New Tax Collection "Law"

Turn the dial on the Way-Back Machine to the days of the Great Depression. Millions of Americans are jobless, struggling just to eke out a living. But one man named Willie Sutton has discovered unlimited opportunities in a truly recession-proof field: robbing banks. And why did he choose banks, an enterprising reporter asked? "Because that's where the money is," Sutton supposedly replied.

When Sutton published his autobiography 40 years later, he denied saying those words. But by that point, they were so famous it didn't matter. Today, med students learn "Sutton's Law" to focus their workups on the most likely diagnosis, rather than every conceivable possibility. (Sutton obviously never saw an episode of Grey's Anatomy.) And accountants use the "Willie Sutton rule" when they focus their activity-based costing where the highest costs occur, because that's where they're likely to find the biggest savings.

Now it seems our friends at the IRS have stumbled upon Sutton's Law, too. Last month, the Treasury Inspector General for Tax Administration released a 34-page report arguing the service spends too much time auditing people who make "merely" $200,000-400,000, and should spend more time on "Global High Wealth" taxpayers earning even more. We know you don't want to read that report, so we'll go ahead and summarize it for you.

For the 2013 tax year, the IRS audited 1.5% of the returns reporting income from $200,000-399,999. They spent 726,258 hours on that effort, and dug up $605 in additional tax for every hour. That sounds like a pretty solid return on investment, until you look at what those auditors do with people stacking real paper. That same year, the IRS examined 12.1% of the returns reporting income of $5 million or more. (That's 6,309 out of 52,078 returns, if you're curious.) They spent 193,559 hours dissecting those returns, and brought in a whopping $4,545 for every hour invested.

Numbers like that suggest that the IRS audit should everyone, or at least everyone above a certain income. (Maybe just everyone who looks really sneaky?) So here's the challenge. Congress has slashed the IRS's budget by 18% in real dollars since 2010. That means picking audit targets more strategically. The Inspector General's report argues the service should spend more time on so-called "enterprise cases," where they examine individual taxpayers plus the corporations, partnerships, trusts, and other entities they control. Those efforts take more time, more effort, and more experienced staff — resources they can't spend on lower-income cases. But that's where the money is! So where should auditors draw the line? $200,000? $400,000? Or even higher? What do you think?

Of course, the IRS can't stop auditing everyone else entirely. Fear of an audit is their cheapest and best tool to ensure compliance. Focusing those efforts entirely on "the 1%" would undermine that deterrent. And if everyone earning less than $200,000 knew they had a hall pass from the IRS, pretty soon there wouldn't be enough tax dollars collected to pay auditors at all!

Here's the lesson for the week. You already know that the key to paying less tax is planning. But did you know that some of the most powerful tax-cutting strategies can also lower your audit odds, too? Planning to pay less doesn't mean waving a red flag in an auditor's face. It might even mean pulling one back. So call us to see if we can help keep you off the IRS radar!

Uncle Sam, Knowing When to Hold'em

Last month, millions of fans across America sat down in front of their televisions to watch the Kansas City Royals beat the New York Mets, 4 games to 1 in baseball's World Series. But few of those fans would ever dream they could suit up and join the players in the dugout. That's because, while many of us played as children or teens, America's national pastime is, for the most part, a spectator sport.

That's not the case with America's favorite indoor sport. Poker players across America look forward to the World Series of Poker, in part because, for just $10,000, they can buy in and join the action themselves. On July 8, a total of 6,420 players from 80 different countries gathered at Las Vegas's Rio Casino to compete in the no-limit hold'em Main Event. And on November 10, there was one clear winner: our friends at the Internal Revenue Service.

To be clear, no one from the Service actually appeared at the final table. And a 24-year-old pro named Joseph "Joey Ice Cube" McKeehen from North Wales, PA, walked away with the coveted gold and diamond bracelet. But the IRS walked away with a bigger chunk of the $24 million in prize money than anyone else!

Joe McKeehen sat down at the final table with three times as many chips as his nearest rival, and never let up. Three days and just 183 hands later, his pair of tens knocked out Joshua Beckley's pocket fours to end it all. McKeehen's share of the purse totaled $7,683,346. And sure, that sounds like real money. But assuming he pays tax on the full amount, he'll give back $3,073,240 of that in federal income tax, $292,000 in self-employment tax (because he's a professional), $235,879 in Pennsylvania income tax, and $76,833 in local Earned Income Tax. (He'll also owe tax on the $500,000 value of the bracelet.) That's sort of like taking a full house and chopping off the pair — it still leaves three of a kind, but it doesn't pack the same punch.

The story is much the same with the rest of the nine who sat down at the final table. Runner-up Beckley turned his $10,000 buy-in into $4,470,896, but gives back $2,081,719 in tax. (His tax rate as a New Jersey resident is a lot higher than McKeehen's.) Third-place winner Neil Blumenfield faces a 12% California tax on his winnings, while fourth-place finisher Max Steinberg of Las Vegas faces no state tax on his at all. Seventh-place finisher Pierre Neuville, of Belgium, actually finishes fifth after taxes. That's because the U.S.-Belgium tax treaty lets him keep all of his $1,203,293 prize. Ninth-place finisher Patrick Chan, who lives in New York City, played just two hands at the final table and gives back nearly half his $1,001,020 to taxes.

In the end, Uncle Sam should take home $8,467,081 of the total prize money. That's not bad considering he didn't even have to sit down to play! No tough decisions over going "all-in" before the flop, no sweating out gutshot draws on the turn or the river. On other continents, Israel's Tax Authority takes a shekel or two from fifth-place finisher Zvi Stern, and Italy's Agenzia delle Entrate takes half a million (dollars, not lire) from eighth-place finisher Federico Butteroni.

Here's the good news where it comes to taxes: Paying less is a lot easier than catching pocket aces at the final table. So if you want to pay less, and you can't take advantage of the U.S.-Belgium tax treaty, call us for a plan. Be sure to do it now, before the year runs out on you. We'll tell you which strategies to hold, and which to fold, and send you home a winner.

"Easily Satisfied with the Very Best"

Few figures from recent history loom larger than British Prime Minister Winston Churchill, "the Last Lion." He spent "the wilderness years" of the 1930s fighting the Conservative Party's leadership, most notably Neville Chamberlain, to campaign for rearmament. As prime minister, he fought the Nazis to victory in World War II. Throughout his life, he fought the "black dog" of depression. But did you know how much he fought the Board of Inland Revenue — his country's equivalent of our own IRS?

The Right Honorable Sir Winston Leonard Spencer-Churchill was born into privilege. His grandfather was the seventh Duke of Marlborough and lorded over Blenheim Palace, one of England's stateliest homes. Maybe that's why Churchill picked up the sort of indulgent habits that led so many British aristocrats to lose their stately homes. Now David Lough, a former banker, has written No More Champagne: Churchill and His Money, to chronicle Churchill's precarious relationship with personal finance. And it includes a story to delight all of us who understand the value of smart tax planning.

Churchill loved to write. He loved to paint. He loved to drink champagne and smoke cigars. But most of all, it appears, he loved to spend. Take those infamous cigars, for example — by 1914, he was smoking a dozen a day, at a cost of about $1,600 per month in today's dollars. Yet he went five years without paying his bill to J. Grunebaum & Sons, his tobacconist.

"These filthy money matters are the curse of my life and my only worry," he wrote his mother when he was just 24 years old. Later, he told her: "It seems just as suicidal to me when you spend £200 on a ball dress as it does to me when I purchase a new polo pony for £100. And yet I feel that you ought to have the dress & I the polo pony. The pinch of the whole matter is that we are damned poor."

Lough's book recounts how Churchill even flirted with bankruptcy. Just one month after becoming PM, he ran out of money to pay his household bills, his taxes, and the interest on his loans. His assistant approached a prominent anti-Nazi banker for a £5,000 handout — equal to $250,000 in today's dollars.
Fortunately, Churchill had financial reinforcements outside his government salary: his income from writing. And that's where he conjured up a little tax-planning magic. In 1940, he cleverly persuaded his finance minister that since he was now "retired" from writing, any income he earned from that source should be treated as nontaxable capital gains rather than ordinary income. This would eventually mean no tax on the sale of film rights to his books, nor on advances for his memoirs. Of course, when he left office in 1945, he faced punishing 90% rates on any future works. (It's no wonder he turned to painting!)

Now it looks like clever planning is a Churchill family tradition. Last year, his daughter died at age 91, and Her Majesty's Revenue and Customs department agreed to accept 37 of his paintings in lieu of £9.4 million in inheritance taxes. The paintings will hang at the family's former home outside Kent.

If you're like most of our clients, when it comes to taxes, you want to fight them on the beaches, fight them on the landing grounds, and fight them in the fields and streams and hills and never surrender. The good news is you don't need to strongarm the Secretary of the Treasury into letting you pay less. You just need a plan. So call us, before December 31, to assure your finest hour!

Quantum Mechanics (or Something Equally Complicated)

How big a tax bill would you have to pay before it really hurt? Would sending the IRS $10,000 do it? What about $100,000? What about $1 million? Would you toast the good fortune that left you with enough income to owe that much tax, or would you stamp your foot and call for the peasants to storm Washington with pitchforks and torches?

Now imagine that you're hedge fund manager George Soros. You survived the Nazi occupation of Hungary and fled the communist regime that succeeded them. You made $1.8 billion shorting the British pound and earned the nickname "the man who broke the Bank of England." You've amassed a $24.5 billion fortune, enough to make number 24 on the Forbes 400 list. What's your reward? How about a tax bill of $6.7 billion.

Soros started his Quantum Endowment Fund back in 1973. Since then, he's grown that first fund into an entire family. Like most hedge fund managers, he charges a management fee based on a percentage of assets under management (typically 2%), along with an incentive fee equal to a percentage of profits (typically 20%). Ordinarily that would mean hefty taxes to accompany those hefty fees. But back then, the law gave hedge fund managers the opportunity to defer tax by reinvesting fees back into their funds.

The problem with deferring fees like that is that your investors — at least the ones who are taxed here in the U.S. — can't deduct your fees from their income. But that's no problem. Just set up offshore funds for clients like pension funds and endowments that aren't subject to U.S. taxes and keep deferring tax on their fees!

Of course, when Washington sees how taxpayers take advantage of the rules in the real world, it's easy enough to change them. In 2008, Congress closed that particular loophole and gave managers until 2017 to cough up the accumulated tax. Soros reports having $13 billion of his own money in the funds. He's subject to 39.6% ordinary income tax, 3.8% net investment income tax, and 12% New York state and city tax. Crunch the numbers and that's where we come up with that monster bill.

But that 2008 law also included a loophole for funds based outside the U.S. that pay local tax. So, just one week before President Bush signed the new law, Soros formed a company called Quantum Endowment in Ireland, where the top tax rate is just 25%, then transferred his accumulated gains into that new company. Of course, that doesn't mean he actually reports any profit. Instead, he issues investors something called "profit participation notes" and pays out most of the income as distributions on those notes. From 2008 through 2013, Quantum Endowment has paid just $962 in tax.

Ironically, back home in America, Soros has earned a reputation as a political liberal. Plenty of observers find it hypocritical ironic that a man who owes so much of his fortune to deferring his own taxes has chosen to dedicate part of it to causes like raising everyone else's.

George Soros has invested millions of dollars to assemble a team of world-class professionals to manage his fortune. This includes the traders who help him manage billions for himself and his clients, and the tax advisors who help them all keep as much as the law allows. You may not have as much at stake as Soros. But don't you deserve the same proactive attention to planning as he gets? You can have it . . . just give us a call!

Who Lives, Who Dies, Who Tells Your Story

Every so often a new show hits Broadway with lights that shine brighter than the rest. In 1996, Rent celebrated a group of impoverished East Village artists struggling to thrive in the shadow of AIDS. In 2003, Wicked imagined the lives of the witches of Oz before Dorothy's unexpected arrival. But who would have thought today's hottest ticket would be a rap-driven bio of the Founding Father responsible for the financial system that collects those taxes we all hate? This week's story is a bit different from our usual perspective. But stick with it . . . how often do you see taxes and finance starring in popular culture?

Hamilton began by chance when the show's creator, Tony award-winner Lin-Manuel Miranda, picked up Ron Chernow's landmark biography of Alexander Hamilton to read on vacation. Miranda saw "the $10 founding father/without a father" as the embodiment of hip-hop: a penniless immigrant who rose to power through the power of his words. The show began life as a concept album before morphing into a full-blown musical which debuted on Broadway in August. The show sold $30 million worth of tickets before it even opened, and prime seats currently commandover $1,300.

The story follows Hamilton's journey from his birth in illegitimate squalor "dropped in a forgotten spot in the Caribbean," through his appointment as George Washington's right-hand man and service as the nation's first Treasury Secretary, to his disgrace in the nation's first sex scandal and his death at the hands of rival Aaron Burr. Thomas Jefferson, James Madison, and Lafayette are all there to challenge him along the way. Even King George III saunters onstage to warn his unfaithful subjects: "And when push/Comes to shove/I will kill your friends and family/To remind you of my love."

Miranda's propulsive score will satisfy everyone who's waited for hip-hop to meet harpsichords and fall in love. It combines traditional Broadway influences from Gilbert & Sullivan and Stephen Sondheim to contemporary sounds like the rapper Notorious B.I.G.

The show has reduced sober critics to drooling fanboys. The New York Times' Ben Brantley gushed "it really is that good," and confessed, "I am loath to tell people to mortgage their houses and lease their children to acquire tickets to a Broadway show. But Hamilton . . . might just about be worth it." Even the Wall Street Journal's Terry Teachout calls it "the most exciting and significant musical of the decade," and says, "Do whatever you have to do short of grand larceny to score a ticket."

As it turns out, there are only a couple of direct references to taxes. At one point Thomas Jefferson snarls, "Look, when Britain taxed our tea, we got frisky/Imagine what gon' happen when you try to tax our whiskey." But that line appears in a song titled "Cabinet Battle #1" that turns Hamilton's plan to finance the U.S. government into a rap battle. (It's not the sort of thing you expect to hear on Broadway, right?) Hamilton championed a strong federal government, with implied powers to assume states' debts, and establish a national bank. His forceful advocacy is arguably why the bulk our taxes today go to Uncle Sam and not your state or local government.

We realize that when the curtain rises on April 15, you probably aren't humming show tunes. But it's worth remembering, at least occasionally, that taxes really are the price we pay for civilization. And while our current tax code may seem as illegitimately-conceived as the Founding Father who paved its way, it's the product of a uniquely American experiment in self-government that seems to still be working 200 years later.