Two Tax Systems

The 16th amendment created two tax systems.

Back to the first article in this chain: In order to get people to vote for the 16th amendment, Congress, by means of newspaper ads,  promised the American public that they would tax only profits. Other additions came by way of litigation.

Congress promised to tax only profits.

This was codified in Section 162 in 1954. It was ratified by the Supreme Court, also in 1954. Economic substance & valid business purpose we added later by litigation.

Today, this is where we stand.

There shall be allowed as deductions all the ordinary, reasonable & necessary expenditures made in pursuit of profits in a legitimate business undertaking as long as it meets the economic substance & a valid business purpose tests.

Who decides to deduct an expenditure? You do. Not the IRS. There are no limitations on that. All you have to do is prove it’s ordinary, necessary & reasonable in pursuit of profits and meets the requirements of economic substance and valid business purpose.

If the IRS wants to disallow a deduction, they have to prove it in a court of law, or you have to agree. But they’re not bashful about challenging deductions, so dot your i’s and cross your t’s.

It was quickly established that wages were pure profits, so this applies only to businesses and business like enterprises, such as rental activities.

This is the foundation of modern tax practice.

The 16th amendment singlehandedly created the modern tax system in which every business files it’s taxes differently from every other business. Those with the best tax advisers will pay the legal minimum, taking advantage of every deduction and other legal maneuvers, but those with lesser tax advisers will pay more tax than the law requires. Do that long enough and you’re out of business. It boils down to a talent issue.

This concept  puts a lot of burden on the taxpayer. It’s up to the business owner to take all the deductions available. If you miss some, it’s nobody’s fault besides your own. It’s absolutely shameful that 98% of businesses pay more tax than the law requires. GAO.

98% if businesses pay more tax than the law requires; more tax at higher rates than the Global 500.

The IRS normally has three years to audit, measured from the return due date or filing date, whichever is later. But, the three years is doubled if you omitted 25% or more of your income. Even worse, the IRS has no time limit if you never file a return. What’s more, the IRS also has no time limit on fraud.

Tax Burden on Private Businesses

Statistics tell us that privately owned businesses pay more tax than the law requires. Privately owned businesses also pay more tax at higher rates than the Global 500. Because their tax professionals are better than yours.

We agree with those statements because it jives with our experience, that’s cause for alarm for every CEO out there. 98% of our clients were paying more tax than the law required when we picked them up.

Here is the primary reason from my perspective. Professional Performance.

“The best tax professionals (or best performers in any profession) are 100 to 1000 times more competent then average performers. A few outliers outperform the entire population by leaps & bounds. There is so much difference, top performers and average performers can’t even understand each other. It is not unlike IQ in that regard.”

A tiny businessman bends over as he attempts to support a huge stone sphere that sits on his back.

CEOs Out

Every CEO has to deal with risk. It is ultimately his or her responsibility to manage any and all potential hazards to the business, whether internal or external. In fact, you could easily call him or her the chief risk manager. That’s consistent with former Intel chief executive Andy Grove’s mantra that “only the paranoid survive.” In other words, CEOs should be constantly concerned about identifying and solving for material threats to the business. Per SmartBrief.com).

Here are some CEOs who have proved the truth of that maxim recently.

NEW YORK (AP) — The CEO of eBay is stepping down as online retailer attempts to sell or spin off some of its major assets. CFO Scott Schenkel will become the interim chief executive as the company seeks a permanent replacement for CEO Devin Wenig.

The CEO of Juul Labs has been ousted, and the e-cigarette company has suspended advertising as it remains embroiled in a crisis over its vaping products. Kevin Burns, who had apologized for the nation’s teen vaping epidemic, resigned effective immediately, Juul announced Wednesday. Juul investor Altria Group, maker of Marlboro cigarettes, said it was a “decision by Juul” for Burns to go. The e-cigarette maker will suspend all of its advertising.

WeWork CEO resigns amid investor revolt.  Saying “too much focus has been placed on me,” Adam Neumann has agreed to step down as CEO and give up majority control of the company. Tuesday’s announcement came shortly after the workspace startup company — whose $47 billion valuation was reportedly slashed more than 50 percent — delayed its initial public offering, thanks to investor concerns over corporate governance and profitability. The 40-year-old has also come under scrutiny for his hard-partying lifestyle.

New York (CNN Business) The outspoken CEO of online home goods retailer Overstock.com resigned Thursday, days after he issued a press release entitled “Comments on Deep State” that claimed he helped the FBI carry out “political espionage.” The strange post from longtime Overstock chief Patrick Byrne triggered a steep decline in Overstock’s stock price last week. The company’s stock price later recovered, and it surged more than 10% Thursday on news of Byrne’s exit. In a letter Byrne issued Thursday, he stated that he is “already far too controversial to serve as CEO” and chose to step away after 20 years so that his presence wouldn’t affect Overstock’s business.

 

Good News About Tax Audits

Good news on the tax audit front for most taxpayers, but bad news on the penalty front.

The IRS trend of auditing fewer & fewer tax returns continued last year with an enormous leap forward. The IRS audited only 900,000 returns out of a total of 150 million individual tax returns filed. That amounts to only 0.06%. In 2011, they audited 12.3% of returns. Let’s face it. That’s not very many audits. That’s good news.

The IRS has been shifting its focus for raising funds from tax audits to penalties & fees for the last several years. As the audit rate has dropped, IRS penalties have become noticeably more expensive. It started with penalties of hundreds of thousands or millions of dollars for failure to report foreign assets. 1099’s have become a cesspool of penalties. But the most noticeable result is the declining audit rate for most taxpayers.

Nobody that we prepare tax returns for needs to worry about a tax audit anyway. In the first place, we absolutely won’t help anyone cheat. Life is too short for both of us to play that game. In the second place, we’ve never had a bad result in a tax audit. Sometimes, there is a disagreement on an audit, and we have to fight. (We absolutely will.) Sometimes, we have to push the issue all the way to the courthouse steps. But, so far, the IRS has always capitulated. Once they capitulated in the hallway in front of the court room. That was a case of a very disagreeable appeals agent.

Some people think the strategies we use are a little risky. Let me disabuse you of that impression. We don’t go anywhere near the dreaded gray areas. We stay right smack dab in the middle of the tax code. Everything we do is completely litigated. But we are not afraid of doing things that are not commonly done by privately owned businesses and their owners. In fact, most of the things we do fall into that category. Multinationals are subject to the same tax code you are subject to. We can do anything they do and many things that are impossible for them to do. Privately owned businesses like you are sitting in the sweet spot. Within reason, the sky is the limit. Unfortunately, it’s been my experience that most tax practitioners spend all their time & effort on preparing your tax return. We spend a good deal of our time trying to find ways to cut your tax, legally.

Here’s a couple of charts to clarify things.

Individual Income Tax Returns Examined in Fiscal Year 2018
by Size of Adjusted Gross Income
Size of adjusted gross income (AGI)* Percentage of returns
filed in Calendar Year 2017**
Percentage of returns examined in
Fiscal Year 2018***
No adjusted gross income 1.68% 2.04%
$1 but less than $25,000 35.59% 0.69%
$25,000 but less than $50,000 23.65% 0.48%
$50,000 but less than $75,000 13.44% 0.54%
$75,000 but less than $100,000 8.66% 0.45%
$100,000 but less than $200,000 12.41% 0.44%
$200,000 but less than $500,000 3.72% 0.53%
$500,000 but less than
$1 million
0.58% 1.10%
$1 million but less than
$5 million
0.25% 2.21%
$5 million but less than
$10 million
0.02% 4.21%
$10 million or more 0.01% 6.66%

From the New York Times, here’s the trend. Trending down.

That’s a little small. Who knew? But you can see the trend from 2011 at it’s highest to 2017. Quite a drop.

There you go. Enjoy.

Good news on the tax audit front for most taxpayers, but bad news on the penalty front.

 

The IRS trend of auditing fewer & fewer tax returns continued last year with an enormous leap forward. The IRS audited only 900,000 returns out of a total of 150 million individual tax returns filed. That amounts to only 0.06%. In 2011, they audited 12.3% of returns. Let’s face it. That’s not very many audits. That’s good news.

 

The IRS has been shifting its focus for raising funds from tax audits to penalties & fees for the last several years. As the audit rate had dropped, IRS penalties have become noticeably more expensive. It started with penalties of hundreds of thousands or millions of dollars for failure to report foreign assets. 1099’s have become a cesspool of penalties. But the most noticeable result is the declining audit rate for most taxpayers.

 

Nobody that we prepare tax returns for needs to worry about a tax audit anyway. In the first place, we absolutely won’t help anyone cheat. Life is too short for both of us to play that game. In the second place, we’ve never had a bad result in a tax audit. Sometimes, there is a disagreement on an audit, and we have to fight. (We absolutely will.) Sometimes, we have to push the issue all the way to the courthouse steps. But, so far, the IRS has always capitulated. Once they capitulated in the hallway in front of the court room. That was a case of a very disagreeable appeals agent.

 

Some people think the strategies we use are a little risky. Let me disabuse you of that impression. We don’t go anywhere near the dreaded gray areas. We stay right smack dab in the middle of the tax code. Everything we do is completely litigated. But we are not afraid of doing things that are not commonly done by privately owned businesses and their owners. In fact, most of the things we do fall into that category. Multinationals are subject to the same tax code you are subject to. We can do anything they do and many things that are impossible for them to do. Privately owned businesses like you are sitting in the sweet spot. Within reason, the sky is the limit. Unfortunately, it’s been my experience that most tax practitioners spend all their time & effort on preparing your tax return. We spend a good deal of our time trying to find ways to cut your tax, legally.

 

Here’s a couple of charts to clarify things.

Individual Income Tax Returns Examined in Fiscal Year 2018
by Size of Adjusted Gross Income
Size of adjusted gross income (AGI)* Percentage of returns
filed in Calendar Year 2017**
Percentage of returns examined in
Fiscal Year 2018***
No adjusted gross income 1.68% 2.04%
$1 but less than $25,000 35.59% 0.69%
$25,000 but less than $50,000 23.65% 0.48%
$50,000 but less than $75,000 13.44% 0.54%
$75,000 but less than $100,000 8.66% 0.45%
$100,000 but less than $200,000 12.41% 0.44%
$200,000 but less than $500,000 3.72% 0.53%
$500,000 but less than
$1 million
0.58% 1.10%
$1 million but less than
$5 million
0.25% 2.21%
$5 million but less than
$10 million
0.02% 4.21%
$10 million or more 0.01% 6.66%

From the New York Times, here’s the trend. Trending down.

 

Apple: Best Company in the World?

The evidence is pretty clear to me, Apple is the best company in the world. If there was a hall of fame they would be the first inductee. Their computers, iPhones, etc. are arguably the best products in the world. But on the flip side of that, from what I can tell, they are the best in the world at tax avoidance. Whatever you think of their products, that’s a one, two punch that’s hard to overlook.

NEW YORK-JULY 24 – The Apple logo on the glass of the Apple Store, Fifth Avenue on July 24 2015 in Manhattan.

One of the biggest costs any Global company has to deal with is tax. There’s 50 different states and 200 different countries with different tax rates. Apple has been the absolute best at avoiding overseas tax (& state tax) since Jobs returned to Apple in 1997. Maybe longer.

Their overseas tax has essentially been zero for the entire time. They manage that with the techniques we describe in the following services on our website: Intellectual assets, interstate taxation & international taxation. That isn’t a coincidence. Ever since I saw a GAO article about multinationals paying less tax at lower rates than privately owned businesses, I have been studying Apples & other multinationals’ tax practices. Obviously, they are not advertising this stuff, but every now and then something happens that allows me to see behind the curtain. This article resulting from a leak of secret documents from Apple’s attorneys is one of them.

Their famous Double Irish with a Dutch Sandwich cut foreign sales outside the U.S. to zero tax until 2015. That arrangement became public in 2013 when Congress held Congressional hearings and Ireland was forced to alter their taxation practices. They restructured their tax strategies in 2014. If something happens again, they’ll restructure yet again. There’s too much money on the table to be lackadaisical about it.

Note. Apple’s Irish subsidiaries claimed that almost all of their income was not subject to taxes in Ireland or anywhere else in the world. And rightfully so. They were right. The Irish government agreed with them. They did nothing wrong. No charges were ever brought. But the EU got involved and Apple had to abandon the Double Irish tax strategy for (an island of Jersy) tax strategy.

This is about as important as it can get. Without out the billions they saved in overseas tax, Apple would never have become the most valuable business in the world. Neither would Google, Facebook, Caterpillar, etc. have achieved their massive valuations. I refer to Apple and other multinationals as businesses rather than a companies, because each of them have multiple companies under their umbrella. No multinational is a single company.

A leak of secret corporate records reveals some interesting things. By quietly transferring trademarks, patent rights and other intangible assets to offshore companies, global businesses cut their tax bills dramatically. Also, Apple’s attorneys mailed 14 questions for their attorneys’ offices in the Cayman Islands, the British Virgin Islands, Bermuda, the Isle of Man, Guernsey and Jersey, asking them to “confirm that an Irish company can conduct management activities . . . without being subject to taxation in your jurisdiction.” Apple also asked for assurances that the political climate would remain friendly: “Are there any developments suggesting that the law may change in an unfavorable way in the foreseeable future?”

For more interesting tax information you probably don’t know, visit our website [https:/elliscpafirm.com] or our blog [https:/bizztrategy.com].

We do the same things, absent agreements with tax jurisdictions for privately owned companies. If you qualify, you could save hundreds of thousands of dollars a year. Or, if you’re not that big, you could save thousands or tens of thousands of dollars. Apple saved billions.

 

 

Carving Your Mark On The Universe

Steve Jobs’ Secret to Carving Your Mark on the Universe.

Before Apple began their meteoric growth, they addressed the tax problem with the “Double Irish & a Dutch sandwich” tax strategy. That & Jobs’ innovations propelled them to the most valuable company in the world. But it wouldn’t have happened without the tax savings. Every dollar of tax saved drops straight to the bottom line as another dollar of cash, working capital, profits & competitive advantage created out of thin air. Without first solving the the tax problem, they would have always been watching from the sideline as other companies beat them to the prize.

The Apple miracle.

In a scant 14 short years, Steve Jobs single-handedly pulled Apple from the brink of bankruptcy and propelled the company he founded into the most valuable company in the world.

Following a long struggle with Apple CEO John Scully for control of Apple, jobs was demoted and resigned in 1985. After a hiatus of twelve years, during which he founded Pixar & Next, two similarly valuable companies, Jobs returned to Apple in 1997. He died in 2011 with Apple on the brink of becoming the most valuable company in the world.

Steve talked a lot about his goal to carve his mark on the universe. The study of Jobs provides a number of lessons about growing companies for every CEO, if they can follow them. 

Addressed the tax problem

Before Apple began its phenomenal growth, they first addressed the tax problem with The “Double Irish & a Dutch sandwich” tax strategy. That & Jobs’ product innovations propelled them to most valuable company in the world. Without first solving the the tax problem, they would have always been an also ran, despite the phenomenal products.

Billions of Dollars

Over the next two decades, Apple harvested billions of dollars in tax savings which quickly added massive amounts of cash to their balance and profits to their income statement, and advantage over competitors. Apple’s stock value grew steadily along with Apple’s profits, cash balance & competitive advantage. Every dollar a company drops straight to the bottom line as another dollar of cash, working capital, profits & competitive advantage created out of thin air. Apple’s billions in cash, harvested from their tax strategies, steadily built Apple’s Balance Sheet and pushed their value higher & higher.

Innovation leads to competitive advantage

Jobs’ innovation wasn’t limited to Apple products. He was genuinely & completely innovative. He was always looking for a better way to do it. Whatever “it” was.  Without those tax savings, it’s unlikely Apple would have achieved the competitive advantage necessary to thrive. .

So, are you having trouble carving your mark on the universe? Give us a call to get started on the right foot.

IRS Reform

“President signs IRS reform bill, the Taxpayer First Act”

“On July 1, President Trump signed the IRS reform bill, the Taxpayer First Act. The Act changes the management and oversight of IRS with the aim of improving customer service and the process for assisting taxpayers with appeals; modifies IRS’s organization; and provides some new safeguards to taxpayers in their interactions with IRS.” (Thomson Reuters)

The IRS is cyclical. Every decade or so, Congress passes a law requiring the IRS to quit pushing taxpayers around and become a nicer & gentler IRS. That starts fine, but generally deteriorates over time. Today, we start the process again.

That’s one reason. But, never-the-less, this is at least partly in response to the Obama administration using the IRS to hassle conservative organizations.

Frivolous Tax Arguments

Frivolous arguments. A frivolous argument is an argument that has no substance but it’s being argued to save face when you are caught with your pants down. Just don’t do it with the IRS. The IRS has a long list of frivolous arguments used against them.

“Tax Court fined independent contractor $1,000 for frivolous argument.”

“The Tax Court imposed a $1,000 frivolous argument penalty under Code Sec. 6673 on an independent contractor who argued that his independent contractor commissions were not taxable income, but loans. The Tax Court warned the taxpayer several times that the argument was frivolous and a penalty might be imposed if he continued to advance it, but he continued to advance the argument anyway. (Staples, TC Memo 2019-75)” Thomson Reuters.

“Have you recently read somewhere or heard someone claim that you don’t need to file a tax return with the IRS? Don’t fall for it—frivolous tax arguments are a scam. The IRS is concerned that people may fall victim to con artists and promoters who sell these schemes and then leave the taxpayer to fend for themselves once they’re caught; they therefore include frivolous tax arguments within their “Dirty Dozen” warning list of known scams.

“Whatever your sentiments may be, frivolous arguments against income tax are null and void in the eyes of the law. Don’t let someone talk you into thinking that taxes are optional or unnecessary; if you owe income tax and choose not to file, you are breaking the law. If you’re confused and asking yourself, “What is a frivolous tax return?”, keep reading to learn more. Without making yourself aware, you could get duped by a scammer and face some serious consequences.” Community Tax.