Tax stuff I think is interesting. It is either copied from my primary blog on forbes.com http://www.forbes.com/sites/peterjreilly/ or stuff that I did not put there because being on forbes is a good gig and they have, you know, standards. Also some guest posts.
Friday, August 1, 2014
How Double Taxed Are Investors ?
Originally Published on forbes.com on August 1st,2011
The current debate raging on the Forbes Platform sparked by a certain charitable billionaire’s complaint about being undertaxed are taking on the quality of the debate about whether the Civil War/War of Rebellion/War Between the States/War of Northern Agression/Late Unpleasantness was about slavery or states rights. It may well have moved beyond that to the “Tastes Great” vs “Less Filling” stage. Nonetheless, one point in the discussion continues to nag at me. The charitable billionaire, who is unnamed lest you think this is another one of my obvious attempts at search engine optimization like this post, which has a largely irrelevant picture of Jennifer Aniston not being naked, said that he was being taxed at 17% of his taxable income, which is largely capital gains. Some commentators jumped in to point out that the earnings of his company are subject to a 35% marginal rate, so that’s like over 50%.
Now you should be able to see the mathematical fallacy in that analysis if you completed your Freshman year in high school. The 17% is only going to be levied on the net. So if you had a corporation that was paying dividends equal to its after tax income, the combined rate would be less than 50%.
There is another problem – 35%. This one requires a little more attention. The billionaire’s net worth is mainly from an insurance company that he converted into a kind of hedge fund. The financial statements are available here. On page 84 you can see what the income tax of the company would have been for the last three years if the expense had been 35% reconciled with the actual expense. In all cases the actual expense is lower. (By the way that is total income tax expense all in federal, state and foreign). Not a lot lower about a billion for 2010 and another billion between 2008 and 2009. You know how it is, though, a billion here, a billion there, all of a sudden you are talking about real money. And there is something else.
You see that income tax expense on the financial statements is not what is on the returns. There is this concept call deferred taxes. Deferred taxes are one of the main reasons to hate Generally Accepted Accounting Principles. The problem is that GAAP and the income tax basis of accounting have a lot of differences. The differences go both ways. I won’t try to enumerate them here. Your income tax expense under GAAP is a make-believe computation. You make believe that your GAAP income was the same as your taxable income and figure out what the tax would be. That is your income tax expense under GAAP. The notes to the statements, again on page 84, show how the make believe number is divided into what is on the returns – current – and the difference to get to the make-believe number – deferred. It can and does go both ways. In total for the three years about 2 billion of GAAP income tax expense on net is deferred. Cumulatively the company has on net deferredincome taxes over 35 billion.
Here comes the really hard part. The billionaire’s company does not pay dividends. He realizes income from it by selling stock. In his case it is probably reasonable to assume that his basis in the stock is negligible so that all his proceeds are gain. When he sells the stock he does not sell it forbook value. As a matter of fact many analysts ignore book value (I understand the billionaire doesn’t when he looks at a company, but that’s another story). I have been struggling to find good price to book ratios to use as an example, but I am going to have to ask you to forgive me and allow me to use 1.25 by way of example. None of that .25 has been subjected to corporate income tax (Not all of the 1 has either, but that’s another story).
Now this book to price thing is much more complicated in looking at the returns of most investors. When they sell stock most of the proceeds are not gain. Often they have a loss. So if you insisted on imputing any taxes that the corporation actually paid during their ownership to them, you might come up with a very high percentage of their gain.
The bottom line is that assessing the impact of corporate tax on investors is fairly complex. Saying that people are financially illiterate for not considering it, as contributor Robert McTeer, does and then just adding 35% is probably even more financially illiterate.
By the way that war, whatever you want to call it was quite clearly about a state right – the right to secede. If you read the statement of causes that were presented by some of the seceding states, it is difficult to discern what secession was about other than slavery, but I’m sure there are some neo-confederates who will set me straight on that.