Archive for December, 2009

There is a big secret about the American tax law, a tragedy in fact.

That is of the great tax advantages (especially to those in high tax brackets) of cooperative ownership of assets, especially of otherwise personal assets.

These tax advantages are known to joint owners of airplanes, jets, yachts, time-shares.

Basically, the way it works is a pass-through entity (a limited liability company) forms to offer a time-share in an airplane say, a luxury. In most cases a private airplane is a personal asset, with no prospect of tax deductions (especially for those subject to the alternative minimum tax, and most are subject to the phase-out of itemized deductions).

That entity then functions at break-even for expenses, charging rents that correspond to the proportional costs to own the plane + a percentage and spins out an annual cash dividend. But, for tax purposes, the entity breaks even on paper, thereby giving tax deductibility treatment to what would otherwise be personal expenses.

The treatment can apply to luxury yachts, cars, time-shares, fashion, RV’s really any assets that are financed, depreciate, and must be maintained and insured.

These entities benefit the wealthy most obviously as the difference in taxation on a luxury yacht can be tens of thousands of dollars per year. (Thats actually the smallest portion of their tax planning, but worth their lawyers and accountants time to set up.) The tax features pass through before itemized deductions so there is no effect of the phase-out of itemized deductions, and are not then subject to alternative minimum tax adjustment.

For those interested in grass-roots cooperation and sustainable society resulting from cooperation, the tax benefits still exist (but applied at lower tax rates), even though the cooperation itself is the more important feature.

For sustainable advocates, car and truck-sharing/rental is also relevant, tool-sharing,/rental, outdoor equipment (canoes, boats, skis, bicycles), entertainment equipment, kitchen equipment, computers, games, libraries (public libraries are better), furniture, vacation time-shares.

For adept tax planners for those wealthy with a charitable interest, there are also ways to achieve tax deductibility of charitable contributions that would otherwise be phased out, by contributing the donations to an LLC that only rents equipment or other assets to charities at cost, but realizes tax losses on the equipment used.

It amounts to scheming in the public interest. So many scheme in the private interest of their clients. Its worthwhile to take advantage of the same tax benefits for the public, even if the tax significance is a smaller portion of the weight of concern.

Cooperation for its own sake, for community building, but also for tax purposes ironically.

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There has been a great deal of press in the last couple years about the alternative minimum tax.

The alternative minimum tax is an alternative taxing methodology that ALL taxpayers are processed through. The tax that people pay is the greater of the tax computed by the alternative minimum tax method or the conventional method. The alternative minimum tax in 2008 affected a large minority of taxpayers (maybe 15%). In 2009, that number will be much less. In 2010, without revision to legislation, the number will be large (maybe 30%), so the impact really depends on emergency or more permanent legislation.

For decision-making, that uncertainty of tax law is a disaster. WHO will make a significant decision if the tax consequences can vary from incidental to profound, depending on what is enacted or not.

One valid criticism of the current economic setting, and stated reason that the recovery has not been as robust as it could have been, is the ambiguity and unpredictability of prospective future tax law. Risk is a BIG factor in economic decisions, and the inevitable volatility of American tax law puts business in a very uncomfortable position.

Tax consistency is a greater stimulus to economic growth than tax breaks, however they are structured.

The alternative minimum tax is the conservative’s dream. It is basically a flat tax with a high tax exemption. There are very limited itemized deductions allowed.

I actually like the alternative minimum tax mode, with some modifications: most importantly a progressive tiered rate structure rather than the near-flat structure currently.

The reason that it is hated is mostly because it is unexpected when it kicks in, and ignores and/or punishes tax planning based on the conventional method.

Its a car dealer selling you a car that you didn’t want originally on false pretenses, that you would like if that was what you were shown by the dealer.

There are many tax strategies for those that are in the range where they are subject to the alternative minimum tax, that are counter-intuitive to the regular tax strategies. One strategy is to intentionally alternate years subject to the alternative minimum tax and time deductions (tax payments, charitable deductions) either in the tax year (conventional tax strategy) and delaying tax payments and charitable contributions in the year adopting alternative minimum tax strategy.

It distorts economic policy to have such confusing and counter incentives within the two tax regimes, and should be simplified. Originally, the alternative minimum tax only applied to less than a 1000 taxpayers who had enormous benefits from tax shelters. Now, the alternative minimum tax applies to 20,000 times as many taxpayers. You know one or two or ten. If you live in New York or Boston and are a lawyer, most were in 2008 (less will be in 2009).

A single system is necessary, but with Congress’s proclivity to regard the tax code as a form of governance, even a simplified single system would likely grow complex and unwieldy.

Accountants have a routine introduction to EVERY year’s professional tax education. That is that Congress in their wisdom sought to again enhance tax professionals’ income by making the tax code more and more complex thereby requiring professional help for the majority of taxpayers.

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My second gripe with the American tax system is the unfairness of itemized deductions.

Some of the inherent unfairness in that system were addressed by the phase out of itemized deductions at $167,000 adjusted gross income. But that and other phase out periods created other injustices in the form of progressive, then regressive marginal tax rates at upper middle class income levels.

What’s wrong with a deduction on medical expenses, home mortgage interest, charitable contributions, state and local taxes, casualty losses, employee business expenses?

There is nothing wrong with employee business expenses or probably on ininsured casualty losses. Employee business expenses should not even be considered an itemized deduction, but should be analagous to a business expense (an expense necessary to earn the income) and be deducted directly before itemization.

On the others there are three major things wrong.

First, they unfairly benefit individuals in higher income tax brackets, or in other terms, the wealthy over most working people. The tax result of the itemized deductions can be thought of a federal subsidy of the behavior. So, for example, the federal government functionally subsidizes 15% of the mortgage interest on a middle class working person (their marginal tax rate), while subsidizes 33% of an upper middle class working person making $150,000/year.

Why should the federal government pay 33% of a wealthy person’s mortgage interest, while only 10% of working poor? If the purpose of the deduction is to encourage home ownership, wouldn’t it make sense to subsidize ONLY the interest of first-time homebuyers, and that in the form of a fixed percentage credit, rather than a variable percentage deduction?

The same logic applies to other personal choice/necessities for charitable contributions. Why should the federal government pay 33% of a rich person’s charitable contributions, but only 10% of a working poor’s? Or state taxes, or medical expenses?

If those federal subsidies are to be considered net helpful, valid, why not convert them to tax credits rather than deductions?

The second aspect that is wrong with itemized deductions on medical and mortgage interest in particular, is that of unintended economic consequences of the deductions.

With home mortgage interest, while stated to be intended to encourage home ownership (and juxtaposed against the business deductibility of rental interest), the functional affect of the home mortgage interest deduction is to raise the prevailing market price of homes. So, rather than make home ownership more affordable, the affect is to make it less affordable. To compound the tail-chasing, with the exclusion of $250,000/person gain on the sale of a home, the federal government encourages a bubble in house prices.

Similarly, in medicine, the itemized deduction functions as an inflationary feature, rather than as a help towards the availability of health care.

The third aspect that is upsetting associated with itemized deductions, especially associated with charitable contributions, is the concept of funding authorization without representation. The itemized deduction at the taxpayers’ discretion amounts to the federal government paying for the taxpayers’ choice of charity.

Directly, the federal government cannot legally support a church, but through itemized deductions on charitable giving, the federal government does do so. It does so on the basis of the donors’ choices, not on the basis of representative legislative process. It ends up resulting in “public expenditure without representation”.

There are MANY ironies associated with taxation. One that I experience as a professional, is that I can deduct expenses associated with professional education towards the income that I receive for professional services. In contrast, my son cannot deduct the expenses associated with his pre-professional education, though associated with his professional training to offer his services.

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There are a number of features to the tax code that I find distorts fairness and sustainability.

The primary feature that currently does so is the preferential treatment of income from long-term capital gains and from C-corporation dividends.

Currently, an individual that derives all of their income from work, either as an employee or self-employed, functionally pays MUCH higher income tax rates than those that derive their income from dividends and long-term capital gains (and municipal bond interest, which is not taxed at all).

A married couple that makes $80,000/year from their work (say two kids), will have adjusted gross income of $80,000, less standard deduction of $11,400, less  exemptions of $14,800, for taxable income of $55,800. There tax would be $7,539 less child care credit of $2,000, or a net federal tax of $5,500 plus social security taxes on the $80,000 of $6,000 or total taxes of $11,500 (14.375% average rate). (If you include the employer’s portion of social security, the tax is $17,500, or 22% of earnings).

In the modern world, $80,000/year of family earnings is middle class. It costs that much to live in any level of moderate comfort.

In contrast, an individual or family that earns $80,000/year in dividends, and gains, on the same $55,800 of taxable income, would pay $6,370 in taxes or 8% average tax rate.

A working person pays close to 3 times the average tax rate as someone that earns all of their income from investments.

From another perspective, a person that chooses to invest the $1,600,000 that they likely have to realize a 5% return to result in $80,000 net income, into a new and innovative business that produces real earned value, and realizes $80,000 in Subchapter S spin off income would pay $6,370 in annual federal taxes compared to $5,500 if they invest their income in pre-existing dividend paying securities.

In effect, the current tax law discourages investment in productive income earning enterprise, compared to speculation in pre-existing securities.

So, at a time when investment in new models of enterprise that realize energy and pollution savings, and other social goods (including regionalization of value-adding economy), such investment is discouraged.

Ironically, this was proposed and passed by conservatives in the name of encouraging investment in domestic productive activity.

Another irony of the reduced capital gains and dividends rates, are that tax-deferred retirement plans don’t currently offer the extent of tax benefits that existed when originally proposed. Specifically, if one were to hold investments outside of an IRA, and realized dividend or capital gain income, they would be taxed when withdrawn at a maximum of 15% (0% for many), while when currently withdrawn from an IRA, they are taxed at the individual’s marginal tax rate (15%, 25%, 28%).

There is still the tax benefit of the deferral of the original contributions, which is a significant benefit. Alternatively, if the current rate structure remains in place, the Roth IRA is a better choice for working individuals. (Income within a Roth is not taxed at all, not the capital gains tax nor the regular rates.)

The provision of reduced tax on capital gains and dividends will sunset (expire) after 2010. It is inevitable that some significant tax legislation will be enacted before mid-2010, but it is anybody’s guess what that will look like.

Politically, the year before an election (2010 House elections), politicians are very reluctant to enact any legislation that could be considered contreversial. Tax legislation originates in the House Ways and Means Committee. If there is any legislation that is contreversial, it is comprehensive tax overhaul.

On attribution of tax rates, I favor parity between all forms of income, including elimination of ALL tax-exemption (even municipal bonds). In that way, individuals don’t have the latitude to play games with the type of income.

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I was staggered to discover how much of my income I paid in taxes. I’m developing an accounting practice, as self-employed, so 15% of my income goes for social security taxes, 25% for federal income taxes, and 6% for state (46%). Plus $3,000/year in property taxes, $200/year in car excise taxes, maybe $400/year in sales taxes. Its really a considerable amount.

We get a lot from governmental expenditure, and at the same time much of it is squandered or worse. We are taxed highly to fund an aggressive military. We are taxed highly to fund an automobile-centric “culture”.

I’m astounded that we pay hundreds of billions of dollars annually to fund military efforts in the Middle East, largely to support our oil habit, and to keep it a wasteful oil habit. Even GW Bush referred to dependance on oil as an addiction, but one that we are not healing ourselves, nor seeking nor getting assertive intervention.

For an individual trying to live a sustainable lifestyle, at least partially motivated by humanistic values, it makes sense to legally save as much on taxes as is possible, thereby controlling him/herself the use of the funds earned.

Advice to individuals and families. It is very useful to develop mentorship relationships over a life, with experienced financial people (friendships, networks, or professionals) to realize  comfortable income and wealth, and to pay a moderate amount and % in taxes.

In spite of paying high tax rates, the US does not provide a confident safety net.

Tax planning and considerations are most often custom to the circumstance, age, current financial status of the individual, so there are advantages of working with a professional that you can be entirely candid with, and can hold to high professional standards.

You can demand that that professional work for you.

I suggest that personal tax planning, attempting to save money, be understood in the context of individual, familial and social ecological goals.

I mean that although I do tax consulting for a living and my relative success at it is in saving taxpayers money on their taxes, currently and over time, I still experience some discomfort in working with financially successful individuals that are minimally charitable, or only consider financial return in their investment decisions.

In other words it is only useful to preserve capital or income, to order to use it well.

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How do we know if public policy is effective at improving lives? How do we know if our charitable and socially responsible business efforts improves lives? Or, are we just kidding ourselves, trying to make ourselves “feel good” rather than “be good and feel good”?

In yogic teachings there is a theme of “subjective approach, objective adjustment”. I wish I knew exactly what that meant. I know how I interpret the slogan. I acknowledge that I “self-talk”, I subjectively theorize, I propose, I endeavor, followed by objective consequences and feeback, which refines my subsequent endeavor and my experience of it.

There is a movement afoot to measure “Gross Domestic Happiness” by some quantitive metric, compile “objective” data on the effects of public policy, charitable efforts, socially responsible business efforts. There are a few different models applied on a national scale, for different political purposes.

One is to take Gross Domestic Product (the measure of market value of value-adding exchanges in a jurisdiction), and adjust it downward for identified negative externalities, and prospectively upward for positive externalities. This is a confusing exercise to say the least. It is unclear what to measure, how to measure the economic impact into some translatable currency definition, or even whether an economic impact is positive or negative. That confusion has led many economists to throw up their hands and just state, “we can’t quantify that” and guide policy decisions to be based on incomplete fundamentally incomplete data.

(This resembles the Sufi Nasruddin story. That is Nasruddin was seen scouring a street obviously looking for something. A friend asked him, “what are you looking for? where did you lose it?”

“I lost a coin inside that dark building.”

“Then why are you looking for it out here in the street?”

“Well, there is not light (data) in there, and there is light (data) out here. I thought that I would have better luck out here.”

GDP does not measure comprehensive social enjoyment, experience.

A contrasting methodology identifies components of levels of personal “happiness”, compiles a score for individuals, adds the scores of those or statistically significant samples of individuals, and defines the “gross happiness” of a community, micro-region, macro-region, planet.

The one that I am most attracted to, and participated in the formation of the metric, applies Maslow’s heirarchy of needs, to define what would otherwise be skew criteria.

The metric applies subjective judgements as to the relative importance of different scales of Maslowian criteria.

Maslow’s heirarchy includes:

Current and short-term survival – To what extent are you confident that you will be able to meet your needs for the next six months?

Long-term security – To what extent are you confident that you will be able to meet your needs and be safe for the next 10 years?

Belonging – To what extent do you feel loved, connected to family and community, accepted?

Esteem – To what extent do you feel that you have earned pride and the respect of others?

Self-actualization – To what extent do you feel that you are accomplishing what you are on the planet to do? To what extent does your work match your natural affinity? To what extent do you enjoy life?

Meta-actualization – To what extent do you feel in a dynamic harmony, at ease, in a state of flow in the world, dancing?

The algorhythm is more complex than I can easily describe here, though is not rocket science.

The weighting of each is the value judgement, and has political implications. Intelligent, moral, committed individuals hold very differing assumptions about the weighting of each criteria, and even if those criteria are in fact heirarchical, complete, or useful at all to measure individual and/or collective well-being.

I do value successful meta-actualization and self-actualization as more important, a higher quality of enjoyment or experience value, than survival. And, that creates elements of class distinctions, some privilige, conflict.

It is a metric that values comprehensive well-being more than literal equality. At the same time, the metric defines a condition of excessive inequality as necessarily resulting in a considerably lower cumulative social level of well-being.

The purpose of developing a metric at all, and particularly a metric that many agree is actually descriptive of human welfare, is that it allows for the determination of the effectiveness of public policy, socially responsible enterprise, charitable efforts, etc.

One ommission of the “gross happiness” metric is that it does not incorporate any social value for  any existential rights of other species (to habitat). The metric and questionnaire (in development) does incorporate the effect of nature on other human experienced needs/values.

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Those of us with net worth at all are capitalists (not that we subscribe to the ideology that capital exclusively should control and profit, and that workers should only labor). We are capitalists in the sense that we have the legal and personal rights of capital, the liberty to use our assets in the manner that we intend.

We can individually choose to just hold the capital in some form of money, or we can choose to make it available for others’ use either directly investing or loaning funds, or contributing our capital to corporate firms that invest or loan funds. (Most “investment” in pre-existing securities is not investment really, but actually speculation in that we are not creating or facilitating anything new but only seeking gain on ownership shares.)

The advantage of investing and loaning directly from our own volition, is that we can put the money to uses that we support, that we want to see happen. The disadvantage is that most of us are NOT financially savvy, certainly not sufficiently to assess whether a business or project is prospectively effective, profitable, humane. So, we delegate that responsibility and control to banks, to mutual funds, to venture funds, to trusts.

Even in our delegation, we are the individuals responsible for the use of the capital, but often NEGLECT to fulfill that responsibility. We JUST delegate and most often entirely on the basis of maximum financial return, with no other consideration.

Even though I think of myself as an educated, morally responsible individual, my own retirement investments are in broad based indexes. I manage them solely on the basis of return relative to market uncertainty.

Even the common sense of portfolio balancing neglects the moral responsibility of capital. It works for the “investor/speculator” in protecting from risk while still realizing market gains, All regulated finance professionals must now subscribe to the conventions of portfolio balancing. (That’s not all that personal financial planners, or investment managers do by any stretch.)

There are currently many good ways for those with net worth to put their capital to socially productive use. There are screened portfolio funds that eliminate certain investments from the pallette of funds that they invest in. There are assertive venture and sector investment funds that identify specific types of enterprises to contribute to. There are community loan funds that make loans available to communities for which capital is not naturally attracted.

These are not inconsiderable in our economy. Often large pension organizations, endowments, foundations and others adopt screens and assertive investing strategies to make good happen, not just return (usually seeking both).

Foundations are potentially especially effective in realizing good in the world, as they can BOTH invest in efforts that further their stated mission, AND contribute charitably to efforts that fill in the cracks or facilitate the development of new institutions.

There is a new generation of social investment efforts that take a step or many steps forward towards assertively and responsively addressing the social problems and efforts that are apparent in the world.

There are many causes to social problems. One key observation (without identifying an institutional cause, though I have my explanations) is that there is a constant migration of capital from working people to large and largely institutional owners (from work to ownership) and from rural to urban.

Communities that are able to develop a porfolio of competencies in their regions, that realize a significant amount of inter-regional trade, can thrive. (There is a down side of accompanying inflation in housing costs.)  Those communities that are dependant on resources, skills, exports in a single company or industry, are more vulnerable. With the globalization of capital and trade, even a region that does very good work, can lose their industry to regions, mostly overseas, that might not even do as good work, but can do it cheaper.

Domestically, the economy migrates to performing services for capital (either investment, professional, or business-to-business trade) more than goods and services for use. Typically, there is then inflation in securities and even commodities’ prices as there is limited available paths for productive use of capital, and money drifts to speculative bubbles.

It takes assertive efforts to affect an alternative outcome. It takes creation of purchasing power regionally, to create any viable economy (even if temporarily inflationary). It takes intentional guidance of capital to every macro-region and micro-region, to realize universal prosperity. And, politically, it takes recognition that the current emphasis on global marketplace and unregulated competition has destroyed macro-regional markets. (Detroyed more markets than were created, ironically.)

As siting production decisions are so cost-driven, even a currently thriving developing region is not confident that their recent development will last more than a generation, as firms may then move to find the next cheap site. (I saw it in my family business – grandfather’s and then father’s and then mine, in which clothing manufacturing migrated from New England, to the Midwest, to the South, to Guatemala and Santo Domingo, all in two generations.)

Those individuals with capital that note that that migration of dirty and exploitative manufacturing migration is NOT an example of sustainable or healthy society, need another vehicle, another institutional form that can confidently fund regional economy/society in a relatively stable, and therefore controllable manner to realize universally convivial communities, with optimal employment opportunity. A place where families can LIVE for more than a single generation.

Common Good Finance is attempting to construct one leg of that model. For capital, the Common Good model emphasizes preservation of capital more than aggressive growth, “Slow Money”. It is conceived as prospectively creating common banking services (CD’s, checking accounts, loans). The model includes features that construct community guidance over lending priorities, that are simultaneously socially good and financially prudent.

The model incorporates features of the Mondragon cooperative network, that creates/insists on a collaborative and intimately accountable relationship between bank and enterprise.

Its design incorporates the establishment of local currency accounting, thereby creating purchasing power locally, based on community intimacy and accountability.

The model doesn’t do everything to create universal prosperity, but it does resemble a/the form that social responsible banking needs to to realize universal regional prosperity by transformation, not revolution.

More later.

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