Why the GOP is Wrong About Millionaire Small Business Owners
Okay, first things first. The title of this post is (intentionally) misleading. This post isn’t about millionaire small business owners.
This post is about the very, very small fraction of small business owners who pay themselves $1m/year or more; the ones that it has been proposed be taxed (along with others earning over $1M/year) to pay for a continuation of a “payroll tax” holiday. I wrote “millionaire small business owners” rather than “small business owners who make $1M/year” because the former scans better.
Second; I don’t know if the the payroll tax holiday is a good idea or not. I like it because it means more money in my pocket, and more money in my employees’ pockets.
I also don’t know if taxing income over $1M/year is a good way to pay for it, or if it needs to be paid for at all. After all, upper income earners have been enjoying a “tax holiday” for last several years, and I don’t see a lot of concern about how that’s gonna get paid for.
Okay, so now that my lying and ignorance are on the table, here’s the meat of this post.
The GOP argument goes something like this:
If you raise the tax rate on income over $1M/year to pay for an extension of the “payroll tax holiday”, some portion of those earners will be small business owners, and faced with a 2% increase on their incomes over $1M/year, these (obviously shrewd and successful) small business owners will decide that the way they will make up for the reduction in their take home pay by not hiring people, using the money their not using to hire people to pay themselves more to make up for what they’ve lost to the additional 2% tax.
This is so stupid it’s hard to know where to begin, I guess I’ll start with something easy, like calculating what a 2% tax increase on income over $1M/year.
For someone making $1,000,001/year, it means an increased annual tax burden of $.02.
For someone making $2,000,000/year, it means an increased annual tax burden of $20K
For someone making $10,000,000/year, it means an increased annual tax burden of $180,000.
That means that a marginal federal tax rate of 37% (the current 35% + the proposed 2%) our very successful, $10M/year small business owner has to pay herself another about another $285K/year to make up for all the money she lost to the 2% tax increase.
Holy moly! Where’s she going to get that money?!?
Never mind not making any new hires! Our very successful small business owner is probably going to have to fire a few people so she can give herself a raise! Oh noes!!!
Except that’s not how very successful small business owners think. If they thought that way they wouldn’t be very successful, $10M/year small business owners.
Very successful small business owners are always looking to get the best value for their money, and taking money out of your business as salary is rarely the best value.
When you take money out of your business as salary it gets taxed and it’s buying power is reduced, as in the example above. You divert $285K from growing your business, but you only actually end up with another $180K to spend.
By contrast, if you use that money to buy more money making assets for your business you get 100% purchasing power, and you’re buying things that make you more money. (And if you’re making $1M/year or more, you’re obviously someone who does a pretty darn good job of deciding when to reinvest in your business, and when to take the money out as salary and take the tax hit.)
Every successful small business owner faces this dilemma: plow the money back into the business (new hires, more marketing, new capital equipment, etc), or suck it out as wages for personal enjoyment and take the tax hit. Any increase in a small business owner’s marginal tax rate is a nudge towards business investment and away from personal consumption.
Sometimes you don’t know what to do: Spend? Or invest? What do you think very successful, $1M/year small business owners do when it’s a close call?
If you think they opt for spending over growing their business, you’ll never be a very successful, $1M/year small business owner.
There’s an interesting NPR piece that just went up today that touches on the same issue, though not as succinctly.
“If my taxes go up, I have slightly less disposable income, yes,” said Burger, co-owner of CSS International Holdings, a global infrastructure contractor. “But that has nothing to do with what my business does. What my business does is based on the contracts that it wins and the demand for its services.”
…
He says his ultimate marginal tax rate “didn’t even make it on the agenda.”
Yankwitt says deciding to bring on another employee is all about return on investment. Will adding another person to the payroll make his company more successful?
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Yeah, heard it on the way to the boat shop this morning. (Don’t know if you’ve heard, I’m a small businessman and a job creator). Made me so mad I started shouting at the radio.Report
Earlier this week, I was listening to NPR interviewing a government guy who supported this tax increase.
The government guy kept saying that the rich should just pay a little bit more to offset this temporary holiday. The NPR guy said that one of the Republican criticisms was that the increase was permanent even though the holiday was temporary and could the government guy clarify whether that was true. The government guy explained that the Republicans didn’t want the American Workers to keep more of their own money in their pockets during this recession if it meant that the rich would pay just a little bit more. “But are the tax increases permanent?”, the NPR guy asked. The government guy repeated himself about how the Republicans were standing in the way of the American Worker from keeping more of his or her own money if it meant the rich paying just a little bit more.
Then the segment ran out of time and they started talking about something else.Report
I dunno. Maybe that could put a sundown on the tax increase like they did on the Bush tax cuts.
OH WAIT THAT DIDN’T WORK!!!Report
A pity that no one was willing to filibuster the extension of the tax cuts.Report
If the government raised taxes by 2% for margins above $1,000,000 a year in personal income, how much money would be raised? Sure, if there’s a million people out there making an average of $3,000,000 a year, and that’s $40 billion, which ain’t peanuts. But it also ain’t even 3% of the deficit — and I’m not convinced that there’s a million people making three mil a year, particularly if they have the ability to control their own incomes and as the post suggests, they would rationally choose to take lower incomes in the first place.
So that gets back to the question — is this modest-seeming marginal tax increase motivated by a desire to a) alleviate our deficit woes, b) encourage reinvestment, or c) give vent to a political perception (whether factually substantiated or not I offer no opinion) that the rich are undertaxed?Report
Can’t it be all three?Report
I should have been more clear — 2% marginal increase over $1,000,000 doesn’t seem adequate to achieve any of those goals, although a) even less than b), and b) less than c). Maybe there’s a d) that did not occur to me.Report
That was my question exactly, Burt. The amount in question is more symbolic than substantial. Further, per discussing political horsetrading w/Mr. Cahalan, that perhaps this isn’t a dealbreaker, but part of making one.
It’s established Republican lore that Reagan gave Tip O’Neill his tax hikes, but the Dems reneged on the promised cuts in return. This should be sub rosa in all of this. I don’t feel like litigating it, but I give it currency in 2011-12. I do not see any Dem bargaining chips on the table, nor do I think we are likely to see any before next November.
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The amount in question is more symbolic than substantial.
How many small symbolic gestures does it take before we have something substantial?Report
Mr. Stillwater, I have found the door only swings one way: toward more taxes, not spending cuts.
My larger argument about the game-behind-the-game is that we’re fools to argue these things on their face and be at each other’s throats or expend endless cyberink on them.
A 2% rise isn’t going to hurt much, help much, or change anything. Both sides in Congress know this, and that’s the part we the people ought to get hip to.Report
the door only swings one way???? huh
Taxes are far lower then they were decades ago. Cap gains taxes and taxes on upper incomes have been lowered more then once. Remember the bush tax cuts? Taxes can and have been lowered significantly so the gate can definitely swing that way.Report
True enough, Mr. Greg. Let us say for now then that gov’t spending ratchets, and seldom swings back. Such is the real crisis, and not just in America.
There was only one Ronald Reagan, and coming out of the Carter years [and Ford and Nixon, mind you], we were as desperate as they were in the FDR era to try anything.
By contrast, the Bush tax cuts remain temporary, subject to the political winds. As for the payroll tax holiday, I expect it to be much harder to unratchet than taxes on the top bracket.
You can’t really demagogue a defense of the 1%, because there are so few of them. It’s easy to demagogue any tax hike on most of the rest of us [that is, the payroll tax returning to its past level], because we are so many.
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You can’t really demagogue a defense of the 1%, because there are so few of them.”
So you haven’t been watching the news or reading opinions papers for quite a while, have you?
Taxes and spending are all temporary and subject to political winds. Its called democracy.Report
If true, Greg, demagoguing for the rich is an interesting phenomenon, not something you see every day, era, or epoch.
If you follow me here…Report
ahoy, ye scalwag! Tis been a long time indeed since demagoguing for the Rich came into fashion. And ye aren’t exactly helpin’ with takin’ it out of fashion, if you take me meanin…
Turnin the poor against the other poor, pulling the person “just a little better” down… it’s a good trick the rich know.Report
Of course you can demagogue the 1%. You rebrand them as “job creators”.Report
A fair enough argument, Mr. Ryan, but I think “job creators” falls short of “demagoguery.” I think it’s an appeal to reason, not emotion. “The rich must pay their fair share” is demagoguery in my view, since I’ve already submitted that the actual dollar amount won’t make much difference either way.
Even if it sticking up for the “job creators” is fiscally false, which you seem to be arguing here, it’s why I asked for a little chillness to discuss this and it sort it all out.
I’m listening. If Ronald F. Reagan could let marginal tax hikes through for the greater good, I can get way good with it.Report
Tom,
With your indulgence, let tell you something about the movie business.
When a typical movie play in a theater, the split is pretty close to 50/50. You’ve got a 300 seat theater, you sell 150 tickets at $10 a ticket, the gross for that show is $1500, you keep half, the distributor keeps half (that’s why the tickets have numbers.)
Unless the attendance goes up to (somewhere around) 90%. When that happens, a remarkable revenue sharing scheme kicks in.
The distributor gets 90% of the gross. The house is full, the gross take is $3,000, the theater owner gets $300 and the distributor gets $2,700. It’s not progressive either. You sell one too many tickets and suddenly you’re share gets cut by 80%.
My goodness? How can this be? Why would theater owners ever agree to such an arrangement?
In fact, theater owners love movies that pack the house. They love them because they make so much fishing money on the concession stand they don’t give a fish about the door. “Please. Give me more movies that pack the house. Give them to me every week and I will happily collect your ticket revs for you with only a modest 10% processing fee.”
This is more or less how I feel about taxes. I don’t want to pay any more than I am legally obliged to pay, but mostly I want a high functioning socio-economy because that’s where I do best.
In what constitutes a high-functioning socio-economy I’m liberalish, except in the areas where I’m conservativish, except in the areas where I’m all, “Fish all y’all, go fish yourselves.” (For a more indepth explanation of my politics, ask E.D. Kain.)
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David/Tony: Mrs. TVD is on the Xmas episode of NCIS:LA this coming Tuesday. Me, I don’t put my autobio up or hers up for review here at the LoOG, except in passing for the amusement of those here gathered.
We came to LA together in 1981 to crash the entertainment business, and are still here. I get it—we get it—believe me. Been all through the ins & outs, from the Spielbergs to the bottom-feeders.
I get art. I shit art. Then there’s the business of art…
I was just encouraging you & Mr. Smith to keep the lines of communication open rather them close them against each other, because you both have worthy testimony to give.
I’m listening to the debate. Rock on, brother.Report
I would say, a, b and c (and on c I’m on the factual side).Report
Paul Krugman wrote about this here. TL;DR is that even large tax increases on the rich wouldn’t fix the deficit, but it would contribute a substantial amount, at least as much as other ideas being bandied about (e.g. raising the eligibility age for Medicare).
IMHO we shouldn’t even have to pay for the payroll tax extension given the current economic slump (that’s the point of stimulus), but if we do decide to offset the cost, taxing the rich is as good a way as any to do it.Report
Dan:
If you don’t pay for the payroll tax extension then it hurts social security b/c that is where the money would have gone. Given that increasing number of boomers that are starting to draw SS is that really smart? Why is is paying for things as you go so much to ask for? Why is increasing taxes always the answer?Report
Well, first of all, I’m arguing for NOT raising taxes, at least at the current moment. Also, the current payroll tax holiday is specifically written to make the Social Security trust fund whole, and is funded instead out of general revenue.Report
funded instead out of general revenue.
That is to say, out of further borrowing.Report
Well, yeah, that’s the point if the goal is stimulus.Report
I’m not arguing that; I’m just noting that it’s not in fact coming out of general revenue, unless we’ve redefined general revenue to include borrowing.Report
The small increase has been offered specifically in response to GOP demands that the current “payroll tax holiday” only be extended if it is paid for.
The GOP response to this method of covering the gap left by extending this tax holiday is that a small increase on income over $1M/year will have a negative impact on job creation because job creators will pay themselves more to make up for the monies lost to taxes rather than making new hires.
I’ve laid out numbers so you can decide if the GOP stance on the payroll tax holiday makes any sense.
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Will this 2% increase actually pay for the extension of the payroll holiday?Report
I don’t know. I do know that the GOP is not contesting on these grounds. They’re contesting on the grounds that very successful, $1M/year small business owners are greedy idiots.
I don’t believe very successful, $1M/year small business owners are greedy idiots. Do you?Report
Greed, for lack of a better word, is good. Greed works.
I’ve met a number of successful small business owners who were, for lack of a better word, greedy (I have not looked at their books to see whether they were in the Megabuck Club, however).
I have never met one who qualified as an idiot. The idiots tended to be former business owners.Report
And I’m thinking about it some more and the ones who weren’t, for lack of a better word, greedy eventually reached a crossroads where they had to choose between being, for lack of a better word, greedy or changing careers.Report
In the construction “I don’t believe very successful, $1M/year small business owners are greedy idiots.” said small business owners would have to be both greedy and idiotic.
And.
Q fishing E D, mutherfisher.Report
Given that that which was to be demonstrated has been demonstrated, I go back to wondering how much revenue there is to raise… and if, perhaps, there is at least one small business owner out there who is willing to say “I am unwilling to continue with the business I am in. This straw has broken my back. I will cease engaging in my business entirely and I’m going to do something else… something that I find personally fulfilling instead.”Report
It’s more fun to think about how many will righteously shut the doors on principle.Report
The idea of someone quitting their job because of some abstract principle being violated is something that I, as a crazy libertarian, have some romantic sympathies for.
But I am a crazy romantic libertarian.Report
Of course. Each person has their own personal Laffer Curve.
But again, that’s not the GOP argument. The GOP argument is that our very successful, $1M/year small business owners are not going to hire people, or heavens for fend, fire people, people who make money for them, to make up for being taxed 2% more on income over $1M/year.Report
What do you want me to say? The GOP is fiscally innumerate if not downright malicious when it comes to spending? That they embody many of the exact same things they decry in the other party? That they pretend to be virtuous on topics where, when given unchecked power, they are chief among sinners?
Consider it said.Report
Accepted.
And if Obama every goes off on his wind-fall-profits-tax-on-the-oil-companies-to-be-returned-as-a-rebate-to-consumers thing again, I’ll pipe up about that. K?Report
So I say something about an entire party dealing with an entire arm of governance and in return I get the narrowest concession dealing with one man, one industry, one particular promise?
This is not making the claims made by the Republicans about their opposition any less credible.Report
Bird,
This post is about one thing; whether or not the GOPs claims that a 2% tax on income over $1M will hurt small business job creation is credible, or inane. I’ve made the case that it’s inane, and then rebutted yours and various others’ challenges to my case.
Because I have sensed that you take this as a broad attack on the GOP, I have also offered that I am willing to make similarly focused critiques on our President, and certainly mean to imply his party is not exempt either. (I find the anti-commercial sentiments that are endemic to the Democratic party irritating in the extreme.)Report
I apologize. I should have seen your concession as more than fair.Report
David Ryan, your entire OP shows a dismal ignorance of the business world.
First question. Is YOUR business organized as a Subchapter S corp?
Second question: If not, why not?
Third question: What in the name of all that’s holy makes you believe that “small business owners” take OUT the money they are supposedly making? (see Sub Chapter S above.)
I have owned SEVERAL Sub S corps. in EVERY case I paid myself (in actual salary mind you) the absolute minimum the IRS would allow me to get away with (there’s a reason for this). At the end of the year however, all the PROFITS that the Sub S. company makes are handed to ME (the owner) as if I’d taken the money OUT (which I damn well didn’t) and put it in my mattress (which I damn well didn’t, but I repeat myself). I then PAY taxes on THAT amount at the then extant tax rate. If I don’t have the money in the company’s bank, too bad, the IRS will not give one tinker’s damn and will come after me tong and nail.
You putatively own a yacht building business. Let’s assume (and now that I’ve seen your chops it is a massive assumption) that you’re incredibly successful with your design (probable) and business acumen (highly improbable) and start pumping these things out like gangbusters. As you move up the efficiency scale you make (gasp) profit, which you /leave/ in your company in the way of paid-for inventory, tools and so on. The IRS is not fooled however, and other than what you’re able to write off (more accurately, defer taxes on) you MUST show as income, even if you’re bank account is empty.
I was really rooting for you Ryan, but this post shows me you have no understanding whatsoever of how these things work.Report
Monthly salary and at year end corp profits extracted as a year-end bonus and taxed as wages so as to avoid double taxation (corp taxes, then dispersed as a dividend and taxed again.)
Alternately anticipate the profits and plow them back into the company as new hires, new equipment, etc with 100% purchasing power.
If you got to the end of the year without enough money to cover the taxes your profit owed on your consuming year-end bonus, well that’s a common error.
Lastly, you don’t own a Sub. S corp. It owns you. Report
Yes Ryan, obviously I know this. The point I was making is what is contained in your OP, wherein you munged thoroughly dissimilar issues to buttress your point, which is fundamentally false. Perhaps I could have worded it better (and spelled your right) but the essential point here is that people do NOT take the money OUT of the company, they leave it IN so the company can GROW! Unless you’ve organized yourself as a 501C3 corp or a not-for-profit corporation where the charter specifically requires the corporation to disburse all funds negating the opportunity for profit. Every other non-hobby enterprise is expected to (and legally required by the IRS) attempt to earn a profit. In fact if you can’t within 5 years you are officially a hobby and multiple write-offs you may have used may be used against you in a court of law.
I personally know a “small’ S-Corp that has over 2000 employees. They were absolutely going to shut their doors when the Bush tax cuts came out, because they were in the Telecom field and were absolutely hammered by the dotbomb recession (you’ll recall there were some massive telecom failures at that time). They could not get a bank loan even though they’d been in business 20 years and had never been one minute late on payments and had the corporate equivalent of an 850 credit rating. The ONLY reason they’re still in business today is because they were able to parlay their tax refund (from the Bush tax cuts) into operating capital to keep the doors open.
But I’m talking about real companies operating in the real world here, not the imaginary world occupied by authors like Krugman who pretend knowledge about economics and business while sucking on the teat that is the NYT. Krugman couldn’t run a lemonade stand.Report
The ONLY reason they’re still in business today is because they were able to parlay their tax refund (from the Bush tax cuts) into operating capital to keep the doors open.
So, uh, they were in a market that was massively over-serviced (which, like the real estate market, everybody who had half a brain knew well ahead of time), and rather than go out of business (as they ought) when said market vaporized, they got a government bailout?
Congrats, Ward, you’re a liberal. 😛Report
THEY did not overexpand, they were continuing the exact same business they had been in for decades. Unfortunately for them, a lot happened around them that they had nothing to do with, and they were caught in the crossfire.
On the other hand, the “government bailout” saved 2000 American jobs. This is change I could believe in. Sneak preview of what I was going to put in my own OP, comparing Perot’s position on NAFTA to the other two. Jaybird may well have been correct after all.Report
Jaybird may well have been correct after all.
I am pleased to hear that I am not the only one drinking tonight.Report
Let me tell you, this Imperial Stout is fantastic, but if I have any more I’m going to start asking to subscribe to TVD’s newsletters.Report
Brother Plinko, you are blessed. In discovering a drinkable American porter or stout, mostly synonymous
http://www.beerconnoisseur.com/porter-versus-stout
you have tapped the vein.
Serious discussions of the Important Things are only possible when you’ve knocked back a few. Pot just won’t do: it just circles back on itself. For the ways of the world, only beer suffices. For religion and God, only an Irish whiskey will do. For metaphysics and thus incomprehensibility, Scotch.
The rest, Jack Daniels or good or bad tequila, violence is necessary to complete the experience. Guns are real experience enhancers. You might even remember what you did with them if it was particularly exotic.
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Nailed it, Mr. Van Dyke. You speak only truth.Report
You theists and your refusal to drink what Jesus practically demanded you should drink.
Everybody can quote Leviticus, nobody can quote John.Report
Cahalan, did you notice Jameson’s Irish Whiskey is one of the Top 5 shoplifted items?
Beats the hell out of going to church.
http://www.metro.us/newyork/life/article/1045312–the-top-10-most-shoplifted-items-of-the-holiday-season
I was riffing here, but I think I might’ve stumbled onto some bigtime truth.
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I am, at the moment, drinking vino.
Whiskey gets the blood up. The prednisone is doing an admirable job of that on its own.
Wine is good for relaxing. Also: best for dalliances, you betcha.Report
Everybody wants a God’s Blessing in the holiday season, Tommy me boyo.
So it’s Jameson’s, as we don’t import Paddy’s and J-dog has a better ad campaign than Bushmills.
Well, Irish Coffee or Eggnog w/Bourbon. Holiday drinks.Report
The absence of bourbon in Mr. Van Dyke’s post is seriously disturbing. Whatever his other valuable qualities, his failure to recognize that bourbon is the proper stimulant for serious political discourse cannot stand uncriticized.Report
Bourbon is the beverage of the white male power structure in America and thus responsible for most of the problems in the world.Report
Bourbon is the beverage of the white male power structure in America and thus responsible for most of the problems in the world.
This is my most favoritest TVD comment of the week.Report
Bourbon is the beverage of the white male power structure in America and thus responsible for most of the problems in the world.
Typical effete left coast urban liberal, incapable of seeing the vital contributions to culture made by our American ancestors.Report
Bourbon is the drink of fascists.Report
Bourbon is the drink of all who oppose unjust government power–hence the Whiskey Rebellion.
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I’ll drink to that!Report
I rest my case.
Gentlemen, left and right, allow me to salute you with an inferior bourbon, James Beam (my funds are short this week). I have tears in my eyes as I salute youz guys and this, the finest thread here at the Leauge! Keep up the good work!
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Liberal? Didn’t all the bailout stuff start with Bush? And his midnight riders telling congress all hell would break loose if “some really large number” 750 billion in bailout money wasn’t authorized? Overnight? Without evidence?
I think you’re confusing liberal/conservative retail politics with private power wholesale politics which gets justified in retail political terms.Report
Mr. Stillwater, any idea where that trillion or so we gave BHO to spread around went?
It’s actually an open question. I have no fishing idea.
Because even if it stuck a finger in the dike, it didn’t fix it. As near as I can sort out, TARP was an emergency measure, with a consensus from both sides of the aisle when the tsunami hit. I can’t be overly critical about what you do in a crisis.
But what came after, I honestly have no idea. Sticking yr finger in the dike forever is not a policy or a plan.Report
PatC, just to keep you on the same page as Mr. Smith, lowering taxes is not a “bailout.”
I’m not fully on his page because we don’t have a direct correlation between cutting taxes by x% and then seeing it on the back end.
There are aesthetics involved here, but the science of economics is increasingly learning that economics is also aesthetics, because the human equation includes aesthetics.
If *I* feel the tax regime is abusive and unsustainable, fuck it, I’m closing up shop and you can send my mail to Tahiti. I’m getting too old for this shit.
And what I earn, I earned; the wealth I manifestly created is mine. You can tax it, but don’t tell me you’re giving me a “bailout” with my own fucking money. That’s absurd.Report
Allow me to disagree here on the “bailout:”, Tom, if only because at the time the Feds were running a massive budget deficit. By giving current taxpayers a cut, they’re only raising the money that needs to be paid in the future by other taxpayers. Someone is going to have to pay those taxes, so the cut is still a transfer of obligations from someone to someone else. We can discuss the ‘money now/money later” alegbra, but the tax break ain’t free unless the government is growing the debt more slowly than GDP, or preferably just running in the black.
On your points on aesthetics, fully agreed with you.Report
Thx for this, Mr. Plinko. The payroll tax holiday seems to apply to yr argument in spades, esp since it’s supposed to pay for Social Security and Medicare, which have no other [legal, technical] means of support.
By giving current taxpayers a cut, they’re only raising the money that needs to be paid in the future by other taxpayers.
I mean, I like the payroll tax holiday and all, but I’m going like, WTF?
And aesthetically, I hope we’re agreeing that you can’t give me a “bailout” with my own damn tax money.Report
Tom:
You know, at the start of the year as a businessman, what your tax bracket is. You budget for it.
Your market disappears. You’re going to go bankrupt. This is the normal course of business.
Suddenly, someone suggests giving you money that – at the start of the year – you knew was going to be collected as taxes. That’s a windfall. It’s like any other debt going away.
Put another way: a bailout is a return of government funds to somebody. A tax cut is a lifting of a previously-established burden on your bottom line. Accounting-wise, they’re both largess from the government.
Now, granted, “bailouts” are usually a largess far in excess of taxes paid. Thus a tax cut isn’t really a bailout, I was being facetious.
Hence the 😛 at the end of the original comment.Report
@Pat,Clearly you’ve never run a business. I’ll help you out here inter alia:
You know guess, at the start of the year as a businessman, what your tax bracket is. You budget hope you can pay for it.Your market disappears is still there. You’re going to go bankrupt because the banks (due to their own stupidity elsewhere) punish you for their own transgressions (with others) and won't (or can't) loan operating capital to you as they have (at a profit) for decades. BTW this is history repeating itself with the "housing crisis"Put another way: a bailout lowered tax is a return of government your own funds to somebody youReport
You’re going to go bankrupt because the banks (due to their own stupidity elsewhere) punish you for their own transgressions (with others) and won't (or can't) loan operating capital to you as they have (at a profit) for decades.Work with this idea. Where does it lead you? I can see this leading to lots of different places; but “letting the bank fail” is probably not going to solve the credit problem. Now, there might be all sorts of other reasons to let the bank fail.
Hey, maybe we could decouple the “credit problem” from the “bank problem” somewhat.
That aside (that’s a topic for a whole ‘nuther post)…
Like I said, Ward, the original comment was intentionally facetious. But I have to be honest, I don’t see much of a difference between “lowering taxes” and “donations from the federales” as “government largess”.
Here’s a hypothetical: let’s say government decides to retroactively apply a tax rebate for last year’s collected taxes. They give everybody in the country somewhere between $500 and $1000.
Is that a tax cut for last year’s taxes, or a payout? What’s the difference, how long the feds have held it? It all works out to black or red on the financial statements, right? Are they giving you back “your money”? Or are they giving you a payout for voting for somebody? Or are they just blowing $500-$1000 x # of taxpayers on a non-directed bailout?
When does it cease being “your money”? When the government actually collects it? Why is that distinction important?
P.S. -> oftentimes when I’m asking you questions that may seem boneheaded, I’m trying to go somewhere. I’m trying to suss something out. Just a reminder 🙂Report
“Render unto Ceaser what is Ceaser’s”
Given that background, it is all the government’s money. It has pictures of dead presidents and some guy named Franklin on it so it must be eh?
Banks aren’t loaning money today.We want to talk about economic malaise, we only have to look there. I was at a wake of all places talking to an old friend who owns something like 30 hotels around the region. They are particularly good operators, keep their vacancy rate below 30% and are minting cash (in an S-Corp BTW, just to reiterate a point I cannot reiterate enough). Their typical property is worth $30Million. Because other hotel owners are not so skilled, there are bargains to be had in quaint little metropolae like Portland and in point of fact they’ve identified one there.
Now in the hotel business, it turns out if you’d like to keep your vacancy rate low you need to keep the place updated. This costs money and is where virtually 100% of hotel failures occurs. The owners get cheap, get lazy and stop fixing things and customers stop staying there. Soon you have a failing and/or empty hotel often sitting in prime real estate downtown.
They have a business plan and a formula they have followed for decades wherein they go to these distressed properties, use skilled craftsmen and tightly managing the timeline and budget convert shady lounge into Shangri La. They were doing one or two of these a year, but since the banking crisis they’ve done zero. The banks won’t lend them money, like my telecom friend, they are in the “wrong” industry. They have nothing to do with housing mind you, but it IS “real estate” and the banks who are completely upside down in “real estate” dare not make (even a sound) further investment in same.
To your hypothetical, meet me at the bottom and I’ll talk about it there where there’s more room.Report
On the “holiday”, this is back to the “money now/money later” algebra. There’s probably a much stronger case today for “money now at the expense of money later” than in 2003 or 2005, agree? But, for the very reasons you object to them, it is not my preferred tool to use at all. The Congress has better options. I’ve shilled for monetary options in the current economic situation, but it’s lonely on this particular island.
On the aesthetic matter of taxes, I guess it’s up to how morally obligated we are to the national debts and the actions of our government. I’m not going to go so far as to say that anybody needs to give their tax cuts back, but I would say that we all need to recognize that the shifts do create obligations that may fall a lot more on others than ourselves.Report
To yr best point and distinction drawn, Mr. Plinko, I feel more moral obligation to our national debt than to the actions of our current government. [You could even source Alexander Hamilton here, and I’m a sucker for the Founders.]
Again, aesthetics, and it looks like were moving aesthetics into our discussion of the economy and the tax regime.
Which is really cool.
I have a semi-Pelagian belief in human beings, Thomist that I am, that they’re capable of doing the right thing, esp when the stakes are fairly naked.
Not that some people are incapable of total depravity: did you know that Congressman Harry Truman made his bones exposing the war profiteers? Which led him to the vice-presidency, then presidency?
I mean, shit. How could somebody undermine the war effort in the slightest for his own greed, fighting fucking Hitler and the equally murderous Empire of Japan?
Come to think of it, Mr. Plinko, i gotta stop here and meditate on this one. As always thx for yr provocative comments. Provoking each other to new thoughts—and be provoked in return—is the only good reason we should spend our time around here, yes?
“Invest” our time here, I like to think of it.
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Exactly.
Which is why the GOP assertion that a small increase on money taken out as wages paid to the owner above $1m/year will hurt job creation is absurd to the point of insulting.
Money left in the these companies will not be taxed. Money left in these companies is available for new hires or whatever other productive use (capital investment, catching up on deferred plant maintenance, etc.) the owner sees fit.
It would appear you agree with me. Not sure why you seem so upset. Perhaps I’m misreading.Report
Money left in the these companies will not be taxed. David, you are completely utterly and irrevocably WRONG. That “money” is taxed whether you like it or not, in fact the very purpose of this legislation is apparently completely lost on you. I’d suggest a business 101 class at your local community college.Report
Should have said “not taxed when/if used for business expenditures”.
Happy now?Report
Por favor, cool this down, O Bros o’the LoOG. There’s a very worthwhile discussion to be had here.Report
Ok, let’s start over with bookkeeping 101. For a business to “spend money” on “business expenditures” requires said money to come from someplace. Can we agree on this so far? Now that money can come from 3 sources. It can come from your own (shareholder’s) pocket, it can come from a bank or it can come from retained earnings (otherwise known as previously attained profits). In fact the bank is unlikely to loan you money (unless you’re politically connected) without a competent demonstration that you know what retained earnings are and have demonstrated a previous ability to attain same.
Retained earnings (otherwise known as profits) will be taxed at the maximum rate allowable by the IRS and will look exactly like you’re some schmuck taking home $10M per year. Unless you’re a fat cat banker taking home a massive bonus, but are instead a small successful business owner (typically Subchapter S) that money has landed nowhere near your pocket. Instead, exactly as I said before, it is showing up on your books as inventory, tools, leasehold improvements and so on. But before you (really) get to spend one thin dime on those things, you have to account for the IRS’ share first, or be prepared to dig in your pockets for the difference when April 15th comes around (and if you’re playing in these leagues, you’re making quarterly payments cause the IRS don’t like to wait for its money).Report
First of all, in the league I play in, April 15th is meaningless. I do business with the IRS about every two weeks and do an annual reconciling on a date of my choosing.
Second of all, if you keep the money moving, it never books as retained profits. It comes in as gross revs and goes back out again on the corporate P&L as expenses, most especially if it is being spent on employees wages and employee related expenses. This is what make the GOP assertion that a 2% increase on wages over $1M/year paid to owners a disincentive to making new hires absurd.
Third of all, I’ve have never had retained earnings. Our corp zeros every fiscal year via dispersal of profits as bonuses to the principles which are taxed as normal wages. I’ve had a business line of credit for about 20 years.
Now will you please stop condescending to me?Report
A question for Wardsmith and David Ryan,
The issue here is, as I understand it, a tax on the business-owner’s earnings. It sounds to me like you are talking about a tax on business earnings, not business-owner earnings. Those would presumably be taxed at the corporate rate, and not affected by this surcharge. So are you two actually talking about the same thing or not?
I’m not a tax expert, and I know diddly about laws governing corporations (except a very little about non-profits), so I may be saying something completely wrong here. That is to say, I’m not arguing, but seeking clarification.Report
In the context of small business, business earning and business owner earning are virtually indistinguishable. Let’s see if I can clearly explain why.
Let’s say my business does $10M/year in revs.
Let’s say that my business’s expenses for the year, inclusive of my $25K/month salary are $9M.
At the end of the year I made $250K and my business showed a $1M profit.
The question is, what becomes of that money?
Well first my business may be carrying an operating loss from previous years, let’s say $500K.
Now we have an after carried loss profit of $500K.
Now perhaps my business may also have some ongoing depreciating assets, let’s say $250K.
So now, after carried loss and depreciation we have a profit of $250K.
So what will become of this $250K?
Well I can just leave it in the business, where it will subject to corporate income tax. This is what Apple does. They pay tax on their profits and leave it in their war chest. Small businesses rarely do this.
(Corporations that pay dividends to their share-holders pay these dividend with after-tax corp profits, and these dividends are taxed again on the share-holders’ returns as ordinary income. This is why opponents of corporate tax talk about double taxation.)
I can make additional capital investment. This will not reduce the corporate tax burden this year, but will reduce it in upcoming years (see depreciation paragraph above.)
I can pay myself a bonus, which is taxed as ordinary income, just like my $25K/month salary.
Or lastly, I can see ahead of time that my business is running profitably, gauge that there’s room for expansion, and use the profits (approx. $25K/month) to make revenue enhancing expenditures; new hires, more advertising, modest expensible upgrades, etc. These expenditures flow directly onto my bizz profit and loss statement and are not subject to any tax.
To your point: The only way* a business owner can get money out of his business for person use (house payments, vacations, food, coke & hookers) is to take that money out as wages, which are taxed as ordinary income, and it’s these wages over $1M/year that would be subject to this additional 2% tax.
Does that help make it clearer?
* Theoretically a small business owner could leave profits in the company, pay corporate income tax on these profits, and then disperse these monies to the shareholders (ie herself) as a dividend, and this dividend would then be taxed as ordinary income on her personal tax return. I’ve never heard of an instance where this yields a more favorable tax treatment then simply paying out profits as wages in the form of a year-end bonus, which is written off on the business P&L (ie no corp. tax) but is taxed as ordinary income on owner’s personal income tax return.Report
Theoretically a small business owner could leave profits in the company, pay corporate income tax on these profits, and then disperse these monies to the shareholders (ie herself) as a dividend
This is actually done in the UK quite a bit and can be advantage in some tax brackets. In fact there used to be, before the government caught on, a trick where someone would resign as an employee on friday and return on monday as a business contracted to do the exact same work for a fee identical to their former wage but with less tax.
Just an observationReport
David, I apologize for my short language last night, I was late for a party where much imbibing and fantastic food was present.
To the rest of your post in response to James. You’ve never answered my simple questions above, you don’t have to but you should. I’m going to assume from the evidence presented that you are not organized as a SubChapter S corp. If you were (or if you’d read the links I provided) you’d understand how the taxation works. You are still wrong about the disbursement of profits as below:
To your point: The only way* a business owner can get money out of his business for person use (house payments, vacations, food, coke & hookers) is to take that money out as wages, which are taxed as ordinary income, and it’s these wages over $1M/year that would be subject to this additional 2% tax.
Here is how it works in the real world of corporations NOT called C corps. Your S corp (or LLC or proprietorship for that matter) makes profit. We’ll even use your example as is. There is NO CORPORATE INCOME TAX ON AN S CORP, read that again, the caps are on purpose. The tax is on YOU the shareholder, 100% on you. Your accountant or friend may have told you the S corp owns you, but there are 10’s of millions of them, and they are the preferred corporate vehicle in this country for a reason. The reason is quite simple. The highest INDIVIDUAL tax rate is LOWER than the highest CORPORATE tax rate. Also you can save money (albeit with the reasonable salary clause articulated above) in payroll taxes by paying yourself less (but still reasonable) and leaving the rest to grow in the company.
Using your number of $250K profit. You “leave it in the company” meaning you don’t take it out of the S corp. However, it gets added (and subtracted depending on loss carry forwards from previous years) to your $250K you took home in salary (and paid FICA taxes on). Now you ostensibly have $500K in net income and will pay taxes at the maximum rate of 35% after mortgage deductions etc. However the $250K is STILL in the corp, available as working capital, inventory etc.
Now to your point about taking money out of the company. No doubt having the wealth in your bank account gives you a warm fuzzy feeling, but what are the drawbacks? Well for starters the banks are only paying, what 1.25% interest? No doubt with that big stash in your bank account, banks are more than happy to loan your business money at what, 7% interest? Now let’s say money is growing in your company at 10% (ie, your S corp is growing at 10% per year). Money left in the company is actually the best place for it. It is growing and compounding your wealth in the most efficient manner. Hell, I owned an S corp that was growing at 10% a month! What possible place on the planet could I make that kind of return elsewhere? I’d have been an idiot to take a penny out of the company and didn’t except for the mandatory minimum salary (which I would turn around and reinvest as paid in capital whenever possible). Ultimately I sold that business essentially as a NPV of the future cash flows with a premium based on my growth rate. Unfortunately for the new owners, they weren’t as smart as me and managed to drive it into the ground. Fortunately I sold their stock (now a big C corp) for cash.
This won’t translate into nautical terms, but taxes to a company are exactly like headwinds to an airplane. The lower your headwind, the faster you can go. Period, airplanes don’t “tack”. The GOP is well aware that the vast majority of small businesses in this country are organized (for good reason) as SubS corps and therefore “appear” to be “making” huge incomes, when in fact the owners are not since they primarily leave the money in the company (unlike you, apparently you don’t trust your own company or on questionable advice it is organized as a C corp).
I admit, I’m not an accountant, but I’m married to one (with an MBA) and my son is a CPA with a Fortune 100 manufacturer. I have multiple “headstones” in my office of companies I’ve shepherded from SubS to publicly traded enterprises. The so-called income increase in our country can be directly attributed to the addition to the tax code of SubS corporations. Everyone (else) wasn’t stupid about the advantages of same and on (good) advice organized their enterprises under that umbrella. This is why your OP is all wet, you completely ignore the impact of S corps on this country.
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Wardsmith,
This is just positively bizzarre. You write these long rants in the most disagreeable tone, which presumably means you disaggree with me, but when I unbundle the substance of what you’re saying, you are in completely concordance with my explanation of how money exits a business P&L and become personal income. Whether a business is a Schedule C sole proprietorship, an S corp, a C corp or an LLC doesn’t change this; when monies move from the business to the owner, they are expenses on the P&L (untaxed) and are then taxed as ordinary personal income; the flow-through of an S corp doesn’t change this, ie, there is no free lunch.
Yet despite this concordance in our understanding of how business revs. become personal income, you continue hectoring me about my lack of knowledge. I can only assume this is because you and I disagree about the effect of a 2% increase on incomes over $1m/year on small business owners inclination to hire people.
That’s fine. If you think someone making $10M/year isn’t going to hire someone because their tax bill went up by $180K, you are entitled to that opinion. It’s not an opinion supported by my observations of people who run businesses that are successful enough to pay them $10M/year, but what evs.
But I really have to protest your condescending interrogation. You are an anonymous internet commentator. You have tombstones in your office? I’ve got an pink elephant and a unicorn. So what? If you want me to take your opinions seriously, you’re going to have to show me something more substantive than your command of the text formating functions in the combox.
Until then consider yourself ignored.
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David, you are more than welcome to ignore me, but your understanding is and I don’t know of a polite way to say this, incorrect. I am horribly sorry that your understanding is incorrect, I wish that were not the case, but it is incorrect nevertheless. I won’t use caps, perhaps that adds to the condescension feeling, but if you were a student in a class and the teacher told you that you were wrong, would you sulk and ignore her?
In this statement: Whether a business is a Schedule C sole proprietorship, an S corp, a C corp or an LLC doesn’t change this; when monies move from the business to the owner, they are expenses on the P&L (untaxed) and are then taxed as ordinary personal income; the flow-through of an S corp doesn’t change this, ie, there is no free lunch. I can only agree wit th “there is no free lunch” component. What is missing in your understanding (and you’re welcome to ignore this, call me names, whatever makes you happy) is the salient fact that in an S-Corp not one penny needs to “move from the business” to show up “taxed as ordinary personal income”. Nada, zilch, zero. Therefore a businessman who is paying himself $250K per year but owns a corporation that made $9,750,000 in (probably paper) profits owes taxes as if he’d taken that entire $10M home with him as income (which he didn’t).
I personally know people in this exact position. They aren’t typically thrilled to be demonized by politicians for having the audacity to own an S-Corp and employ hundreds or thousands of employees. As far as their personal finances are concerned, they may be barely scraping by. Read the book, “The millionaire next door” for some real world examples. My next door neighbor was one of those. Living in his middle class house (worth less than mine in fact), mowing his own lawn, building his own furniture, clipping coupons and paying taxes every year as if he were bringing home millions of dollars which he was not doing.
Perhaps not with you, but with anyone who is interested, I can walk through this example financial statement of an S-Corp and explain exactly what is going on.
And perhaps I should have said tombstones instead of headstones. Clearly you were sophisticated enough to catch my gaff. As for anonymity, perhaps I’d get along better with Tony Comstock?Report
@wardsmith-
OK, appeals to authoriteh are among the weaker of arguments- whenever I see people attempting the “you have no idea how business works” stuff it always sounds like Eddie Murphy “A’m a BIDNISSMAN, y’unnerstand- a BIDNESSMAN!”
In some ways, bidness tax accounting is wickedly complex; but in basic principle its pretty straightforward.
I work for a medium sized professional design firm; and corporate taxes are just part of the overall burden we add to each employees; for example, our burden is about 2.75; for each dollar we pay is wages, we have to add 2.75 in overhead, taxes, and benefits.
Among all the factors that comprise the burden, corporate taxes are one of the smaller ones; health plans, professional liability insurance, and rent are the most significant.
Why do we get so hysterical over a small adjustment in the corporate tax rate (not the exact topic of the post, but close enough) yet no one seems to feel the same way over commercial rent, or insurance rates?
When was the last time we heard some breathless report featuring a small bidnessman who declares “If Aetna/ Edison/ Pac Bell/ my landlord raises its rates ONE MORE TIME, I’m gonna lay off all my employees!”Report
It’s dawned on me what’s wrong with all this—that’s not the GOP argument atall, it’s the Dem argument reversed and put in the GOP’s mouth: If you raise my taxes by this minimal %, I’m going to lay off employees, or at least refuse to hire any more.
But it’s a constellation of factors that making business sit tight and not expand, not a single this or that.
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So lets call it the Fox News/ Conservative Blogosphere argument; because really, this argument or its variants are pretty common in those parts:
Raising corporate taxes will cause bidnesses to lay off employees;
Lowering taxes will stimulate job growth;
Raising personal income txes will cause rich people to flee to, well somewhere. Or stop buying stuff, causing layoffs in the yacht/ private jet/ luxury handbag sector;
Arthur Laffer was and is, a genuine conservative in good standing.Report
Let’s call it a simplistic caricature of the GOP argument, Lib60, and leave it at that.Report
Let’s just take it from someone… anyone. We can worry about the consequences later.Report
Of course at the expense of higher taxes folks could organize as C class corporations and pay the corporate tax at 35%. The main issue is that the corporate income tax goes up far to fast, peaking at 39% at 100k. (The 39% is to make up for the lower rates below). Perhaps this practice should be stopped and the 35% rate apply above 10m. Then as a part of the deal treat all corporations as C corps, but with the mod that either dividends are business expenses, or that interest paid is not a business expense (to equalize the treatment of equity and debt). The reason folks go for S class is to avoid the double taxation in the first place, so that they pay a lot less than if we said there are only C class corporations.Report
I’m open to arguments that we’d be better off with no corporate income tax and instant depreciation of all capital investment.
Except I remember when the instant depreciation allowance went from ~$20K to ~$60K. Suddenly every other contractor on the East End was driving a ginourmous luxury pickup or SUV. I suppose whether or not that’s a good use of a more generous year one depreciation allowance is a question of values, but from where I stand it looks mostly like a gift to Detroit. (What’s good for GM is good for America?)Report
@ Ward
From up there:
Therefore a businessman who is paying himself $250K per year but owns a corporation that made $9,750,000 in (probably paper) profits owes taxes as if he’d taken that entire $10M home with him as income (which he didn’t).
Okay, now I think I know how to read a financial statement. I have not, in fact, run a business myself so as far as the tax implications go I’m feeling my way around the S-corp rules at the moment, granted, and I certainly don’t get practice as an academic who isn’t actually a business guy.
Said businessman pays himself $250k in salary, and he pays taxes on that normally, sure.
An S-Corp is formed because the founder doesn’t want to pay corporate income tax. Okay so far. So the S-Corp has no taxable income. This is why the profits need to be disbursed at the end of the year as income; the S-Corp pays no taxes, but the stakeholders do.
Now, the stakeholder Bob may want to plow that money into some other investment, but that’s just bad planning; if he has $10 million in profit at the end of the year, he’s paying either the tax rate of an individual on that cheddar (and then he can take the rest of the money and invest it back in the business or buy a kite or invest in some other business or whatevs)… or Bob can go back in time and charter as a C-corp and pay the corporate tax rate on that money. There is no free lunch, the Federales want the vigorish.
You and David are talking past each other. David’s whole point is at the end of the year there aren’t $10million in profits to disburse: the S-corp owner has already put a chunk of that money back into the business by investing in capital equipment or land or hiring employees or heck, buying corporate bonds and investing the profit itself in a profit-making asset. Indeed, in a particularly good year, hiring somebody is actually enabling Bob to improve his corporate value without paying any taxes on that money, because it’s no longer profit.
Now, your point, if I’m reading you correctly, is that your S-Corp holder Bob has $10 million in cash and he wants to hold that money as cash assets in the corporate bank account for whatever reason. Future investments, probably. Well, I can have some sympathy with that… but whatever he wants to do with the money, it’s earned in that tax year and it has to be reported.
Correct me on this, if I’m wrong. I certainly may be.
Marketable securities can be purchased as an asset. Assets – Liabilities = Equity. Bob can buy $9.5 million in corporate bonds or some other marketable securities on the market. He’s got a $9.5 million dollar asset (the marketable securities he bought with cash earned from operations), a $9.5 million dollar expense (buying said securities) that shows up on the Income Statement as a Non-Operating Expense and is deducted from the $10 million in revenue so that his net income is only $500K… so he only has to disburse $500K and pay taxes on *that*.
Further, Bob can pull a loan out using those marketable securities as collateral and thus he’s acquired a nice liability that he can also finagle to give him a lower reportable income in any given year. a $M million dollar liability (the loan value), and $N or so million dollars in cash that isn’t earnings, but money from the loan. The nice thing about this is that next year, he’s got to pay interest on that loan which cuts into next year’s profit, but he has most of the money today to put into the business. Now, if Bob is cagey, he’s invested in marketable securities that will outperform the rate he’s paying on the loan, so he’s rolling.
Now, I’m entirely unfamiliar with S-Corp rules, so maybe there are limitations on investment activities or requirements for a net income/disbursement ratio or something of which I ain’t aware; but in that case, this is kind of on the corporate officers for electing to incorporate as a company that can’t have $X in investment activities. And I’m not a real financial accountant, and I’m dusty on the stuff that I did learn, so maybe my last couple of paragraphs is out of whack for some reason in which case I will gladly accept a tutorial. But isn’t this essentially one of the main dodges that big corps pull to keep the money in the house without having to call it retained earnings?Report
Pat, actually you’ve misread me in so many regards that I think I’ll just start over. For instance this quote from you indicates you are apparently reading an entirely different thread:
David’s [??] whole point is at the end of the year there aren’t $10million in profits to disburse: the S-corp owner has already put a chunk of that money back into the business by investing in capital equipment or land or hiring employees or heck [this part is close], buying corporate bonds and investing the profit itself in a profit-making asset. Indeed, in a particularly good year, hiring somebody is actually enabling Bob to improve his corporate value without paying any taxes on that money, because it’s no longer profit. [this part isn’t]
David actually says nothing anything like that anywhere above (or please provide a permalink). It is however close to what I’ve been saying above, so maybe you confused me for David? I was admittedly harsher on David than I should have been, but it is specifically because the guy is running a business. In my opinion you can’t /really/ run a business and not know these things. I suspect he’s ignoring me now that he’s thought about it a bit more and realized how completely wrong he was, but I could still be mistaken. There is simply no chance I am wrong although I could always work to express my thoughts better.
Let’s say you own a computer store. At the beginning of the year you initially started the business just to make things easy. Over the course of the year, you sold hardware and software and made profits. Every time you sold a computer you bought another one. You’re in wonderful land so you’re making 30% margin on every sale.
Just to make things easy, we’ll assume you started the business as an S-Corp with $100K that came from a CD you just cashed and put every penny in inventory (ie you have $100K worth of goods to sell and not one penny in the bank). At the end of the year you have $300K worth of inventory to sell and not one penny in the bank. How much have you grossed? Remember, you have zero dollars in the bank.Report
I’m not sure what the unstated assumptions are, here.
You’ve grossed your total sales, whatever that is. Your net income is that… minus the cost of goods sold, SG&A, depreciation/amortization, r&d expenses, and non-operating expenses. You don’t pay taxes on gross, you pay taxes on net income.
You currently hold $300K in inventory as an asset implies you’ve at least
nettedmade $200K in sales, assuming a magic expense of zero and that you took every dollar of sales and bought inventory with it. But I would assume that you’ve had expenses of some sort, and you need to at least pay yourself a salary.Now, uh, all other things being equal, are you saying, “I started off with 100K worth of inventory and now I have $300K in inventory, so let’s assume all those other numbers are zero: I’ve made $200K and have to pay taxes on that even though all my money is tied up in inventory”…?Report
“I started off with 100K worth of inventory and now I have $300K in inventory, so let’s assume all those other numbers are zero: I’ve made $200K and have to pay taxes on that even though all my money is tied up in inventory”…?
Your answer is correct. The person, Bob let’s call him, has made at least $200K in gross sales. and he’s tied it all up in inventory. This is basic bookkeeping. I’ve overly simplified things, because I had to go someplace but you’ve just figured out what a lot of folks who get into a small business can’t figure out. In point of fact if Bob has sloppy books but is sitting on $300K worth of inventory, as far as the IRS is concerned (and until he can prove otherwise), he’s just made “income” of $200K and owes about $70K effective immediately. This again is overly simplified because we’ve already lost the majority of folks who want to have an opinion on these things dealing with wrong information. I could spend a few more minutes and gen up a company where the business ends up with $10M in “profits” and virtually nothing to show for it but the tax bill. This is the real world.
My fundamental point in all this was to demonstrate that it is entirely possible (in the real world where we all happen to live) for a company to show profit that seems excessive to some schmoe making $70K and because of the pass-through nature of an S-corp for all that income to look like “Bob” just put $10M in his mattress, even if that has nothing to do with reality and even if Bob has to mortgage everything he owns just to pay the tax man. This also happens every day, and is where guys like Warren Buffet get to pick up entire companies on the cheap. David buys into this myth thoroughly and he won’t engage with me because (A) his feelings are hurt or (B) he feels incredibly stupid now.
Don’t take my word for it, contact your local SCORE office and ask them about any horror stories in your town. You could ask CPA’s but they’re not supposed to talk about clients although they will gossip with each other till the cows come home. You might ask whomever about now-defunct businesses and whether the tax man had anything to do with the ultimate demise. The statistics are pretty daunting not to mention your odds are considerably greater of getting audited running a small company vs a large one.
Per Liberty’s point above that I don’t feel like addressing there, businessmen fear the IRS more than any other entity because the IRS will happily drive them out of business. It isn’t so much a matter of scale versus other expenses but the fact that they have unlimited resources at their disposal (including money the business is obligated to give them) and have zero interest in playing fair. This is just the real world and is yet another reason I prefer to remain anonymous on a site like this. I don’t want to bear the expense of continuous audits just because I pissed off the IRS.Report
Sounds to me like your fundamental problem isn’t with taxes, Ward… it’s with GAAP and what qualifies as expenses vs. assets.
According to general accounting principles, that $200K in inventory is just as good as cash.
Now, in the hypothetical you talk about here which is admittedly very stupid simple, the businessman is a fool. Not only because he is carrying all of his net worth in inventory (which is foolish in the extreme), but because he’s tied up all of that net worth in something that is considered a liquid asset when (to him, being a small biznuz dood) it may not be. He’s in the biz of selling stuff, he shouldn’t be carrying inventory he can’t liquidate in the next 30-60 days. If he *can* liquidate it in the next 30-60 days, then he really doesn’t care if the inventory counts as cash: when the tax bill comes due he’s already sold some of that $300K in inventory and he has plenty of cash on hand.
If he’s got $300K in inventory because he has a contract for $200K of deliverables in four months, he can get a loan on that contract, and pay his taxes. If he’s silly enough to make $200K worth of inventory on a verbal agreement, he can just as easily be screwed by his customer going bankrupt as he can by the feds.
But that’s not the tax man’s fault, nor is it properly really even GAAP’s fault; that’s the rules under which the game is played. The matching principle is there for a reason.
Let me put it to you another way: why do you think that inventory should count as a long term capital asset?Report
Pat, you’re not going to get anywhere with wardsmith.
You and I know that just like a dumptruck or an Arriflex, whatever tax liablity is incurred by inventory (or more accurately, the tax liability on earned profits then used to make capital investment or buy inventory), it come right back off again as Depreciation or Cost of Good Sold. And unlike capital investment, which prudently made may still take years to depreciate, only an idiot is going to be stocked with years worth of inventory.
Idiot or not, capital investment or inventory, what you pay in tax this year, you don’t pay in tax as those assets convert to a loss, either as depreciation or cost of goods sold, and are written off against future profits. If a business owner dumps their cash into trucks or cameras or 300,000 cans of beans and can’t bridge the gap till they see the loss on their P&L, either via depreciation or selling the goddamn cans of beans, well that’s just bad business, and has nothing do to with whether your running a sole proprietorship, LLC, or S corp. When you make money, you pay tax on it, whether you hold that money in cash, gold bars or navy beans.
Which reminds me, I’ve been working on an essay about externalizing vs. internalizing as coping strategies. People who blame their lack of business acumen on the IRS definitely fall into the latter category. More on that in an upcoming post, even though it will make James Poulos squirm!Report
Patrick, Please don’t presume to tell me anything whatsoever about accounting, GAAP or anything of the kind. You have not the background, knowledge nor experience to tie my shoes in these subjects. Same frankly goes for David. Furthermore I structured the hypothetical to teach YOU that that $200K in inventory is for all practical purposes – cash.
Your reading of what I’ve written has so often and so far on this subject been completely off-base, clearly you’re wearing your prejudices on your shoulder and then some. I never once said the “idiot” running the computer store put ALL his money in the store’s inventory. I merely (for the sake of the example and for no other reason) stated that he had cashed in a CD to purchase same. I also didn’t bother correcting your voluminous mistakes in your post #94 above (basically every word that followed): Correct me on this, if I’m wrong. I certainly may be. Consider it all deleted, it is not worth correcting line by line. You also don’t need to take my word for it, you work in a school of higher education, surely they have accounting there also (or is Cal Tech too highbrow for that?_)
Getting back to David’s OP, wherein he claimed that businessmen who were unwilling to part with 2% of the vast wealth when they’re “taking home” more than $1M needed to be corrected, which I tried to do. He whined that I was being condescending to him, and maybe I was, I was over-simplifying because I don’t know how complex he can handle. Perhaps I need to do my own OP and put in a full on financial statement to demonstrate that it is not only perfectly plausible, but completely COMMON for a business to have paper profits in the millions, which by NO MEANS WHATSOEVER indicates that said businessperson has taken home millions of dollars (even if that’s what the financial statements seem to indicate). This has nothing to do with signalling, nothing to do with internalizing nor externalizing this is simply the way businesses are run in this country under our rules and regulations.
Furthermore it is entirely possible that a well-run business operated by a knowledgeable and sophisticated businessman or woman can find themselves in a situation where the inventory (which looks to the IRS exactly like profit) might be worth substantially LESS than the profit already reported (gee too bad about your computers in inventory there are new models out and yours are all obsolete – yes we know the models were hot, yes we know you had tons of back orders from paying customers, yes yes yes and too bad). Once that inventory gets sold for a loss for instance in the FOLLOWING year’s books there will be a loss carryforward. But exactly how much might the individual get to claim, in the year immediately after they had for instance $10M in “earnings” (phantom though they may be)? If you guessed $3K you would be correct.
As for your questions at the bottom of 98, do I really need to get into the operation of phantom businesses and the best way to operate same? The OP is about jobs and job creation. The sad fact of the matter is 90% of all new jobs in this country come from small businesses. The other sad fact is 93% of all new small businesses are OUT OF BUSINESS within 5 years. It is difficult enough to succeed operating a company (yes, I’ve been successfully operating companies for over 30 years thank you very much and have had ZERO go out of business – so please, no dissing me on hypotheticals). Why compound the already difficult task with onerous legislation and taxes as McGovern found out to his dismay? This country needs jobs, small businesses create jobs, leave small business the hell alone.Report
Leave Britney Spears the hell alone too!Report
Furthermore I structured the hypothetical to teach YOU that that $200K in inventory is for all practical purposes – cash.
I knew that already. What does that have to do to your larger point?
Furthermore it is entirely possible that a well-run business operated by a knowledgeable and sophisticated businessman or woman can find themselves in a situation where the inventory (which looks to the IRS exactly like profit) might be worth substantially LESS than the profit already reported
Ward, if you are running a goods-based service, and you have sold and taken in as net sales $300,000 and after your COGS you show a net profit of $200,000 and you’ve gone and taken that $200,000 in cash and bought all-inventory with it and you have no cash on hand, I can only come to a few conclusions.
One, you’re relying on a warehouse line which you’ve already secured for easy access to cash (if the bank screws you here, we can get back to talking about banks). In which case you have cash to pay your taxes. Also the power bill.
Two, you might be a badass salesman, or a great contract negotiator, or a inventive genius rivaling Edison… but you are not a knowledgeable or sophisticated businessperson and you don’t know how to properly gauge the risk of keeping all your goddamn money in inventory that can depreciated below the level of profit you gained this last year.
I mean, come on, I did inventory management for a small computer shop two jobs ago. Knowing how much inventory to keep on hand (and what to only “stock” as special order, keeping open agreements with suppliers so that we didn’t have to carry the stuff but could get our hands on it in 24 or less) was basically my entire job. If the owner of the company doesn’t have this skill, he or she better goddamn hire somebody that knows the problem domain. You know what I don’t own a computer shop? Because it’s the most screwed, stressful, horrible supply chain subject to wild vagaries in both supply and demand and nobody in their right mind would run a place that couldn’t get a substantial quantity of repeat business from corporate buyers: in other words, you have to already have a network to even think about hanging out a shingle in that market.
Tangent to that last is Three, you’re in some business in some market where carrying large amounts of inventory is required for you to keep your customers happy. You are in a very high risk business in a very volatile market and if you’re aware of that and taking that risk, that’s your choice.
Four, some major market adjustment happened that was unforseeable by a knowledgeable or sophisticated businessperson in your particular sector. There’s a huge crash; you were carrying $5 million in something that is now worth $2 million. Well, now it sucks, but keeping access to enough cash on hand to pay your bills – including taxes – is kinda important if you don’t want to wind up declaring bankruptcy.
Five, you’re smart and savvy and you saw a potential for a major payoff that warranted putting all of your eggs in one basket: maybe a four-fold increase in profit due to a major deal, or cornering the distribution of whatever by getting every one of ’em in five counties in your warehouse, and something happens that screws you. Well, that’s basic risk management. You went for it. If you nailed it, you’d be taking that $10 million home not on paper, and still leaving $10 million in the biz. The market didn’t play out. Too bad, you’re broke. The fact that the tax man is bringing you the bill that broke your cash flow is again… your fault, though. I’m not going to say, “You’re greedy and you deserve it”, but I am going to say, “I respect your autonomy as a risk-taking businessman enough to let you fail with honor.”
Patrick, Please don’t presume to tell me anything whatsoever about accounting, GAAP or anything of the kind. You have not the background, knowledge nor experience to tie my shoes in these subjects. Same frankly goes for David.
Go stuff yourself, Ward. This is a blog. By its very nature your commentary is going to be limited in scope; I get that. If you’re putting up a simple example to teach me something I already know (not knowing I already know it), and I’m asking clarification questions, you copping an attitude and getting pissy at me is not something I’m inclined to take very well. I respect your desire for anonymity, but as a result you don’t get to claim shit from authority, all right? Unless and until you demonstrate otherwise, I’m going to assume you don’t know what you’re talking about on any subject because to do otherwise would be to grant you an authority you don’t deserve, and I’ve been bitten in the ass by that before in my life. I like you most times, that doesn’t mean I’m going to assume.
Are you trying to tell me that the feds count other things as non-COGS expenses? I know that too. Are you saying that there are particular cases where this can create a bind for a small businessman in a particular sector? I know that, too. Are you trying to lead me to a place where you offer a list of said things that you thing ought to count against sales to cut taxable profit? If you are, just get it out there.
I also didn’t bother correcting your voluminous mistakes in your post #94 above (basically every word that followed): Correct me on this, if I’m wrong. I certainly may be. Consider it all deleted, it is not worth correcting line by line.
I readily admit I’m not overly familiar with tax law, Ward. I think I pretty much put that up front.
If it’s not worth correcting line by line, then it’s not worth teaching me anything and you can take your “I know more than you attitude” and go walk. That’s fine, in and of itself: it’s not your job to re-teach me Financial Accounting. It’s also not your place to tell me I don’t know what I’m talking about and then not demonstrate why.
On the other hand, when you come to a thread talking about how you know this subject, I’d find your commentary a lot more interesting if you brought knowledge to the thread, instead of crapping in my milk.
I have met many the small and large businessman in my life and most of them over scotch have told me one or more of a long laundry list of ways that they’ve managed to completely legally keep some money in their businesses without breaking any rules and without having to declare a large amount of profit (admittedly, they could all be full of it, too). From the little I know of the financial (not tax) account side of things, the example I gave was hypothetical, I’m not entirely surprised if it was incorrect.
Perhaps I need to do my own OP and put in a full on financial statement to demonstrate that it is not only perfectly plausible, but completely COMMON for a business to have paper profits in the millions, which by NO MEANS WHATSOEVER indicates that said businessperson has taken home millions of dollars (even if that’s what the financial statements seem to indicate).
So what? Really, Ward, let’s say I have paper profits in the millions. Are you telling me that I can’t convert enough of that to cash to pay my tax bill? I’m sure this happens, but for crissake this happens to people who don’t run businesses, too.
Are you telling me that you think, in principle, that businesses should be allowed to retain (some) earnings and get a tax break on those earnings? Hey, that’s an actual policy proposal that we can talk about that might have some merit: I like me some growing businesses just fine. Good for the economy. Allowing a company to exist entirely with paper profits, indefinitely, I’m sure you can also agree is a really bad idea. Fraud and tax evasion and whatnot. There’s probably a middle ground in there somewhere.
The sad fact of the matter is 90% of all new jobs in this country come from small businesses. The other sad fact is 93% of all new small businesses are OUT OF BUSINESS within 5 years.
If 93% of small businesses are out of business within 5 years, when the S-Corp businesses are still paying a lower tax rate than they’ve paid in forever, I don’t see how raising or lowering their tax rate by 2-4% is going to have a significant effect on the failure rate.
I apologize somewhat for my attitude, but I’m on four days of less than four hours of sleep from meds and my temper is very, very, short. You’re out of fucking line, sir.
clearly you’re wearing your prejudices on your shoulder
Heh. “Schmoes” – your word – “who makes $70,000 a year”:
Frankly, I don’t care that someone can make $10 million a year. I make plenty of money, I’m way up in the 90s percentile-wise, well above those schmoes who still make more than 87% of the rest of the country. I live a very fiscally conservative life and I’m completely happy with it. This isn’t about class warfare, for me. Sounds like there might be a tad bit of it in there for you, though.Report
First of all Patrick, I hope you’re getting better. This disease thing of yours has been going on if I recall for most of the month of November when you were trying to do the nanomowrite. So I hope you get better, or consult with a different doctor if the one you’re working with isn’t getting you healthier.
I admit between David’s snark and a statement like this: Sounds to me like your fundamental problem isn’t with taxes, Ward… it’s with GAAP and what qualifies as expenses vs. assets. It got my Irish up a bit. Obviously I know accounting, obviously I know running a business and obviously I don’t expect you to take MY word on it, which is why I directed YOU to talk with an accounting prof right there at your school! I also produced links to back up everything I said, so to equate me with pretend lawyers leaves me a bit inclined to invite you to sniff some taint as well.
I’ll blame the lack of sleep (and furthermore blame the horrendous state of business education in this country) for you (and others) completely missing the most salient point here. S-Corps cause their owners to APPEAR to be bringing home major coin because of the pass-through nature of those returns. So when you look at IRS statistics talking about the highest INCOME users (the IRS is all about Income Tax), are you looking at investment bankers making multimillion dollar bonuses, overpaid actors cashing in, or small business owners, who on the advice of their accountants and lawyers have decided to organize themselves as S-Corps instead of C-Corps? Statistically I think you can guess at the answer.
Is there a class-warfare problem here? Absolutely and absolutely I’m concerned. Not just because I’ve acquired wealth but because I know others who have or aspire to, and they’re not all who you think. I mean if the fundamental issue here is a socialist meme that NO ONE DESERVES TO BE WEALTHIER THAN ANYONE ELSE, we’re all done talking. I know enough about drive and ambition and desire to understand why the Kaufman institute can show that since 1980 virtually 100% of all new (net) jobs come from new companies. Some of them are still small, some (like Apple and Microsoft) have grown quite large. The question we should be asking ourselves isn’t whether we can squeeze a few more shekels out of the next nascent Bill Gates or Sergey Brin, but what it is the best way to encourage them so they can create the jobs our children will need to prosper? Or do we just have done with it and stick a fork in the American Dream?Report
Mr. W. Smith it’s always a pleasure to read your enlightening comments in the face of librul ignorance.Report
First of all Patrick, I hope you’re getting better
Today is much better, actually. It’s raining outside and a lot of the crud that freaked out my allergic reactions is being washed out of the sky and off the lawns and down the storm drains. Which I imagine is not a big “horray” for the storm drain management guys, but it’s definitely improving my ability to breathe. Thanks!
Completely missing the most salient point here. S-Corps cause their owners to APPEAR to be bringing home major coin because of the pass-through nature of those returns. So when you look at IRS statistics talking about the highest INCOME users (the IRS is all about Income Tax), are you looking at investment bankers making multimillion dollar bonuses, overpaid actors cashing in, or small business owners, who on the advice of their accountants and lawyers have decided to organize themselves as S-Corps instead of C-Corps?
I’m not missing that point, my friend. I get it.
A corporate structure (S-Corp) exists more or less explicitly to avoid corporate income taxes, yes? That’s why it’s there? So that small businesses, where the proprietor is (in a very real way) employed by himself ...*can* avoid the corporate income tax by taking the profit as pass-through income. That’s the whole point of the existence of the S-Corp, if I’m reading the right information about S-Corps. If you’ve incorporated as an S-Corp (on whomever’s advice), you ought to be aware that this is how it is going to work.
Saying, “My preferred business model isn’t going to work with an S-Corp taxation framework”… again, why is this anybody’s problem other than the guy who filed for incorporation?
You’re not coming back to the conversation with an answer to my most salient point:
Let us assume, for the moment, that N% of small business owners are hoisted on their own petard by failing to manage their cash flows in a way that enables them to have dead Presidents on hand when the IRS comes knocking. I’ll grant for the sake of argument that (a) this happens and (b) it’s bad for society in general, particularly in today’s economy.
Okay, now aside from the fact that when it happens it’s still on the biz owner’s head for not managing his or her cash flows, what do you propose we do to give these people an out?
Should we allow S-Corps of a certain size to be able to treat a certain percentage of their retained profits *not* as pass-through income but instead as short-term (nontaxable) “semi-liquid” assets so that we enable these sorts of businesses to have a larger inventory? You hammered on this particular case a bit so I’m assuming you believe it’s a particularly egregious problem with S-Corps.
I can see lots of potential drawbacks to this approach (it will provide a very strong incentive for S-Corp owners to plow their profits into this class of inventory to avoid taxes and thus encourage them to take risks with inventory market depreciation they might not otherwise take, but maybe that’s an acceptable side effect here, at least in some industries). I’m absolutely open to this discussion and I think it’s a much more clear and reasonable conversation to have than arguing about the upper tax bracket and the unintended consequences of corporate structure on personal income filing status.
Again, this seems like more of a change in “How we allow S-Corps to account for profit, from a tax accounting perspective” problem than “Raising income taxes *in general* on the upper bracket might catch some of these guys out and we don’t want that right now.”
Not that I endorse the “class warfare” aspect of this discussion, really, but one further point, this is what taxes look like this year:
10% Bracket $0 – $8,500
15% Bracket $8,500 – $34,500
25% Bracket $34,500 – $83,600
28% Bracket $83,600 – $174,400
33% Bracket $174,400 – $379,150
35% Bracket $379,150+
Just over half the country makes between $27,500 to $29,999. So yeah, they’re only paying 15% (or less), but that 15% affects their ability to buy food in SoCal not to mention a lot of other places in the country. 87% of the country makes less than $70K a year (even that doesn’t qualify as a middle class income in Pasadena if you have a family). Shoot, a $140K double-income can be tough with daycare costs around here.
Now, it might be hard for a small business person with $10 million in paper S-Corp income and $160K in bring-home base salary to solve their cash-flow problem, I have no doubt of that. But the cold fact is: they have $10 million in paper S-Corp income. They have accounts receivable they can sell. They have inventory. They have access to business credit lines. They have collateral so that they can get loans at less than 22%, which is something completely out of bounds for people who make, say, $30K a year in most cases today. Maybe due to credit drying up they don’t have access to all of those things, right now, today – but that’s a problem with the banking system, not the tax code. Maybe due to a number of market factors they don’t have access to some of those things, right now, today – but that’s a problem with the fact that market forces aren’t easily predictable, not a problem with the tax code. But generally, they have access to multiple exit paths for their cash flow problem. And, if they don’t, right now, today… they’ve made a pretty bad strategic error in their business management because they haven’t accounted for the possibility that some of those exit paths might dry up.
And finally, they had the capability of deciding not to keep all $10 million in the business but actually disbursing enough to at least pay their taxes (which, I’m given to understand from the web site you pointed me to among others I read up on over the weekend is a standard practice in S-Corp incorporation bylines so that investors don’t get screwed if the guy in charge wants to keep all that $10 million in the biz). Any one of these things is an advantage that they have over that schmoe who makes $70K a year. Put them all together on a list, and its not entirely unreasonable to guess that the schmoe is going to say, “Embedded privilege! I don’t care that you didn’t take that money home, you could have taken at least enough of that money home to pay your taxes, and for crying out loud that’s more money than I will ever see in my lifetime busting my hump off writing code for 60 hours a week so frankly I don’t give a crap about you and your millionaire problems!”
That might be bad for the economy, but it’s eminently predictable human behavior and if you’re surprised by it (or expect it to change), I can only tell you that this is the way people are.
Someone(s) close to me works in the mortgage business. When the crash was approaching but most idiots didn’t see it coming, her boss did and he sold off the whole subprime division at a massive profit, and six months later that was almost worthless. They only write A-paper 30-year fixed loans, FHA, and VA stuff now. When he sold off the subprime division, he used the profits partially to negotiation a long-term warehouse line so when credit dried up (which he also saw coming) he had a nice contract that assured that he could still borrow money to turn around and lend. Most small mortgage companies didn’t do any of those things, and many of those small mortgage companies went out of business. I’m pretty sure that most of the people who were working at running most of those mortgage companies thought they were smart businesspersons and they probably still think, today, that they are smart businesspersons and they only got screwed by bad luck and maybe it’s all the fault of the tax man. Truth is, they were not smart businesspersons. Said person’s boss was a smart businessperson. He didn’t get drunk off the easy profits on the subprime business, he knew it was going to blow up, and he exited at just the right time to walk off laughing at everybody. If he had waited six more months because, gee, he was raking in $N million in paper profits a month, X% of which came from that division and he just couldn’t give it up just yet… not just yet… well, then he’d be in the same situation as everybody else.Report
First, I’m glad you’re feeling better, I didn’t know what it was but allergies can be a bitch. If you’re willing to try acupuncture you might even cure them completely. Mine are all (apparently) gone because he made “my stomach talk to my lungs”. That’s how it translated (oh, the best acupuncturists probably won’t speak any English). Yes I speak Mandarin, and when he said that to me, I turned to my wife and said, “What does he mean?” They proceeded to have about a 10 minute conversation in Mandarin of which I grok’d about 60% and at the end she turned to me and said, “Your stomach needs to talk to your lungs”. A few treatments later and 35 yrs of recurring suffering during allergy season was gone forever. YMMV but it was worth about 1000 times what I paid (not covered by insurance then BTW but only about $150-200 IIRC).
Second, you’re in the tall weeds about whether a person can afford their taxes. That was never my intent, up above I was invoking writer’s embellishment when I went into the “too bad for him” rant but that was all, it was a stylistic point, not at all germane to the conversation. I also didn’t want to get into the tall weeds on the details of my hypothetical such as being a computer store, I obviously picked computers as an easy target of a business that could conceivably acquire much inventory that would become essentially worthless overnight. Fresh out of college in the Carter years I went to work for a computer store (the economy was at least as bad then as now). My deal with the owner (a rocket scientist who’d previously worked for NASA) was that I would help him just long enough to pay off a “portable” computer (suitcase sized) that I wanted for my consulting business. About a year later I finally left, and got to watch him go through all the things you talked about above except there were no options then of 24 hr “stocking” and just in time purchases (which BTW is also what killed computer stores – because if they don’t have what I want on their shelves and are going to order it in, why wouldn’t I just order what I want online and save 20% plus the hassle?).
Third, see my response to Cheatham below.
Fourth, mortgage banker. I’m only curious in light of this OP whether he was organized as an S-Corp as 1/3 of Commercial Banks now are. They’re not just for small businesses you know. My own timing in getting out of the dotcom stocks at the peak of the market is partially intelligence and partially luck. In hindsight everything looks easy but reality is always different. I have a friend who got out years earlier than I did for exactly the same reasons and left about $50M on the table only clearing about $4M (we’d both sold companies for stock at approximately the same time).
Fifth (and I’m going to open one tonight after this OP and it’s going to be Maker’s Mark in honor of my good virtual friends Bob and Tom) Every businessman is going to utilize the best of whatever tax options are available at the time. During the Clinton years an S-Corp made less sense than a C-Corp because the individual rate was higher than the corporate rate. Make no mistake about this. If Obama passes a 2% tax on “small businesses” to pay for this 2% lowering of SS taxes businesses will adjust, they have no choice. Yes there will be some for whom this, plus Obamacare, plus banking ineptude, plus economic uncertainty, plus whatever else the gov’t decides to throw our way, will finally be the straw that breaks the camel’s back. Which brings me to
Sixth The wealthy in this country are not at all obligated to continue with business as usual indefinitely. Many here (none of whom own a business) want to yell at those who do to just suck it up and take their medicine. But it is a sad fact of we’ll call it evolution, that those who have been blessed by success or inheritance or both actually have the choice to fold up their shop, take their marbles and go home. That doesn’t do a lick of good for their employees who are now unemployed, but I’ve personally seen it happen dozens of times. Even my liberal friend was recently mightily chagrined when I reminded him in an email discussion wherein we were talking about the rich not paying “their fair share” that HE HIMSELF did precisely this! He had a highly successful training company, with 40-50 employees all making excellent wages and he shut the doors because as he and his wife said, “We are sick and tired of giving 1/2 our money to the government when we are working so damn hard”. They folded their tent and took their winnings home and he’s never had to work a day since. Yes he’s a millionaire but no he’s not a contributor to society like he once was. He really really wishes I hadn’t thrown that little tidbit in his face because it really really stung.Report
“I wrote “millionaire small business owners” rather than “small business owners who make $1M/year” because the former scans better.”
Unfortunately for your aesthetic sensibilities, the two phrases aren’t synonyms. As wardsmith pointed out at some length it’s entirely possible to “make $1M/year” but not have any actual money in the bank.Report
It’s also possible to make under poverty level, as a small business owner, and be a millionaire (land is worth money, ya know?). Ain’t that what one of our senators did, before he took to washington?Report
I’m not going to state my opinion on the whole S-Corp thing except to say this: Is the poor sad owner of the S-Corp paying more taxes than he would as a C-Corp? If no, then shut up. If yes, then reorganize as a C-Corp.
Seriously, this is getting a little screwy…if you can’t keep down the amount of ‘money’ you’re holding from the corporation down at tax time, then you’re either do it wrong and have crappy accountants or are in an industry where have to hold a lot of taxable assets and have mistakenly structured your business as an S-Corp when it should be something else.
But none of this has anything to do with employment, which obviously _reduces_ the amount of money the owner of an S-Corp pays income tax on. So the entire complaint is dumb to start with.
The idea that someone would see ‘Oh no, any money my S-Corp (aka, me) holds at the end of the year is going to be taxed slightly more than before…I better not hire those guys I was going to hire. Because either they’ll make me more money to help cover my taxes, or, um, they’ll make me less money than their salaries, reducing my taxes.’ If anything, this change in tax law would make more incentive to hire people, not less. At least if you were anywhere near a million in assets.
Really, for this premise to make any sense, you have to postulate that all businesses are exactly right at the peak of the Laffer curve, and are so perfectly situated that not only do the owners not want to ‘work harder’, but somehow they don’t feel like employing people who will work harder. It’s some sort of Platonic Ideal of the Laffer Curve, where hiring people is too much work even if they make more money.Report
Cheatham, you’re talking like someone who doesn’t own a business and doesn’t care how (or whether) it succeeds. For a SMALL business (re-read the title of this OP if you’ve forgotten already) it makes the most sense to organize as an S-Corp (or an LLC taxed as an S-Corp the difference is nil). The issue isn’t just the taxes, as David and others are correctly stating, they are just another cost of doing business. However, other costs aren’t typically a percentage of the action, but are relatively fixed (for instance rent isn’t tied to income unless you’re a retailer in a mall or department store). My point and the elephant in the room David Ryan is so studiously ignoring, is that an individual can appear to be “making” millions a year in “income” when that is merely an artifact of the structure of S-Corp tax law. He said, “This post is about the very, very small fraction of small business owners who pay themselves $1m/year or more” As far as tax returns are concerned, there are millions of taxpaying entities (read: individuals) who are in this category.
He has made the classic mistake of conflating PERSONAL income with BUSINESS income. The other issue is critical. A small business owner does NOT want to pay HIMSELF millions a year in wages. He wants to leave the money in the company, to grow the business and allow himself the opportunity to open more locations, hire more staff, pay down debt and get bigger still. The difference between the highest corporate tax and the highest personal tax is 4% (and is often less), and yet 99% of small businesses are organized to pay taxes as S-Corps, and have to bear multiple burdens just to save that 4% (and it could be less). Now you blithely say out of complete ignorance on the subject, “Is the poor sad owner of the S-Corp paying more taxes than he would as a C-Corp? If no, then shut up. If yes, then reorganize as a C-Corp.” .
Here’s a little guarantee. Revamp the tax code, eliminate the pass through advantage of S-Corps and watch the so-called rich (as interpreted in tax return information from the IRS) immediately disappear as every S-Corp reorganizes into whatever makes the most sense then. Same America, same companies, just vastly different (and immediately lower) status of “millionaire tax returns”.
I strongly recommend that ever single person still reading this OP (especially YOU David) read this testimony to Congress from a small business owner.Report
He has made the classic mistake of conflating PERSONAL income with BUSINESS income.
But that’s not a mistake, Ward. That’s what the vehicle itself is designed to be!
The other issue is critical. A small business owner does NOT want to pay HIMSELF millions a year in wages. He wants to leave the money in the company, to grow the business and allow himself the opportunity to open more locations, hire more staff, pay down debt and get bigger still.
That’s kind of what David’s OP was talking about, as I read it, with these paragraphs:
When you take money out of your business as salary it gets taxed and it’s buying power is reduced, as in the example above. You divert $285K from growing your business, but you only actually end up with another $180K to spend.
By contrast, if you use that money to buy more money making assets for your business you get 100% purchasing power, and you’re buying things that make you more money. (And if you’re making $1M/year or more, you’re obviously someone who does a pretty darn good job of deciding when to reinvest in your business, and when to take the money out as salary and take the tax hit.)
Now, some things you might buy for your business might count as expenses and some might not, but David’s point was that the smart businessperson buys stuff that counts as legitimate business expenses and thus cuts into end-of-year profit (taxable income) while increasing net business value. At least, that’s how I read these two paragraphs.
This is why David’s hypothetical small business owner doesn’t typically have all of that declarable profit at the end of the year, so there isn’t as much pass-through income.
They’ve hired someone. They signed a lease for a new location. They bought capital equipment. All this stuff counts as legitimate business expenses, usually (at least, that’s my understanding, I haven’t read all of Publication 535 (2010), Business Expenses).
Aside from holding onto *cash* or liquid assets counted as cash (inventory), are there a large number of expenses that aren’t allowable under S-Corp rules, by the IRS?Report
When you take money out of your business as salary
I don’t need to take another single step because everything wrong with Ryan’s OP is indicated in the word I’ve highlighted every way I could to get it into your head (and anyone else still reading this). Even Ryan’s own replies to me indicates he still thinks this way, showing that he’s likely personally organized as a C-Corp and likes to take as much money out of the company as salary that he possibly can. I’m not going to get into his hypothetical, nor try to figure out why his protagonist makes $25K per month but only $250K per year, but can only assume that when you work for yourself and choose to pay yourself that much, by damn you can take a couple of unpaid months off for vacation! To the rest of David’s points and my responses above, you have to consider the sources of funds that purchases those new assets. There are 3, paid in capital, borrowing or profits. Ryan pretends a business owner takes the money out as salary, then decides whether to put it back in as paid in capital. Ryan is wrong. Leaving the profits in the company is the only intelligent approach, not least because of payroll taxes (his 2 week IRS dealings, having nothing whatsoever to do with quarterly estimated returns). I wish his business the best but as an accredited investor I wouldn’t put a dime into his yacht company if he operates it as he seems to.
There are thousands of pages of tax code, I don’t feel like walking anyone through them. We have a number of lawyers posting here at the League and a doctor or two who have passed their respective bars and boards. However, the CPA exam has a much higher failure rate than either of those two not because the math is difficult (it is trivial) or because the test takers are stupid (5 yrs higher ed minimum over 50% with advanced degrees) but because the rules are ridiculous and complex. I know several attorneys who specialize in bankruptcy law who figured they could pad their resume (and billings) by adding a CPA to their JD. Of the ones who stuck it out, they invariably have said the CPA tests were considerably more difficult than the bar exams.
By identifying inventory I was trying to keep things stupid simple. There are an infinite number of ways to make things more complex but why bother? Economics is tough enough and business is what drives economics. The sad thing is so many of our pundits don’t know squat about either.Report
According to my dad, half the problem with the CPA exam is that it’s not “are you smart enough to do this” but rather “have you learned the canned procedure for dealing with a situation”. There are questions which have multiple “right answers” but if you don’t pick the specific one they want you get the question wrong. There are questions that have an identical answer stated two different ways, and if you don’t pick the specific one they want you get the question wrong.Report
Hrumph. Seems like what wards is talking about is dodging corporate tax rates — which is fine, fwiw. However, I don’t mind bouncing up business tax rates a bit. Seems to me that isn’t such a bad thing.
Then again, I know a guy who’s run about ten times the number of businesses ward has.Report
According to Harry millionaire job creators don’t exist, how funny. I wonder who creates jobs then, I guess only the gov’t creates jobs?
http://www.realclearpolitics.com/video/2011/12/12/reid_millionaire_job_creators_are_like_unicorns_because_they_dont_exist.htmlReport
I would love to hear an explanation of how a person “creates jobs” using nothing but capital, in the absence of demand, skilled labor, raw materials, and infrastructure.Report
Liberty60:
How do you expect to get skilled labor, raw materials, and infrastructure without capital to begin with? Come on, that is econ 101.Report
Wow, this is a chicken and egg dilemma we have, isn’t it?
Its almost as if “jobs” are the product of the convergence of skilled labor, raw materials, and infrastructure, with adequate supply of capital and a strong demand for the end product.
I know that I am naught but a humble architect, and woefully ignorant of the bidness world, but it sounds to me like there isn’t any one of these job creation factors that is the single source of job creation.
So maybe there isn’t any such thing as a “job creator”. But maybe one of these Galtian ubermench financial wizards like Jon Corzine can explain it all for me.Report
Capital is the fuel that drives everything else. Fuel alone isn’t that interesting (although in a pinch you could burn it to keep warm) but coupled with the other elements of labor and infrastructure, raw material and demand, well now you’re cooking with gas!
As a “humble architect” you realize that without capital, the buildings you want to design are just castles in the sky no? Without capital there is no point in accumulating the raw materials needed to build said buildings, nor acquire the skills to put those materials together nor develop the infrastructure (including your firm) to develop those skills. In our society at least, capital comes first – there is a precedence order to these things.Report
OK, I am with you here. That capital plus labor plus other stuff creates jobs.
Capital is the all purpose fuel that we use to do things.
But does it really come first? Either sequentially or in order of importance?
Does a real estate investor go to the bank and say “I want cash to build some an apartments, and thereafter there will be demand for housing?”
Or does he say, “There is demand for housing documented here in this market study, and therefore I want to construct a building with this group of skilled laborers, facilitated by these roads and suppliers and government infrastructure services here there and the other place, all so as to serve that demand.”
When people go around saying that those who hold capital are, alone given the lofty title of “job creators” it sets capital in a privileged place, more important to society than labor or skill or infrastructure.
It logically leads to making holders of capital a de facto aristocracy, “more equal than others”. An example being the idea that income earned from capital is taxed less than income from labor.
In your example, the people who rent those apartments are ultimately the ones who “created” the jobs since they are the ultimate paymasters who paid for the land, wages, taxes and interest.
But I would maintain that job creation is the end result of a confluence of factors, many of which you listed, all of which equally important.Report
Liberty, good points all. I still have to say capital uber alles (definitely not to be confused with Das Kapital). Enough “fuel” cures a multitude of sins. As a case in point I give you Amazon.com
During the dotcom era, Amazon was one of the early darlings as you’ll recall. However, running the numbers on the business (as I did), you could quickly come to the conclusion that there weren’t enough book readers, let alone book buyers to justify their market capitalization. But here was Bezos sitting on billions in cash and the ability to borrow billions more based on that market cap. And a funny thing happened along the way to apparent insolvency. Amazon diversified using that big pile of cheddar otherwise known as capital.. Today books are only a sideline to the company. They are actually an incredibly successful fulfillment company. Uncounted small retailers utilize Amazon as their complete frontend and backend. Amazon hosts their websites, carries their inventory and delivers same on what is admittedly a state of the art automated warehousing and fulfillment system. Had they stayed with books alone, they would most certainly sit on the trash heap of failed dotcoms or be 1/100th their current size.
There are other examples of “build it and they will come” success stories, I could have shown you some real estate examples but would have gotten in the tall weeds pretty quickly and assuming anyone is still reading this old thread, would hate to have lost them.Report