You bought a vehicle for $49k, and you can deduct $10,960 from your taxable income this year. These are all prorated by business use -- if you use the car only 80% for business, take 80% of everything (approx $8,768 deduction). I'm assuming your employer pays for 80% of your gas, and all the mtc (15k miles a year, 20 mpg, 2.49/gal $1,494 + $200 mtc). Company deducts a total of $10,462. You can roll that excess deduction forward, but come on -- I'll charge you more (as your accountant), as it's more work for me.
If you buy the vehicle -- assume same purchase price, no depreciation. You pay for gas/mtc, your company reimburses you for mileage ($0.55/mi). You pay 49k, and an additional $1,694 for fuel/mtc. Your company reimburses you (this is a deduction for the company, and not income to you -- pay attention!) $6,600 for mileage.
You could also lease the vehicle. Let's assume the same $950/mo. You don't pay anything, the company pays $13,094 ($11,400 in lease payments, $1,694 fuel/mtc). Depending on lease term, and applicable taxes you could pay another $3 in sales tax/lic. Let's assume worst case, $100 lic, $2775 sales tax (6%), for total out of the company's coffer of $15,969. With a lease, you may have some included in income as a fringe benefit. For a $46k car (FMV, not actual cost), it is $157 for the first year up to $705 for 5th & later years.

Let's analyze --
Prius -
Company buys: $18k capital outlay (by the company), $8,873 deduction.
You buy: $18k capital outlay (by you), company deducts $6600, and you receive $6,600 (tax free). Let's assume 35% tax rate (20% tax rate, and 15.2% FICA/Med). You also save $2,310 in tax. Net capital outlay of $9,090.
Company leases the vehicle: Company deducts (and outlays) $6,117. Your W-2 income goes up by $38 (this year).

Mercedes -
Company buys: $49k capital outlay (by the company), $10,462 deduction (higher accounting fees).
You buy: $49k capital outlay (by you), company deducts $6600, and you receive $6,600 (tax free). Let's assume 35% tax rate (20% tax rate, and 15.2% FICA/Med). You also save $2,310 in tax. Net capital outlay of $40,090. You will get that 8,910 (6600+2310) every year (provided you drive 12k miles for business).
Company leases the vehicle. Company deducts (and outlays) $13,094. Your W-2 income goes up by $157 (this year).

Now comes the part when you decide. If the variables change, it can severely affect your decision.

Like all advice -- let me know the specifics of your case, and I let you make a better informed decision of what's better for you.

Send me an e-mail and I can taylor some advice to you directly -- ctdmonet@gmail.com