No Free Lunch But Please Pass the Tea
With tomorrow being tax day, April 15th, you have probably heard a lot of social and political chatter about tax reform and our need for an “equitable” tax system. This issue has been seriously misrepresented by politicians and the mainstream media. Many folks have come to believe certain things about the burden of taxes in this country that has very little to do with reality.
If you are one who feels like the politicians are taking too much and spending too much, you are in the majority. The problem is that the tax code is so complex it is nearly impossible to decipher even for those who are paid professionals.
The proposals for change are met with all kinds of objection; one of my favorites being the argument that if the “flat tax,” which was being promoted by Forbes when he was running for the presidency, was implemented, it would be too easy for people to do their own tax returns and we would put thousands of tax preparers out of work!
We can let bankers and insurance people join the ranks of the unemployed; we can let autoworkers lose their jobs, but how could we ever consider letting tax preparers and IRS employees face the chopping block?
With recent increases in spending, huge loans and bailouts, reductions in tax revenues and new tax proposals, this message of this story becomes even more relevant.
Like me, you may have seen this story before or heard it on the radio. It is a story about 10 businessmen who had lunch together every week. They were all at different points in their business careers and decided to settle the bill according to the structure of the “tax system” in this country.
This story of the business lunch is obviously fictitious, but the analogy is accurate. Some have attributed the unconfirmed authorship to Don Dodson of Ft. Worth TX in a letter to the editor of the Chicago Tribune in March of 2001 but the earliest distribution that I have been able to find is by T. Davies, Professor of Accounting at the University of South Dakota School of Business who has personally disclaimed authorship but acknowledges distributing it to his graduate students to stimulate discussion.
It seemed that 10 men decided to have a business lunch once a week. They always met in the same restaurant and the bill was always, $100.00, for all 10 men. If each man was responsible for his share of the bill that would be, $10.00, each. The men decided to divide the bill based upon their ability to pay (using the progressive structure of the tax code). Using this formula the following payment arrangement was worked out based upon income.
Men 1-4 who made the least amount of money paid nothing.
Man 5 paid $ 1.00
Man 6 paid $ 3.00
Man 7 paid $ 7.00
Man 8 paid $12.00
Man 9 paid $18.00
Man 10 paid $59.00
After several weeks the owner of the restaurant told the men that because they were such good customers he was reducing the bill by $20.00. Their dilemma was how to divide up the, $20.00. If each person got the same amount then the first 4 men would be getting money back but they never paid anything for the dinners. After much discussion and no resolve the owner offered the following suggestion which they all agreed to.
Original Payment- New Payment- $ Amount Saved- % Saved
Men 1-4 paid $ 0.00 $ 0.00 $0.00 0%
Man 5 paid $ 1.00 $ 0.00 $1.00 100%
Man 6 paid $ 3.00 $ 2.00 $1.00 33%
Man 7 paid $ 7.00 $ 5.00 $2.00 28%
Man 8 paid $12.00 $ 9.00 $3.00 25%
Man 9 paid $18.00 $14.00 $4.00 22%
Man 10 paid $59.00 $50.00 $9.00 15%
Once outside the men began to argue about the settlement. Man 5 said he only got, $1.00, while Man 10 received $9.00. Men 1-4 were upset because the received nothing. They said that the cut only benefited the rich and the poor got nothing. They were upset so they beat up Man 10 and left him. The next week they met for lunch as usual except man 10 did not show up. When the new bill arrived the men discovered that between them they did not have enough money to pay even half of the bill.
This story shows a simplified version of the Federal Income Tax. Even the “New York Times” admits in an article that 80% of the taxes are paid by 20% of the people highest income people. Any time you have a tax cut the people who are carrying the tax burden are going to get the money. The next time you hear of a tax cut and the media tells you that the wealthy are getting all the money, remember they are the ones paying the taxes.
There are currently many Tax Tea Parties planned for April 15th. People are concerned about the trillions being borrowed and spent buy the same people who have drained the social security coffers on questionable programs and pork barrel projects. They are looking for real change and considering options while waiting for that change to happen.
One epitaph to the story has it where the tenth man moved overseas and took his lunch purchasing dollars there…
That may be an option for some, but with the IRS looking at anyone who moves their money overseas as a criminal and taking a “shoot first and ask questions later” approach, a better option just might be to use existing rules to legally reduce your tax load domestically. It can be a few simple steps to real tax savings while we wait for a solution to the madness; a fair tax or a flat tax.
Here are a few simple strategies that can make a world of difference in your total tax burden.
Business to Business: Most of the states tax on a Net Income basis. That being the case, the lower your net income, the less tax you have to pay. The only problem this strategy creates in most people’s minds is that they are in business to make more profit, or net income. The solution is really quite simple however. Businesses can contract with companies from other jurisdictions, right?
What would happen if your business, in your high tax state, was doing business with a company from a low or no tax state? Absolutely nothing; except as you paid the bills to that company your high tax state income would be reduced, thus lowering your tax load. But you still don’t want to lose money just to reduce your tax load. What if the business you were dealing with in the low or no tax jurisdiction was actually owned by you? Is that legal? Could your home state business do business with a company in another state? Of course, is the answer to all of these questions.
You or your spouse could own the company in a low or no tax state and it could have high profit levels. Each company would still have federal tax to pay, but you could eliminate part or all of your home state taxes. With many states looking to raise already high tax rates, this is a great way to minimize your state income tax load.
The main issue to deal with is choosing the low or no tax state, and believe me when I say that many times the obvious choice is not the best choice.
Income Splitting: During the legislative debates in 1993 while considering the Clinton Tax Hikes, several congressmen brought up their fear that if the tax hikes were approved, the people would begin using the provision passed in the 1940’s that allowed for income splitting. The simple idea of the program is that family members are allowed to split income in an effort to balance out and lower the tax burden. It was used when one family member made a lot of money and another family member made little. They are allowed to balance out the income to lower the taxes for each party.
The same process can be used with multiple companies under similar or related ownership, as long as they are not owned completely by the same person. Rather than trying to come up with another scenario, let’s use the last example again, where two businesses are related, in the proper way, and they shift some of their income to the other, lowering the effective tax rate to keep incomes below a certain level. Again, a simple strategy that can be put into place and operated very inexpensively, and provide great returns in added profit through lower taxes.
Added Deductions for Wage Earners: Wage earners can also benefit from the tax code by taking some simple steps. As most people know, the tax code provides for many more tax deductions to businesses than to individuals. Wage earners can take advantage of the additional deductions by opening small and even home based businesses. If they are set up as corporate structures or limited liability companies, a wage earner can use many pre-tax dollars for items that would normally be paid with post tax dollars. The savings can add up quickly and greatly reduce the individual’s tax burden.
Setting up a proper structure can help with added deductions as well as providing a tool for added profits.
Like most people, I don’t like what I hear about all the spending, borrowing and bail outs. I used to get furious and upset until I found out there are methods to control my own outcome. Instead of being upset, take control and do something positive to reduce your tax load.
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