Tax Memo: October 10, 2019

Teeny Little Slices

tax planning.jpeg

Here in the United States, we spend a lot of time arguing about income taxes... who should pay, how they should pay, and how much they should pay. Right now, the average American forks over 13.5% of their income in individual income tax, and 30% of their income in federal, state, and local taxes overall.

Of course, "average" covers a pretty wide range — 50 million families pay no income tax at all, while the top twenty percent of earners pay over 69% of all revenue collected. It costs the economy $409 billion just to figure out the bill and get it paid.

Here's the biggest problem with today's tax system: no matter where rates fall or who picks up the tab, Uncle Sam still spends more than he takes in. Keeping up with spending is like playing tennis against Serena Williams — if Serena was an octopus with rackets in eight arms. So politicians are constantly looking for new ways to cover their bills.

Now some politicians are proposing wealth taxes on the richest Americans. Massachusetts Senator Elizabeth Warren's plan starts at two cents for every dollar of net worth above $50 million, rises to three cents on amounts above a billion, and raises $2.75 trillion over 10 years. Vermont Senator Bernie Sanders's plan climbs all the way to 8% on assets over $10 billion. Both senators argue that limiting their reach to board-certified fat cats means most voters have nothing to fear from their plans.

A wealth tax may sound like an impossible lurch to the left in today's politically polarized era. But polls show it winning more support than higher income taxes. And if you own your own home, you're already paying one in the form of your local property tax. The real problem with a wealth tax is making it work. It doesn't matter how small a slice it takes if the people who owe it can't or won't report their balance sheet accurately — especially if it's stuffed full of hard-to-value things like businesses, real estate, and art.

Want to see how much we can raise with even smaller slices? Consider calls for a tax on financial transactions. Hawaii Senator Brian Schatz's proposal is typical: he would charge just one-tenth of a penny for every dollar on stock, bond, and derivative trades. The Joint Committee on Taxation estimates this would raise about $777 million over 10 years.

Bernie Sanders has a similar proposal that would charge 0.5% on stocks, which he says would raise enough to pay for free college (and bring the species Homo Billionairus to the brink of extinction). 

A financial transaction tax would be far easier to manage than a wealth tax. It would-also take dead aim at the sort of high-speed trading Michael Lewis described in his 2014 book, Flash Boys, which Schatz says accounts for half of the market's eight billion daily trades. "High-frequency trading... screws regular people; that's the main reason to do this," he says. Does that sound like creeping socialism? Well, Australia, France, Hong Kong, Italy, South Korea, Switzerland, and the U.K. already have financial transaction taxes, and their markets seem to be doing just fine.

We spend most of our time looking for the green lights in the income tax system that let you pay less. But we'd be negligent if we weren't keeping our eyes out for new ways the government can nick you for small percentages (which add up big time). But not to worry! We'll be ready with the plans to help you pay the least.

In the News: September 28, 2016

Moneyball? Ehhh, Not Really
America is a nation divided. Cat people vs. dog people. Trump people vs. Clinton people. And last week, we discovered a new gulf to bridge: "Brad" people and "Angelina" people. That's right, Brad Pitt and Angelina Jolie are filing for divorce after two years of wedded non-bliss. Will the "Brangelina" breakup turn into a fight club? Will it drag out, or will she be gone in 60 seconds?

Whose side are you on? How much do you care about the biggest celebrity divorce of 2016? Will you breathlessly wait for the next issues of your favorite supermarket tabloid, follow #brangelina on Twitter, and pass along rumors of infidelity, drug use, and child abuse? Or will you turn your nose up at the whole celebrity gossip machine and get on with your own life, thank you very much?

Odds are good that our friends at the IRS will fall into that second group that just doesn't care. It's not that there aren't oceans of money at stake — it's just that the divorce isn't likely to change how much of it falls into IRS hands. Let's take a closer look:

•    Jolie isn't asking for alimony. But even if she were, both stars earn well into the top 39.6% bracket on their own. (Forbes estimates Pitt has raked in $315.5 million since the couple met, with Jolie picking up $239.5 million more.) Alimony is deductible by the payor and taxable to the payee. That means, with Brangelina, it would be deductible by Pitt at 39.6%, and taxable to Jolie at . . . 39.6%. It's hard to see the IRS caring much who pays the tax on that last slice of income.

•    Next, property settlements. Pitt is a renowned architecture buff, with homes in Malibu, Manhattan, New Orleans, and the south of France. Jolie was famous for wearing a locket of her ex-husband Billy Bob Thornton's blood around her neck. (Let's just call that "separate property" and move on.) But transfers of property between divorcing spouses are tax-free — as far as the IRS is concerned, it's a wash no matter who winds up owning what.

•    Next, child support. Jolie has requested full physical custody of the couple's six children. (She's accused Pitt of being an inglorious bastard with the kids.) If she wins, Pitt will probably wind up paying child support. However, child support in any amount is nondeductible by the payor and nontaxable to the payee. In fact, it doesn't even appear on a tax return. Once again, there's no reason for the IRS to get excited.

•    If Pitt and Jolie really were just like us, the one area where the IRS might get concerned involves their filing status. Generally, when a couple earning more than about $100,000 gets divorced, they wind up paying less tax as singles than they would jointly. But again, Pitt and Jolie will both still pay the maximum 39.6% on the vast bulk of their income.

We talk a lot here about the importance of planning. When it comes to divorce, it's almost inconceivable that Brangelina, with three previous divorces between them, didn't have a plan for it — also called a prenuptial agreement. Now, prenups are an asset protection tool, not a tax-planning tool. But it's equally inconceivable that a couple earning $555 million between them doesn't also have a plan to beat the IRS. So, while we can't get your picture on the cover of People magazine, we can help you with that same sort of protection. So call us!

 

In the News: September 14, 2016

Ahoy, Maties!
Labor Day has faded into memory, and before you know it, the holidays will be here. Halloween, Thanksgiving, and the year-end Christmas/Hanukkah/Kwanzaa cavalcade of commercialism are the obvious "Big Three." But in all the holiday season hype, it's easy to overlook a newer celebration that grows more popular every year. We're talking, of course, about International Talk Like a Pirate Day — observed this year on Monday, September 19.
Have you heard about the new pirate movie? It's rated ARRRRRGH!
When you think of pirates, you probably picture swashbuckling "Golden Age" captains like Edward "Blackbeard" Teach or "Calico Jack" Rackham. Maybe your tastes lean towards the fictional Jack Sparrow or Long John Silver. Either way, you'd probably be surprised to learn that the real pirates of history could be a sophisticated lot, organizing themselves into democratic societies, with checks and balances to enforce discipline — and even "taxing" themselves to pay expenses.


What has two eyes, two arms, and two legs? Two pirates!
Some captains went so far as establishing written codes to maintain law and order. (No one walks the plank without due process!) Bartholomew "Black Bart" Roberts, who captured over 470 ships before dying in a broadside of British grapeshot, ruled according to 11 articles. Number ten on his list provided that, "The captain and the quartermaster shall each receive two shares of a prize, the master gunner and boatswain, one and one half shares, all other officers one and one quarter, and private gentlemen of fortune one share each." Even Bernie Sanders could approve of such equal distribution!


What do you call a pirate that skips class? Captain Hooky!
Today's pirates face a whole new set of challenges, including how to handle their ill-gotten gains. If you decide to deep-six your desk job for an eyepatch and life on the sea, you'll find your income subject to the same tax as any other business, legal or not. "Booty" is taxed at fair-market value under the rules of Code Section 83(b).


What was the pirate's golf score? Parrrrrrrrrr!
Fortunately, you'll get the same deductions as any other business. Ships and equipment you buy to conduct raids are considered capital equipment, depreciable over the applicable period. Guns, grappling hooks, and smaller items qualify for first-year expensing. And if the Indian navy sinks your ship, you can claim a capital loss. It's good to know that if an IRS auditor says "I'm the captain now," you won't be completely hornswoggled.


How much does it cost a pirate to get a piercing? A buck an ear!
Yo ho ho mateys, pay attention here. The end of the year isn't just holiday season, it's planning season. And planning is the key to keeping your treasure and making it grow. So call us to help keep the scallywags at the IRS from getting too many of your pieces of eight!

 

In the News: September 21, 2016

Zero Tax Thirty
Matt Bissonnette grew up in a dinky flyspeck of a town off the Alaskan coast that you can't get to without a boat or a plane. He ultimately escaped to join SEAL Team Six, the Navy's most elite counterterrorism force. He took part in the 2009 mission to rescue Captain Mark Phillips from Somali pirates, a story which was told in the movie Captain Phillips. But that was just a warmup for his biggest mission: "Project Neptune Spear," the 2011 raid that killed Osama Bin Laden.

In 2012, Bissonnette wrote a memoir called No Easy Day: The Firsthand Account of the Mission That Killed Osama Bin Laden. It earned him $6.7 million in royalties, which he planned to donate to the families of fallen SEALs. It also launched a lucrative second career as a public speaker. Unfortunately, Bissonnette broke the Pentagon rule requiring him to submit it for vetting before publishing. The day after the book landed on shelves, officials said it revealed classified information, a breach that could subject him to years in prison.
Last month, Bissonnette settled the dispute and agreed to pay back every dime of royalties, plus another $100,000 in speaking fees he earned before they approved the slides he uses in his presentations. Question: can he now deduct that payment from his taxes going forward?
Code Section 162(f) seems to shoot down any tax benefit. "No deduction shall be allowed . . . for any fine or similar penalty paid to a government for the violation of any law." But what about payments made to settle a dispute before a fine or penalty is imposed? Treasury regulations state that payments made to settle that sort of potential liability aren't deductible. But the regulations also state that compensatory damages do not qualify as fines or penalties.
So, that's the $6.7 million question. Does Bissonnette's payment serve to compensate the government for the damage his book caused? If so, then he gets his deduction. Or does it merely settle his potential liability for civil or criminal fines or penalties — in a way that benefits both the government and him by avoiding the time, expense, and potential public disclosures involved in a trial? In that case, no dice.

Bissonnette isn't the only celebrity who may miss out on a fat tax deduction for a big gesture. Actress Amber Heard recently finalized her divorce from Johnny Depp with a $7 million lump sum payment, then announced she's giving it all to charity. But she probably won't get the deduction you'd expect. That's because you can only deduct up to 50% of your adjusted gross income in any year (and carry any remaining balance forward five years). Ouch! Bet she didn't see that coming!

Now, there are two ways Depp and Heard might be treating that $7 million. It could be a transfer between spouses, incident to the divorce. In that case, it's nondeductible to Depp and tax-free to Heard. (Too bad her financial disclosures show she doesn't have nearly enough income to take advantage of the full deduction.) Or it might be alimony, deductible to him and taxable to her. In that case, she'll still owe tax on the 50% of her donation that she can't deduct this year.

Here's the lesson. Sometimes pricey things happen, and we console ourselves by saying "at least I get a tax deduction." But that's not always true, and it's rare that value of the tax deduction is enough to compensate for the loss that creates it. So call us before your next big transaction and make sure it serves you best!