Trump’s Taxes

Four years ago, Republican Presidential candidate Mitt Romney severely criticized 47% of the American people. He said, “These are people who pay no income tax. 47% of Americans pay no income tax.” They are wholly “dependent on government,” and taxpayers will “never convince them they should take personal responsibility and care for their lives.”

So let’s fast-forward four years. Does Romney’s Republican Party still support the notion that people who pay no income taxes are failing to take personal responsibility and care for their own lives?

Apparently not. In response to the New York Times’ story that Donald Trump may not have paid income taxes for two decades, Republican Mayor Rudy Giuliani claimed that “The man’s a genius. He knows how to operate the tax code …” And Republican Governor Chris Christie concurred that “there’s no one who’s shown more genius …” than Trump.

So which position is correct? Is a person an irresponsible, uncaring free-loader when he doesn’t pay income taxes? Or is that person a genius? For some American politicians, the answers to those questions appear to depend on whether the person is an ally or a foe.

Nevertheless, it may be helpful to consider the facts that we actually know about the Trump tax situation. And, in turn, we may consider (or perhaps reconsider) a central presumption that serves as a foundation of our tax code.

Let’s begin with the fact that the Times revealed pages from Trump’s personal tax returns, and not from his business tax returns. That fact casts a harsh light on Mayor Giuliani’s assertion that Trump “had no choice but to utilize” the tax deductions.

Why does Giuliani believe this? Because, according to the Mayor, “If he didn’t take advantage of those tax deductions of tax advantages that he had, he could be sued, because his obligation as a businessman is to make money for his enterprise and to save money for his enterprise.” Furthermore, claimed Giuliani, these plaintiffs would be “investors in his business, people who loan money to his business, banks that loan money to his business.”

That argument would make perfect sense if Trump declined to claim deductions on his business tax returns. After all, his business stakeholders are impacted by the tax liabilities of his business. But his stakeholders are never affected by anything that Trump chooses to claim on his personal tax returns. That’s why the Mayor’s argument is simply not correct.

And yet Giuliani’s argument raises an interesting question. Why does the tax code allow a business loss in one year to eliminate tax payments in other years? Why should one year affect any other(s)?

The answer to that question reflects a fundamental assumption that underlies our tax code. Although we all file taxes on an annual basis, the code does not presume that a year necessarily reflects an appropriate period of time to determine the profitability of a business.

Here’s a simple example. Let’s assume that you open a business on December 30th, and that you spend your first dollar on December 31st. But you don’t earn your first dollar until January 1st.

Have you made a profit during those three days? Well, no; you haven’t done so. Simple arithmetic calculates that a dollar of expense and a dollar of revenue yield no net profit. And thus, based on common sense, you would pay no income tax.

Now let’s assume that your tax year ends on December 31st. For the period ending December 31st, you would file a tax return that shows no revenue and a dollar of expense. And for the subsequent period, you would file a return that shows a dollar of revenue and no expense.

Should you pay any income tax on the dollar of revenue that you earned during the second period? Again, based on common sense, you wouldn’t do so. After all, the December 31st filing cut-off date is an arbitrary one; you still haven’t earned any profit in total during those three days.

This illustrates a core premise of our income tax code. Namely, its tax period cut-offs are arbitrary dates that do not affect the overall profitability of an entity.

Therefore, if a businessman loses $1 billion in a single year but earns $50 million a year during the twenty year period surrounding or following it, he would earn no profit during the entire twenty year period. And he thus needn’t pay income tax on the $1 billion of revenue, given the aggregate $1 billion of expenses in other year(s).

To be sure, it is not correct for Trump’s Republican supporters to say that he could’ve been sued if he had declined to claim his business loss on his personal tax return. And yet it is also not correct for his Democratic opponents to claim that he is not “paying his fair share” of taxes.

So which side is correct? Well, neither side is correct. And in a political year when each side simply wants to win at any cost, it may not be surprising that no one is bothering to ask whether a central tenet of the tax code is itself correct.

The Congressional Busy Season

As you probably already know, the current United States Congress ranks among the most dysfunctional in history. Given its state of inactivity, is it possible that our local legislators might be growing bored and fidgety with all of their free time?

Don’t count on it! Apparently, our elected officials aren’t concerned about their failure to pass productive legislation. Instead, they are spending their time proposing legislation that has no chance to pass into law, and passing legislation that serves no purpose.

Last week, for instance, the U.S. House of Representatives passed H.R. 4890, the IRS Bonuses Tied to Measurable Metrics Act. If enacted into law, it would forbid the Internal Revenue Service from paying any bonus compensation to its employees until it “puts taxpayers first.”

At first glance, of course, one might conclude that this Act is a reasonable one. After all, why should any employee receive a bonus if he doesn’t put his customer, client, or constituent first?

The problem with the proposed legislation, though, is that it bans the payment of bonuses to any IRS employee. In other words, the Service would be unable to recognize, incentivize, or reward any individual employee who wishes to “put taxpayers first.” Under such circumstances, why would any employee actually choose to do so?

The proposed Act itself serves no purpose because President Obama has already declared that he would never sign the legislation. But Congress passed it any way, and then moved on to a proposal entitled No Budget, No Pay. Sponsored by Senator Dean Heller of Nevada, the Act proposes that Congressional leaders should not be paid any compensation when they fail to enact a federal budget into law on a timely basis.

But … hold on! Wait a minute! Didn’t President Obama sign a No Budget, No Pay Act into law three years ago? Well, yes … he did. But it only applied to that single year of budgetary activities. And it didn’t actually require Congress to fund its own budget; it simply required that the legislators pass a resolution to approve one. So Congress proceeded to approve a budget that year, and then never funded it.

Apparently, our legislators are quite fond of “no pay” legislation. But in the case of the IRS law, they proposed it while knowing that there was no chance of it ever becoming law. And in the case of their own budget law, they passed it with terms and conditions that would ensure that they would never actually lose any pay.

Nice, eh? It’s the Congressional busy season, and our legislative leaders are busy at work, doing what they do best.

Facebook’s $45 Billion Donation

Wow … talk about a demanding audience! One moment, Facebook’s co-founder and chief executive Mark Zuckerberg announces that he is giving $45 billion of corporate stock to charity. And the next moment, members of the media criticize him for self-serving behavior!

That’s a harsh response to a $45 billion donation, isn’t it? But do the media critics have a point? Why are they so concerned?

Apparently, instead of creating a traditional nonprofit foundation in the style of the Bill & Melinda Gates Foundation, Zuckerberg and his wife Priscilla Chan decided to transfer the stock to a Limited Liability Corporation (LLC). That’s what drew the ire of their critics.

So what’s the difference? Well, a nonprofit foundation must adhere to certain rules of conduct in order to earn its income tax exemption. For instance, it must disclose many activities to the federal government and the general public. And it must refrain from making many investments in profit-making ventures.

LLCs, on the other hand, are simple corporate entities that are not required to disclose their activities to any one. They are free to invest their funds in any legal operation. And although they do not receive income tax exemptions per se, they usually do not pay income taxes at all because they pass any taxable earnings or losses through to their owners.

So what makes an LLC a charitable endeavor? Nothing, really, other than the intention of its owners to utilize it for the public good.

And that’s why some people are criticizing Priscilla Chan and Mark Zuckerberg. Had they placed the $45 billion in stock in a nonprofit foundation, they would have accepted the need to comply with legal rules of conduct that ensure the expenditure of the funds for charitable purposes.

But by placing the stock in an LLC instead, they avoid any legal requirement to expend the funds for the public good. In fact, the only constraint that compels them to do so is their own conscience.

So perhaps it would be fair to neither praise nor criticize their announcement at the present time. Instead, perhaps it would make sense to wait and see how they actually expend the LLC’s funds before drawing any conclusions about their intentions.

Obama Care’s Mortal Threat

Last week, we learned that the Affordable Care Act of the United States faces a new, and potentially mortal, threat for the first time.

And what is the source of the threat? Believe it or not, its threat is itself. More specifically, it is a single phrase that lies buried within its thousands of pages of legal jargon.

You see, the Act provides citizens with financial subsidies to purchase health insurance on each state’s online web site. The subsidy levels are based on each citizen’s annual income level; without those subsidies, health care coverage would probably be unaffordable for all but the wealthiest Americans.

So what is this threat? Well, according to the legal text, each of the fifty states can choose to either develop its own customized web site, or to utilize the federal government’s “built for every one” web site. And if a state chooses to develop its own site, it can either operate its site with public employees, or it can subcontract the function to private organizations.

Thus, a diverse array of options has emerged during the past year. Although more than two thirds of the states have opted for the federal government’s site, the remaining states are selecting from a wide range of choices.

Some are designing their own sites to integrate seamlessly with other state benefit systems. Others are contracting with for-profit heath insurance corporations to design freestanding sites. And some states are even acquiring software that is already in use in other states.

It appears that a healthy, competitive free market is now emerging to serve the needs of the states regarding the Affordable Care Act, doesn’t it? So what is the Act’s mortal threat?

Apparently, opponents to the Act are focusing on a single vague phrase in the original law. The language in Section 1401 states that subsidies are available to citizens covered by health plans “which were enrolled in through an Exchange established by the State.”

So if a state decides to adopt the federal government’s Exchange site, is it utilizing a site “established by the State,” or is it using a site established by the federal government?

Opponents to the Act claim that the latter is true, and that more than two thirds of the states have thus opted for a choice that deprives its citizens of the very subsidies that make health care coverage affordable to all. Supporters of the Act, conversely, claim that the former is true, and that citizens of all states can receive subsidies.

Last week, a federal court in Washington DC decided that the Act’s opponents are interpreting this ambiguous phrase correctly. It thus declared that citizens in more than two thirds of all states are not eligible for subsidies.

But just hours later, a different federal court in Virginia decided that the Act’s opponents are wrong. That court declared that the writers of the federal law could not have possibly intended to deny subsidies to citizens of states that choose to use the federal Exchange site.

It will undoubtedly take months, or even years, for the dispute to work its way through the federal court system. Nevertheless, the case represents a disturbing illustration of America’s dysfunctional political and legal systems.

After all, an opponent of any lengthy and complex law will always be able to find a vaguely written phrase that can be interpreted in a counter-productive manner. By allowing opponents to tie up such laws for years of legal challenges, the American judicial system makes it less likely that such transformative legislation will be drafted, debated, and passed into law at all.

And if there is one fact that Americans across the ideological spectrum can agree upon, it is that many of the nation’s economic and social sectors are in desperate need of transformation. Thus, the Affordable Care Act’s ambiguous phrase is more than just a mortal threat to the Obama Care program.

It may well represent a mortal threat to the nation’s ability to address any of the underlying causes of its troubling economic and social malaise.

Catching The Ball: An Income Tax Nightmare

You don’t need to be a fan of the New York Yankees to congratulate their Captain, Derek Jeter, for becoming only the 28th player in the 135 year history of Major League Baseball to reach a career milestone of 3,000 hits. At a time when so many other professional sportsmen have chosen to inject their bodies with artificial steroids, Mr. Jeter’s performance decline in the twilight of his career is apparent testimony to his decision to rely solely on his natural skills.

Unfortunately, Mr. Jeter’s dramatic quest for his 3,000th hit led to another drama, one that is currently playing out in the offices of the Internal Revenue Service. The IRS, as always, is simply applying the tax law in the manner that it has been written by politicians. The details of this particular drama, though, may lead us to wonder whether those very politicians ever anticipated this particular situation.

During a week in which President Obama repeatedly called for the closure of tax loopholes for the very wealthy, a working class fan who caught a baseball found himself immersed in a debate about tax fairness. His gracious actions, and their resulting tax implications, reveal much about our government’s fiscal policies.

See the Ball, Catch the Ball

On July 9th, Derek Jeter began a baseball game against the Tampa Bay Rays with a career total of 2,998 hits. He would eventually hit successfully in all five batting appearances that day, ending the game with 3,003 in total.

His second appearance, though, led to the historic event that allowed him to ascend to the 3,000 hit level. And he met the challenge in a most dramatic fashion, socking a home run that soared into the stands instead of simply grounding a ball through the infield.

The nature of his hit set off a series of events that ultimately involved the Internal Revenue Service. A 23 year old cell phone salesman named Christian Lopez caught the ball and returned it to Mr. Jeter after the game as a keepsake. Jeter and the Yankees, grateful that he didn’t sell the ball at auction, rewarded him with game paraphernalia, autographs, and free tickets for future games.

How much could Lopez have earned by selling the ball at an auction? There’s no way to know for sure, but Bloomberg speculated that he might have received as much as $250,000. It may have sold for a far higher amount; Barry Bonds’ record breaking 756th career home run ball, for instance, actually sold for a whopping $752,467 in 2007.

Enter The Tax Man

Although Mr. Lopez did not pay or receive any money as a result of these events, he is now in need of expert tax advice. That’s because his brief catch represented a compensatory activity that resulted in his receipt of an item with resale value. In other words, to put it simply, he did some work and received compensation, thus making him liable for income taxes on his receipt.

Wait a minute … he gave the ball back to Mr. Jeter, didn’t he? Yes, but his generous gesture represents a personal gift, and donors of personal gifts must pay taxes on gifts of items with values exceeding $13,000 under American tax law. In other words, the loss that he incurred by “gifting” the ball back to Mr. Jeter cannot fully off-set the value that he received by catching the ball earlier that day.

Furthermore, the fan’s receipt of the merchandise and tickets may itself represent the collection of taxable compensation. Thus, he may need to pay income taxes on his receipt of those items, whether or not he ever actually resells them. And although a number of organizations have stepped forth and volunteered to pay some or all of his tax obligations on his behalf, such acts may themselves represent taxable gifts, leading to additional tax obligations for the firms or Mr. Lopez.

Back in Washington

Meanwhile, while these events were unfolding, President Obama continued his tussle with Republican Congressmen over the tax code. The Congressmen continued to insist that the federal government already overtaxes the American people and should not attempt to balance the federal budget through additional tax increases, while the President responded that many wealthy Americans are beneficiaries of tax loopholes that can be equitably closed.

One group of beneficiaries, the President notes, consists of wealthy managers of hedge funds. Such individuals generally pay a relatively low 15% capital gains tax on their “carried interest” earnings, an amount that is less than half of the current 35% top marginal tax rate that Mr. Lopez may end up paying on his earnings and gifts.

It may take months for Mr. Lopez to sort out all of the tax implications of his moment of glory. Hopefully, though, our representatives in Washington will not wait that long to reassess the practical implications of their taxation policies on fans who catch baseballs in the stands.

The Met and MOMA: Nonprofit Luxuries?

Seven years ago, in 2004, New York City’s Museum of Modern Art generated headlines by becoming the first major art museum in the United States to establish a standard admission fee of $20.

$20? For a nonprofit organization that claimed — and still claims — to be “accessible to a public that ranges from scholars to young children”? At the time, many critics believed that the charge was a bit steep.

Nevertheless, the year 2004 was a time of economic growth and prosperity in the United States. Perhaps the executive team at MOMA believed that, at a time of low unemployment, $20 represented a reasonable and affordable charge for access to world-class cultural exhibits.

Our current recessionary climate, though, appears to represent a different economic environment … and yet the guardians of our cultural heritage are once again increasing their prices! Just last week, for instance, the Metropolitan Museum of Art in New York announced that it would be lifting its standard admission charge on July 1st from $20 to $25.

Broadway? The Yankees?

The Met, somewhat predictably, explained its decision to institute a $25 ticket price by noting various daunting budgetary challenges, including lower rates of donations and reduced levels of government support payments. The weak economy has likely damaged other sources of cash flow as well, such as the Met’s lavishly extravagant on-site facility rental and catering businesses.

$25 tickets? A catering business? Although the Met and MOMA both help support the Big Apple’s global reputation as a center of world culture, such characteristics are more commonly found at for-profit businesses than at nonprofit institutions. After all, New York’s Broadway theaters and its champion New York Yankees baseball club also serve food and produce entertainment events while charging high ticket prices, and yet they do not enjoy the benefits of nonprofit status.

All of these institutions produce high quality cultural experiences that enrich their local and global communities. And all are well known to their global audiences as world-class icons of the United States in general, and of New York City in particular. For that reason, all of these organizations receive some level of financial and operational support from local government sources. But if they all share these common characteristics, why are museums — but not theaters or baseball clubs — permitted to classify themselves as nonprofit organizations?

Nonprofit? Tax Exempt?

According to the Internal Revenue Service (IRS), tax exempt organizations must dedicate themselves to charitable, religious, educational, scientific, literary, or similar endeavors. Among other additional requirements, they cannot distribute their earnings to private shareholders or individuals, and cannot attempt to influence political legislation or elections. Instead, they must reinvest any net proceeds into these same charitable endeavors, and must remain completely apolitical at all times.

Interestingly, although all of the fifty states of the United States maintain their own nonprofit requirements, they do not necessarily need to synchronize their laws and regulations with those of the IRS. Thus, one can always find organizations that are registered as nonprofit entities at the state level, but that nevertheless pay income taxes to the federal government and other entities. In fact, some local taxation authorities skirt the IRS’s tax exempt regulations by mandating and collecting Payments In Lieu Of Taxes (PILOTs) from such charitable organizations.

The New York Yankees baseball team, as well as many Broadway show organizations, are controlled by owners that benefit financially from the earnings of these organizations; thus, these institutions cannot be classified as nonprofit or tax exempt in nature. The Met and MOMA, though, do not repatriate their earnings to owners and thus can legally exploit the benefits of nonprofit, tax exempt status.

Hybrid Entities

The clarity of this distinction is surprisingly sharp, isn’t it? Basically, even though museums may charge high ticket prices, their profits are plowed back into charitable purposes and do not enrich any organizational owners. Thus, unlike civic-minded family businesses like those of the Shuberts and even the Steinbrenners, the museums are not required to pay income taxes on their earnings from ticket revenues.

Nevertheless, hybrid entities are now emerging in forms that obfuscate the distinctions between nonprofit and for-profit organizations. Socially responsible investors and companies, for instance, dedicate themselves to serving the public interest even though they maintain for-profit, privately owned firms and pay corporate income taxes. Conversely, even the Smithsonian Institution in Washington D.C. — a museum that declines to charge any ticket prices — operates restaurants, gift shops, and publishing houses in order to raise funds to support its charitable activities.

So the next time you find yourself paying more for a set of museum tickets than you do for a decent dinner, please don’t complain that the institution is engaging in profit-gouging! As long as it adheres to the requirements of its nonprofit, tax exempt status, no private individual or organization will prosper from your ticket revenues, except for the museum itself and the public whom it serves.

Dow Hits 11,000! Why Aren’t We Celebrating?

American investors, happy days are here again! The Dow Jones Industrial Average (DJIA), the landmark statistical index of large corporate stock values in the United States, just nudged over the 11,000 level for the first time since May.

American firms are clearly recovering from the Great Recession, and their shareholders are benefitting as well. But the latest American unemployment figures are grim, with limited private sector hiring overwhelmed by government sector lay-offs.

How is this possible? How can American companies (and their investors) be growing stronger while their employees lose their jobs? And how long can these trends continue until employment finally strengthens …

… or, conversely, until American firms again weaken?

Gunning For Growth

The primary reason for this “disconnect” between American firms and their employees is that, to put it simply, American companies aren’t wholly American any more. Quintessential red, white, and blue firms like Coca-Cola, Disney, and General Motors are experiencing far more growth in global markets than in domestic markets, and thus they are inevitably hiring new employees in regions that are generating more business. Why would Coca-Cola, for instance, build its work force in the United States instead of Asia when its North American sales volume is dropping by 1% while its Chinese sales volume is soaring by 29%?

Other United States firms claim that they would prefer to hire more American workers, but immigration laws prevent them from doing so. Technology firms like Microsoft and Google note that many foreign nationals are attracted to American universities, where they are trained to perform highly sophisticated value-added functions. However, even though many of these individuals would prefer to remain in the United States and become American citizens, our immigration laws make it easier and cheaper (and, in fact, often legally necessary) for American firms to establish new locations in foreign nations and then to employ these graduates overseas.

The bottom line is that, for a variety of reasons, companies inevitably hire employees in locations where sales volume is growing and talented employees are eager to work at relatively affordable salaries. That’s why American firms are increasingly building their work forces overseas instead of in the United States. And, in the process, the companies are becoming less American themselves.

The Investor Class

This divergence of fortune between United States corporations and the American work force also impacts the differing circumstances of domestic investors and workers. Last month, for instance, the DJIA jumped by over 7%, while the Nasdaq stock index soared by over 12%. A 68 year old retiree with a fully guaranteed pension and a 401(k) investment “nest egg” worth $1 million would thus have seen his 401(k) savings soar by over $70,000 in just one month if he had invested all of his funds in a relatively conservative DJIA stock fund. Of course, he would have received his monthly pension payment and government funded social security and health care benefits as well.

Meanwhile, a lower middle class supermarket clerk scraping by on minimum wage would not have felt any benefit from the stock market surge; such individuals generally own few or no investment funds. He may well have felt the burden of soaring health care service costs, though. Many working Americans who possess no health insurance coverage, after all, are employed in clerical positions that offer no benefits.

Furthermore, the American income tax system places higher rate burdens on lower middle class supermarket clerks than on wealthy retirees. Most retirees are paying a long term capital gains tax rate of 15% on their retirement fund withdrawals, whereas employee wages are subjected to higher rates in total by the income tax, social security tax, and Medicare tax systems of revenue collection.

Valid Arguments, But No Solution

There are, quite naturally, perfectly valid arguments in favor of maintaining these status quo policies in the United States. After all, the United States does indeed maintain a mature economy and cannot possibly match the explosive economic growth rates of emerging nations. American firms are thus far better off pursuing explosive growth opportunities in emerging nations than not pursuing them at all.

Furthermore, the immigration laws have indeed been developed to protect the American labor market from being overrun by immigrants seeking better lives. And senior citizens don’t perceive their government financed retirement benefits to be wealth transfers from working adults; instead, they assert that they paid into the retirement system during their own decades of employment, and they are now simply receiving equivalent value during their retirement years.

These are all valid arguments, and yet they offer no solution to the problem that is now confronting American society. Namely, an economic recovery is clearly underway for corporations and their investors, but an end to massive unemployment is not yet in sight for the work force. And eventually, if America’s employee pool collapses entirely, it may pull all of the other American stakeholders down with it.