I Love Depreciation! (A Primer On Election Tax Issues)

During election season, everybody talks about taxes.  This year, the focus has turned to how the ultra rich get away without paying taxes, probably because we have an ultra rich candidate running for President.  (Hillary is just plain old rich.)  Here are a few of the more outrageous inequalities built into our tax system:

The Carried Interest Rule

The name is a little confusing.  The “interest” has nothing to do with interest as in “credit card interest rate,” but interest in the sense of “having an interest” in a business or investment.  Although the carried interest rule originated with marine trade, it is its application to the hedge fund “business” that is the source of its controversy.  Here is how it works.

First, understand what a hedge fund is.  It’s nothing more than a bunch of money thrown together for investment purposes.  The hedge fund manager convinces people with a lot of money to invest the money with him (less often, her), because he/she supposedly knows how to pick winning investments.  Let’s say that the manager convinces 100 people to invest 10 million dollars each.  (That’s a billion dollars for those of you who don’t typically deal with money in 10 million dollar increments.)  

The hedge fund now has a billion dollars to invest.  Most hedge funds employ the “2 and 20” rule.  It’s not a rule at all, but calling it a rule makes it sound “standard” so that the investors accept it without question.  (Just because somebody has 10 million dollars to invest doesn’t make them financially savvy.  Think professional athletes.)  The 2 and 20 rule means that the hedge fund manager is paid 2 percent of the money under investment and 20 percent of the profits.  It’s a heads I win, tails you lose type of rule.  (The real genius of hedge fund managers is convincing people to give them money in the first place, but that’s a different story.)  

Let’s say that our example hedge fund has a good year, and its investments are worth 1.3 billion after a year.  The 2 percent comes to 20 million dollars, and the 20 percent comes to another 60 million dollars.  Nice work if you can get it.  Well, you might think, at least the manager is going to pay a lot of taxes on all that income.  Wrong!  This is where the magic of the carried interest comes in.  The 20 million is considered regular income (i.e., the kind of income we mortals earn and pay taxes on), but the 60 million is treated as a capital gain, and capital gains are taxed at a special rate that you and I can only dream about.  Think Mitt Romney and his 14 percent income tax rate.

The reason it is called the “carried interest” rule (again, not a rule at all), is because the manager’s 20 percent interest in the fund’s profits is “carried” as a capital investment.  Of course, it is nothing of the sort.  It’s a complete fiction.  The investors’ money was the capital investment.  Their profits are capital gains.  (Reminder: a capital gain is the profit made from an investment.  You buy a stock at 20, sell it at 30, and you have a 10 dollar per share capital gain.  Whether this type of income should be taxed at a low rate is a topic for another day.)

So there you have it:  the carried interest rule allows hedge fund managers to have their ridiculously high income taxed at a ridiculously low rate.  

Depreciation.  

I love depreciation! Exclaimed Donald Trump last night.  Depreciation is the most common form of what are often called “paper losses.”  Here is how it works:

Let’s say that you buy an office building for 117 million dollars, and that every year you receive 10 million in rental income after expenses.  You pay taxes on the 10 million dollars, right?  Wrong!  Depreciation “shelters” part of that income.  In theory, the office building is not going to last forever.  At some point, the building will have to be demolished and replaced.  According to the IRS, a commercial building lasts 39 years.  Therefore, every year the owner “loses” 1/39th the original value of the building, which in our example conveniently comes to 3 million dollars a year.  The IRS allows the owner to treat that as an expense, so that the 10 million in profits is reduced to 7 million in taxable income.  In theory, you will have to pay the piper when you sell the building, but in reality, that day rarely comes because of a bunch of other ultra rich friendly rules that we can’t cover right now.  

You should be shaking your heads in disbelief about that 39 year rule.  We all know that most buildings are not torn down after 39 years.  The office building in which I work was built in 1911, and as far as I know, there are no plans to demolish it any time soon.  In fact, most real estate appreciates in value.  You don’t pay taxes on the appreciation until you sell the property, which is, in theory, when you actually get the money from the appreciated value.  In reality, owners of commercial real estate can enjoy (i.e., spend) the appreciated value of their real estate and never pay taxes on it, but that’s for another day.

It’s sure good to be super rich, isn’t it!

The Debt Forgiveness Rule

Let’s say a bank lends you 300 million dollars to buy a business, let’s call it, hmmm, Trump Airways.  Technically, the loan isn’t to you, but to the company, which is all the same anyway, because the bank expects to get paid from the profits of the company.  But it turns out that you are really no good at operating an airline, and it loses tons of money.  After five years it has 100 million dollars in accumulated losses and, since it is carrying the 300 million dollar loan on its books, it has a negative net worth of 400 million dollars.

Because the company is a special type of corporation called an “s” corp, you’ve been able to deduct the $100 million in losses from your taxes, even though it hasn’t cost you a dime.  Cool right?  It gets even cooler.  You put the corporation into bankruptcy, and the creditors get ten cents on the dollar from the sale of the business assets.  In this case example, the bank gets back $30 million, and it writes off the remaining $270 million.

Ordinarily, when a debt is forgiven, it results in income to the person who borrowed the money.  (Loans are not taxable, because you have to pay the money back, and therefore you don’t have any income.  But once you don’t have to pay it back, the loan becomes income.)  But in this example, because of certain debt forgiveness rules, the write off is not taxable income.  The bank gets a deduction from writing off the loan, but you have paid no taxes on receiving money you never had to pay back.  You might ask, well what advantage was that money, since it was used to buy the business and I didn’t actually spend it on myself?  The short answer is (a) well, you did get to use the money, you bought a business with it and (b) there are all sorts of ways to take money out of a business, even one that loses money.  For example, you may pay yourself a 10 million dollar a year management fee, or, in the case of an airline, the airline may not actually own the planes but lease them from you, at very generous lease rates.  

Caution:  the above example of debt forgiveness is a gross oversimplification, and there are a numerous requirements and limitations, which I have left out for purposes of illustration.  In other words, don’t try this at home.

Posted in 2016 Election, Business, Politics, Taxes | Comments Off

I’m Sorry I Got Caught

He got caught saying this:

And here is his fake apology for getting caught.

The scandal isn’t just that he said these things, but that he was pushing 60 years old and still feels the need to talk like an 18 year old high school drop out, and that’s probably unfair to high school drop outs.  It’s not like Billy Bush is his best friend; he talks to this way to a guy that’s basically a stranger.  So he’s incredibly insecure and immature, and he lacks any discretion whatsoever.

Trump’s success in business, such as it is, is due to the fact that he was born rich, was propped up by his family when he faced financial ruin because of his bad decisions, and has an insatiable drive to get as much for himself as possible, by any means possible, without a hint of a social conscience.

 

 

 

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I Loved Watching This

Speaks for Itself

 

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When Elections Kill People

A story, and perhaps the story, of this year’s election will turn out to be the votes drawn away from Hillary Clinton by the third party candidates, Gary Johnson and Jill Stein.  We have been hearing for some time how voters, predominantly young (“Millennials”) are disillusioned by the candidates of the legacy parties (I get that) and are turning to Johnson and Stein as alternatives (I don’t get that.)  Though neither candidate has a chance in hell of finishing second, much less winning, the reasons I see most commonly for voting for one of these candidates is to “send a message” or “vote one’s conscience.”  Since young voters typically vote for Democrats, by a wide margin, this trend is seeing as taking more votes away from Hillary than Trump.  

The most startling development has been the endorsement of Gary Johnson by the Detroit News.  Seriously, this is as irresponsible as it is bizarre.  I would be more upset if it were something other than the Detroit News, which has endorsed nothing but Republican candidates for over a hundred years, and so it is unlikely that anybody influenced by the News would be switching from Hillary to Johnson.  But still, the endorsement of Johnson by a mainstream newspaper lends an aura of respectability to Johnson as a legitimate candidate.  He is not.  Recently, Gary Johnson was unable to name a single leader of a foreign country.  It might be unfair to say that Johnson is more unqualified than Trump, but when somebody is as spectacularly unqualified as these two, who’s worse is just a moot point.

The simple reality is that either Hillary or Trump will be the next President.  No matter how much one rails against the two party system (as I do), it isn’t going to be changed by voting for a candidate that has no chance of being elected.  For the most part, if you vote for anybody other than Hillary or Trump, it is a wasted vote.  The exception would be if you live in a state where one candidate truly has no chance of winning, such as New York (Trump is despised in his home state, that ought to tell you something.)  

For everybody else, elections can have devastating consequences.  Millennials are, by definition, too young to remember the election of 2000.  That year, Al Gore won the general election but lost the Presidency.  Bush was elected President, because he won Florida by 537 votes.  Ralph Nader, the Green Party candidate, won over 97,000 votes in Florida.  The overwhelming majority of Nader voters would, if given a choice between solely Gore or Bush, would have voted for Gore.  Had only a small percentage of Nader voters in Florida faced reality and thought to themselves, who would I rather have as President, Gore or Bush, Bush never would have been elected.

While it is impossible to know what would have happened if Gore had been elected, we know for sure that he never would have invaded Iraq.  Over 4,000 Americans lost their lives in Iraq, tens of thousands more suffered life changing injuries, and upwards of a million innocent Iraqi civilians lost their lives.  Putting aside all the other consequences of the Iraq war, the hundreds of billions of dollars wasted, the rise of Isis, etc., we can say for sure that hundreds of thousands of people lost their lives, because a few thousand Americans “voted their conscience.”

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First Thoughts On Last Night’s Debate

I think most guys have had the experience of becoming infatuated with a new girlfriend because she’s new, different, and a lot of fun.  But when it comes time to have her meet mom, you see her in a different light.  New is no longer so new (and since when does Mom care about new?), different becomes an inappropriate person to date, and a lot of fun becomes just plain trashy.  Ouch!  I’ve had that experience, and it is a wake up call.1)I suspect that women, who are infinitely smarter about these things and far more selective than men, do not often have this experience.

Well, last night should have been that wake up call for Trump supporters.  This is not the guy you want to represent this great country of ours to the rest of the world.  New?  Well, maybe new isn’t all that it has been made to be, especially when new is wildly inappropriate and trashy.

There isn’t much point in talking about the substance of the debate.  Trump had little or nothing to say other than to talk about how “unbelievably great” he believes himself, his company etc., to be.  In law, we call these “conclusory assertions,” and they have no evidentiary or persuasive value whatsoever.  If all you have are conclusory assertions, you are thrown out of court.

Here are a couple things that stood out for me:

Trump claims to have an income of something in the neighborhood of $650 million a year, and yet pays no federal income tax.

How do you think that makes the average working stiff feel?

Trump complains about the state of our airports, and he certainly has a point about that.

How do you modernize the airports without tax revenue?

How can we improve the infrastructure and cut taxes at the same time?

Trump interrupted Hillary to point out that paying no income tax means you’re “smart.”  

What if we were all smart?

Does that mean those of us who pay income tax are stupid?

Trump kept whining about the country being led by politicians.  We all hate politicians, but the fact is that our great country has been led by politicians for over 200 years, and we have accomplished quite a bit: won world war two, put a man on the moon, built the world’s largest economy and been responsible for most of the great technological achievements over the past 100 years.  We are led by politicians, because that is how democracies work.  Do you know who is not led by politicians?  Dictatorships.  

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1. I suspect that women, who are infinitely smarter about these things and far more selective than men, do not often have this experience.
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