Genesis of the U.S. Tax System

Little Know Fact

Something very few people realize, the 16th amendment to the constitution created two tax systems, one for individuals and and one for businesses. And there’s a world of difference between them.

After proposing the new amendment, Congress began to worry that the amendment wouldn’t be ratified by the states. The issue was the way it was worded.

“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.”

The specific language causing the concern was, “collect taxes on incomes from whatever source derived.” The concern was, the way it was written included money borrowed & the proceeds when selling at at loss in income subject to taxation.  Obviously, Congress had a good reason to be worried. So at the last moment, Congress took out ads in newspapers all over the country promising to ‘tax only profits’.

That relieved an uneasy electorate and the amendment passed unanimously among all the states that voted. Voters weren’t opposed to income tax, they were opposed to an unreasonable tax.

The 16th amendment was subsequently ratified by the Supreme Court in ‘Glenshaw Glass’ and added to the tax code in section 162 of the 1954 tax code. In their deliberations, both the Supreme Court & Congress considered those ads as ‘legislative intent’. Courts have subsequently looked back at those ads to determine Congress’ intent. Intent is crucial to determining how the law will be interpreted and enforced.

In the final analysis, this created two tax systems, which I will explain in my next post.


Targeted Tax Preferences

A great way to save on taxes if you can find them.

When a Congressman wants something, all he has to offer in return is legislative favors. If he pays them outright for something, that would be bribery and he could go to prison. But if he passes legislation to fund a bridge or an airport that supporter wants, that’s perfectly legal. And of course, that happens. Remember the bridge to nowhere?

In other cases it turns out to be targeted tax breaks, which is apparently legal also, even though it probably shouldn’t be. In this situation, the Congressman or Senator sponsors a bill that gives a tax break targeted at the supporter’s profession or to his company specifically.

Consider Wall Street. Wall Street traders are the largest contributor to political campaigns, so they get a lot of these favors directed their way. Here are two examples of tax breaks targeted at Wall Street hedge funds.

These breaks cut tax rates in half for Hedge Funds and their owners, from 39.6% to 20%. In this case, the company involved took it even farther with tax havens, cutting their tax rate all the way down to 1%.  This is all perfectly legal. Some tax preferences are targeted at specific Wall Street traders, who shall remain nameless.

Obviously this stuff isn’t publicized, it’s hidden. But if we find it and meet the requirements, we can use it to the full extent of the law.

This isn’t anything new. It’s been around for a long time.

Here’s the reason for this post.

We’ve just found one of these. The language eliminating a tax break was published in the tax code. But the language that restored the tax break to a limited number of people was printed in another branch of the law. But it’s specifically a tax law.  It carries the full impact of a tax law.  Oddly enough, the requirements fit our purposes exactly. Someone up there is looking out for us.

Color me suspicious, but I don’t think that was a mistake. Those crafty devils in Congress did it on purpose.

This may seem awful, and it is, but thank God we found it. We use this stuff to save taxes for clients. If we can locate them, and if we meet the requirements, we can use them to the full extent of the law. This is what I describe as working in the seams of fully adjudicated tax law.  It’s like being bullet proof.

This is where our intellect prowess comes into play. When we look at these things, we see things that other people don’t see.


Hello Depression

Obamacare gives U.S. Firms $3000 incentive to hire illegals over native born workers.

This will obviously be bad news to working Americans. Watch people lose jobs to illegals and wages plummet. Can this be what Democrats, Republicans and the big employers want? (Chamber of Commerce, Zuckerberg)? Apparently so. I’m hearing no uproar. None at all. they’re playing Russian Roulette with voters. They’re liable to get one in the brain.

Everybody, let’s sing.

If you want to be happy for the rest of your life, have a cash flow business on the side.

It lost a little something in the translation, but that is the best advice I can give you. You can open a network marketing business for under a thousand dollars. Great way to learn how to do business. Also has a high upside. But, for your own good, get something going on the side, even if you’re cutting hair in the alley.

Just saying. Then you’re your own boss in control of your own destiny.

And that’s just good news.


Oregon immigration vote is a warning for Obama

PORTLAND, Ore. (AP) — The fate of a little-noticed ballot measure in strongly Democratic Oregon serves as a warning to President Barack Obama and his party about the political perils of immigration policy.

Even as Oregon voters were legalizing recreational marijuana and expanding Democratic majorities in state government, they decided by a margin of 66-34 to cancel a new state law that would have provided driver’s licenses to people who are in the United States illegally.

Taken from Drudge

Tricky Government

Income inequality is real and it isn’t being fueled by hard work and perseverance. In Vox Day’s opinion, it’s being fueled by “…neo-feudal largesse distributed by the federal government to the financial aristocracy through the central bank.”

Sounds reasonable to me.

If it’s true, one of the pillars of financial success is to avoid investments in the stock market, Wall Street, equity bankers & stock brokers; don’t finance anything and consider alternatives to the federal reserve backed banking system. Of course this is possible for some of us and impossible for others. If you own a business, you’re basically stuck with the banking system. But the stock market is a whole different issue.

I had some clients who took this to heart. Both business owners. One buried his money in his back yard. Apparently $100,000 in $100 bills fits nicely in a Folgers coffee can. No problems. Happy guy. Another client rat holed money in the basement of his restaurant. The day before the closing was scheduled on a new restaurant purchase, he learned a squirrel had discovered his cache and made off with most of his $100 bills. This guy died young. Somewhere in that mountain village, there’s a very expensive squirrel nest.

Even if you avoid Wall Street and do all the other things I listed, the government can still take your money and peel it off to the ‘financial aristocracy’, which, if you remember the ‘bail out’, they’re perfectly happy to do. And it really doesn’t matter whether you vote R or D. They’re just different sides of the same coin.

An uncomfortable conversation I often have with clients is when I tell them the government didn’t institute IRA’s to help you prepare for retirement. They instituted IRAs to drive investment in the stock markets in order to line the pockets of equity bankers. And it worked like a charm.  All but a few dollars of all the money in those IRAs and 401(k)s is invested in the stock market.

First of all, let’s cover the basics. You deduct it when you invest in a tax advantaged retirement account, and you pay tax on it when you take it out. For the purposes of this article we’ll assume this is a wash or very nearly a wash. (Time value of money be damned. See below.)

As far as I’m concerned, it’s a more efficient use of your money to avoid all tax advantaged retirement vehicles.  If your goal is for your investments to increase in value (and if it’s not, what the hell are you doing?), it’s far better, in my opinion, to invest in your personal name (or an LLC) instead of an IRA. You may leave the money in your IRA for more than 40 years, so it’s reasonable to expect a tidy gain on your investment. (After all, these are professionals investing your money.) But if they do a good job of investing and you do make a profit, you have to pay taxes on everything, profit and all, at ordinary rates. Which are twice what capital gains rates are.  If the profits were in your personal name, instead of the IRA or 401(k), you would pay tax only on the profits at capital gains rates, (less money at half the rate).

One more time to make sure you’ve got it. Every penny you take out of an IRA or 401(k) is taxed at ordinary rates. But if you sell a personal investment, only the profit is taxed, the original investment isn’t taxed, and the profit is taxed at capital gains rates. A phenomenal savings on the back end.

A word of warning. The people who howl the loudest about what I just wrote are the people who make money off the system. They will talk about a lot of things like the current value of money. (Here’s what the current value of money is today >> the interest rate on my recently opened money market account is .0001, one, one hundredth of one percent. Not much.) Plug them in with equity bankers. Although to be perfectly honest, my argument will probably catch your retirement planner by surprise. He probably thinks he’s helping you.

There is one caveat to this; that’s if your employer is matching all or part of your 401(k) investment. If that’s the case, jump in with both feet. You might still lose money, but with no gains or losses, you have a fighting chance that your employer will pay your taxes for you, leaving you even with where you started and getting today’s tax savings for free.

Two interesting facts.

Most people invest in tax advantaged retirement accounts not to prepare for retirement, but to save on taxes. Tax savings is the lure the government used to lure your money into the stock market.  If a client says he wants to save $100,000 on taxes, I tell him to send me a $200,000 check. So for, no takers, but a lot of people who are a little smarter. It costs you 100% to save 50% (or less). The only genuine tax shelter today is a cash flow business.

I once did a survey of my clients with stock market investments. They were all carrying losses forward. That means none of them had made enough profits to cover all their losses.

Just saying.

Politics & Hollywood

Catching up on my reading when I stumbled across this doozy on Blog Maverick for 3/19.

” In Hollywood every one will talk and listen to you about your project.  But while they are standing there, right in front of you, they are not looking at you. They are looking past you to the next project where they can raise/sell more.  Where they can be a bigger star. There is always a bigger fish. Who ever is standing in front of them is hopefully just the bait. “

In my ’tilting at windmills’ era, I was a pretty big player in politics. I even ran for Congress on a tax reform ticket but lost. Campaigning was great. When I walked into a room, everyone would stop what they were doing to cheer and clap. That kind of stuff can get in your blood. Unfortunately it can also go to your head.

When I was running for Congress, I flipped over a few too many rocks to see what lived underneath them. The comment bolded above was something I heard more often than not. I particularly remember this particular statement about a governor candidate. “While I was shaking his hand and trying to carry on a conversation, he was looking over my shoulder to see if there was anyone more important behind me.”

I can see that. Politics and Hollywood have more than that in common.

Administration Urges Anti Inversion Legislation

Treasury Secretary Jack Lew has urged Congress to pass legislation that would stop inversions, which are used by some multinationals to avoid U.S. taxes by incorporating in other countries. He warned in a speech that many more U.S. companies are planning this strategy, even as the pace of inversions has slowed in recent weeks. Lew also said he would decide in the near term what regulatory actions the Obama administration can take on its own. The preference, though, is for Congress to pass a law, he said.

The New York Times (tiered subscription model) (9/8),

The Wall Street Journal (tiered subscription model) (9/8)

This is an exercise in ignorance for the administration.  In the first place it will be easy to get around.  Just have the American company acquired by a foreign company you have already taken control of, or subsequently will take control of.  The Brazilian trio used this technique when they sold Burger King to a Canadian company they already had control over. They first used it a few years ago when they sold their Brazilian beer company to a Swiss beer company that they subsequently took control over.

In the second place, the only way to effectively counter the Abandon America movement that has individual Americans giving up their citizenship and American companies inverting into foreign companies is to cut taxes. High taxes is the problem. But the administration thinks it’s all powerful, imprisoning people and businesses that want to leave and forcing them to pay draconian taxes to fuel their socialist machine.  This is beginning to look like the Jews fleeing Nazi Germany before the “Great Eradication Solution” began.

They will never cut taxes.  Cutting taxes is more foreign to the average Congressman or Senator than the new foreign corporate owners of inverted companies.

C’est la vie

Live and learn.

U.S. Competitiveness Hurt by Tax Code

The AICPA reports

on a Wall Street Journal article

“A survey of Harvard Business School alumni found that the U.S. economy is helped by strong capital markets, universities and entrepreneurial zeal, but hampered by a weak K-12 education system, a complicated tax code and a dysfunctional political system. According to the poll, 41% of respondents expect lower benefits and wages for American workers and only 27% forecast an improved environment for most Americans.”

For those or you who thought that the ability to think is educated out of HBS grads, apparently you’re not entirely correct. 

The problem with lists like this is that often good ideas are listed right next to horrible ideas. In this case the horrible ideas are only two, but if they gather steam, they could hurt the American economy more than these perceived problems are hurting it right now.

The first error is really not so bad as all that. It’s just patting themselves on the back by including the university system as an economic plus. Although this is widely debatable, in my opinion it’s at least in doubt. The University system and its partnership with the government is pumping out way to many unqualified, unemployed graduates with advanced degrees and burdening all students with two decades of student debt repayment. This is as much havoc with the stagnant housing market as the blow up in 2008.

The second error is way more dangerous due to it’s popularity with a large portion of our knee jerk voters … “a complicated tax system is hurting our economy.”  Much to your surprise I suppose, that’s obviously false. It hooks the wrong cause to the wrong effect. It isn’t the complication that is hurting the economy, it’s the high tax rates and high taxes. The citizens surrendering their U.S. citizenships and all the corporations inverting to foreign corporations are not doing that because of a complicated tax system. They’re doing it to escape the high U.S. taxes.  And, as I pointed out before, at least in the case of the corporations, they would not be diligent if they didn’t pursue inversion.

This is evidence of weak thinking on the part of HBS, which is apparently endemic to the institution.

Or sophistry. This is my new favorite word. … Sophistry is a rhetorical art form which relies upon ingenuity, fallacies and specious effectiveness rather than soundness of argument. It’s probably disingenuous to blame the inaccuracies in this article on HBS. But, after all, they are a convenient scapegoat.

The last thing we want is tax reform. Pro tax increase people love to hide behind tax complication as a reason for tax reform so they can raise taxes. I fervently hope every thinking person realizes the U.S. government is drooling about making tax reform popular so they can use it as a cover to hike taxes. They’ll reform taxes all right, just like they reformed the medical system, and we’ll see the results in our tax bill and our take home pay. Besides, who’s stupid enough to think that a simple tax code would work with our complex economy? If we did simplify it, Congress would start tinkering with it and five years later it would be just as complicated as it ever was. But we’d be stuck with the higher rates. 

Which is why the government drools when it reads articles like this in the popular press.

To locate the bullshit, always follow the money.

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