One word makes a difference
First things first:
Tax Evasion is illegal – If I fail to report income, I have evaded taxes. If I just don’t write a check payable to Da Man, I have evaded taxes.
Tax avoidance is not – If I (as I usually do) dump $4K at the end of the year into an IRA account to avoid paying taxes on $4K in income, I have avoided paying taxes using a legal means.
Via Publicola comes this media advisory about the IRS and nine states cracking down on abusive tax avoidance. The money shot:
Abusive transactions to avoid taxes, according to private estimates, deprive state and federal governments of billions of dollars annually.
First of all, if the money isn’t earned to begin with, then no one is depriving governments of anything. Secondly, if it is tax avoidance, it is in every way perfectly legal.
The webcast occurred today. I haven’t seen it yet (no speakers at the office). I’d like a transcript if one is available. Cracking down on abusive tax avoidance sounds to me like code for cracking down on the self-employed.
Update: tgirsch informs me i have my IRAs confused. I meant traditional. Bad CPA! Down boy! Corrected. Did I mention I don’t do taxes? I should.
September 17th, 2003 at 2:31 pm
Just a question: What kind of money isn’t earned? Besides gifts, I mean?
I agree that the only legal way to crack down on tax avoidance (as opposed to tax evasion) is to modify the tax code to close existing tax loopholes. However, if tax avoidance isn’t done carefully, it can easily become tax evasion (assuming you didn’t comply with all the codes). This is why you NEED an accountant if you’re self-employed.
Tax avoidance is not – If I (as I usually do) dump $4K at the end of the year into a Roth account to avoid paying taxes on $4K in income, I have avoided paying taxes using a legal means.
Um, that’s not how a Roth account works. On a Roth account, you DO pay taxes on the $4K. What makes a Roth account so attractive is that you DON’T pay taxes when you withdraw. So if your $4K turns into $10K, you’ve effectively (and legally) earned $6K tax-free.
If you dumped the $4K into a traditional IRA, then you avoid paying tax on the $4K this year, but you will pay income taxes on the withdraw amounts when you later withdraw from the account. This is because traditional IRAs are tax-deferred investments.
Both account types are legal because sooner or later, you DO pay taxes on the income. With a Roth account, it’s sooner. With a traditional IRA, it’s later.
September 17th, 2003 at 2:37 pm
What kind of money isn’t earned? Besides gifts, I mean?
earning money (income) depends on the entity. The government earns money when it is paid or when it is identifiably a valid tax recievable. To say in this case you’re not earning it is admitting you budgeted poorly, in essence. i.e., we didn’t expect people to do that.
I agree that the only legal way to crack down on tax avoidance (as opposed to tax evasion) is to modify the tax code to close existing tax loopholes.
Bingo, we have a winner
I get my IRAs confused, i have one of each (two technically, with the wife). So sad that i get them confused, being a CPA and all. Did i mention i don’t do tax work?
September 17th, 2003 at 3:09 pm
earning money (income) depends on the entity. The government earns money when it is paid or when it is identifiably a valid tax recievable. To say in this case you’re not earning it is admitting you budgeted poorly, in essence. i.e., we didn’t expect people to do that.
Huh? I think we’re talking past each other here, so let me ask for clarification:
First of all, if the money isn’t earned to begin with, then no one is depriving governments of anything.
What money are you talking about here? Are you talking about the tax revenue? Or about the money that’s being taxed to generate the tax revenue? It was my (possibly flawed) understanding that you were talking about the latter.
So what I was asking was, if you start with $X, and now you’ve added some additional amount $Y, you now have $(X+Y), right? In what case is the additional $Y not earnings?
I may have been attributing an argument to you that you weren’t making. I’ve seen a lot of the anti-tax types try to argue that the only type of “earnings” that should be taxable are wages or salary, and that anything else isn’t really “earnings” and therefore should not be taxable. Or that taxing other earnings like dividends or interest somehow amounts to double taxation (which it isn’t — that would only be true if you re-taxed the initial $X instead of taxing just the additional $Y).
Anyway, that type of argument really pisses me off, and I see now that you never actually said any such thing, so I’ll shut up now. 🙂
September 17th, 2003 at 3:31 pm
I may have been attributing an argument to you that you weren’t making.
I think so. Essentially, a group is saying that the gummint doesn’t earn (btw, it technically doesn’t earn anything but takes it) as much as it should. But that’s not the case really since the the government earns an amount based on collections or pledges to pay (tax returns). If someone is using tax avoidance, it doesn’t really affect the amount earned because the gummint hasn’t earned it yet. What the group should say is the gummint can collect more money if people weren’t using these avoidance techniques.
Or that taxing other earnings like dividends or interest somehow amounts to double taxation (which it isn’t — that would only be true if you re-taxed the initial $X instead of taxing just the additional $Y).
Actually, it is true. Not because they tax X & Y (if i understand your reasoning here) but because two entities pay taxes on the same earnings. Company pays tax on income, and investor pays taxes on his share of already taxed income.
September 17th, 2003 at 4:36 pm
I get my IRAs confused, i have one of each (two technically, with the wife). So sad that i get them confused, being a CPA and all. Did i mention i don’t do tax work?
Same thing happens with me and those pesky decimals when I do budgeting. Did I mention that I DO Defense work?
September 17th, 2003 at 6:51 pm
Actually, it is true. Not because they tax X & Y (if i understand your reasoning here) but because two entities pay taxes on the same earnings. Company pays tax on income, and investor pays taxes on his share of already taxed income.
Really? I thought that if the company is paying out a dividend, for example, then that dividend is an expense and is not taxed (at least I think it is an expense). Similarly, interest paid is an expense for the payor, so only the payee is taxed on that interest “income.”
The other type of investment income, capital gains, are a bit trickier, but they are in no way directly tied to the earnings of the company. They solely have to do with the difference between what you paid on the stock and what you sold it for. And you’re only being taxed on the difference — your profit.
Unless there’s something besides salary, wages, interest, dividends, and capital gains that I’m missing. Profit sharing, maybe? But I thought they could expense that, too… You’re the CPA, you tell me. 🙂
Anyway, just about any time money changes hands as part of a legal transaction, that’s taxable according to the income tax code. Sales tax is a little different — stuff that you buy solely for resale is not taxable to you, it’s taxable to the person to whom you sell it.
*Head explodes* Augh, it’s complicated!
September 17th, 2003 at 9:29 pm
then that dividend is an expense and is not taxed
Nope, just a debit to equity on the financials. No expense effect at all. FOr taxes, it’s different, I think it is expensed (again, i’m not a tax guy and am not at the office to look it up).
Interest is different and capital gains on stock sales don’t affect the company’s financials, just the investors’.
But essentially for dividends, there’s one rule for taxes and one for financials (as with other transactions).
September 17th, 2003 at 11:04 pm
Which means that dividends aren’t double-taxed either. So what type of income were you talking about when you said the business profit is taxed and then the investor’s share of the profit is taxed again?
September 18th, 2003 at 9:00 am
Which means that dividends aren’t double-taxed either
I looked it up, a company may not deduct dividends as an expense to reduce taxes. It is therefore doubly taxed. The financial and tax treatments are similar.
So what type of income were you talking about when you said the business profit is taxed and then the investor’s share of the profit is taxed again
I was speaking of dividends. The last comment I made was using the supposition that companies could deduct dividends in computing tax liability, which I now know they can not.
September 18th, 2003 at 9:32 pm
OK, so the argument can be made that dividends are double-taxed. But very few companies even bother paying dividends any more (perhaps for just that reason).
Another question (and I don’t know the answer): Are dividends taxed at the same rate as other income?
September 18th, 2003 at 9:34 pm
I’m still a little confused. I run an S-Corp, and paid myself several thousand dollars in dividends last year, and paid taxes on them only once…
September 18th, 2003 at 9:45 pm
If you run an s-corp, why not just make a capital withdrawal and simply lower your investment amount? And an S-Corp is different because earnings pass through to owners (if i recall correctly).
I think dividends are taxed at the regular rate, unless held for a year then they are capital gains. But talk to an accountant because i’ve not done taxes since 1998. And most companies don’t pay dividends. Most don’t even pay taxes. In fy2000, pepsico paid $0 in taxes.
September 19th, 2003 at 9:46 am
So what you’re saying, then, is that very little double-taxation is going on.
September 19th, 2003 at 9:57 am
So what you’re saying, then, is that very little double-taxation is going on
Not at all. Dividends are not deducted by corporations. They are reported as taxed twice. Other things make it possible to avoid paying taxes. The shareholder is definitely getting screwed.
September 19th, 2003 at 12:18 pm
Dividends are “double taxed” because the company paying the dividend is taxed on the profit that the dividend represents, and the shareholder is taxed on the dividend. However:
1) Most companies don’t pay dividends
So not many people are being double taxed, because they’re not getting any dividends to begin with. And:
2) Most companies don’t pay taxes
So even if those companies DO pay dividends, if they’re not paying taxes, the dividends aren’t being double-taxed.
All of your statements cannot be true. Something’s got to give.
September 19th, 2003 at 12:26 pm
You fail to grasp that they are separate issues.
Dividends (regardless of the frequency paid) are reported on tax returns by two entities. They are double taxed.
Some corporations pay no taxes due to creative corporate tax structures.
All my statements are true:
1 – dividends are double taxed.
2 – Most companies don’t pay taxes.
The cash flow is kind of irrelevant to the point. The company may not pay any actual cash in income taxes, but they can’t deduct dividends. So sure in many cases, no actual cash is paid as taxes by the corporation but the dividends are not a factor in determining tax liability.
September 19th, 2003 at 1:15 pm
I think we’re talking past each other here. I’m not disputing that dividends are double-taxed. I’m saying that it’s an infrequent occurrence.
The only time the shareholder is “getting screwed” is in those infrequent (based on your statements) cases where (1) the coproration pays a dividend to its shareholders; AND (2) that corporation actually paid taxes.
If what you say is true, and Pepsico paid $0 in taxes, then any dividends they paid were NOT double-taxed.
September 19th, 2003 at 1:20 pm
If what you say is true, and Pepsico paid $0 in taxes, then any dividends they paid were NOT double-taxed
While there was no cash paid (assuming pepsico paid dividends, which i don’t know), pepsico could not deduct dividends in their tax computation. So when that income was passed to shareholders, it was already included in the calculation of taxable income. I’m totally speaking accounting geek now, aplogies.
September 19th, 2003 at 1:21 pm
At any rate, the point I’m trying to make is that the VAST majority of income in this country is NOT double-taxed. In the case of dividends, there may be a loophole that needs closing. Fine.
I argued incorrectly that dividends are never double-taxed. But even if every dividend ever paid were double-taxed, it would just be a drop in the bucket in the overall tax picture.
Wow, we’ve gotten way off-topic, haven’t we? This all has very little to do with tax avoidance. 🙂 Alter the tax codes so that corporations may expense dividends that they pay out to their shareholders, let the shareholders worry about the taxes, and the double-taxation problem is solved. (Or, alternatively, let the company pay the tax on the dividend, and make the dividend a tax-free benefit for the investor.)
September 19th, 2003 at 1:22 pm
So when that income was passed to shareholders, it was already included in the calculation of taxable income. I’m totally speaking accounting geek now, aplogies.
Ahhh, I get it now.
[Adopts thick southern drawl] “See, now, Tom? He’s a little slow…” [/thick southern drawl]
January 4th, 2004 at 11:23 pm
Seems the max you can put in an IRA is $3,500, so when – as insisted above – you put $4,000 in, you have diddled with the rules, which is only one step – namely, intent – from being evasion and fraud. –Harry
January 5th, 2004 at 9:30 am
Not when you’re married 🙂
January 6th, 2004 at 1:13 am
So you have a *joint* IRA into which you contribute $4,000 for one year? Seems to me that would be outside the legit, also. –Harry
January 6th, 2004 at 9:12 am
No, we have two separate IRAs in which i contributed $2K and the wife contributed $2K.
For maximums go here:
http://www.aarp.org/financial-planningretire/Articles/a2002-08-14-PlanningRetirementIRASetup.html
Married people can double the maximums.
January 6th, 2004 at 11:42 am
Well, finally. I guess when you wrote “If I (as I usually do) dump $4K at the end of the year into an IRA account…” it was just a case of loose lips. Well OK. –Harry
January 6th, 2004 at 11:47 am
Yes, i should have clarified. Thanks for the comments and keeping me honest.
January 10th, 2004 at 2:23 pm
I wasn’t really interested in keeping you honest; thanks for considering my intentions to be good. I thought you might be on to something that I could benefit from… 🙂
Harry B.