Comment by T-hawk | Hacker News Reader

Comment by T-hawk | Hacker News Reader

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Although technically true, there's a very widespread misconception underneath that. The low tax rates for business-derived income such as capital gains and dividends exist because that income was already taxed at the corporate level. Uncle Sam already got his bite out of the corporate balance sheet. http://en.wikipedia.org/wiki/Corporate_tax_in_the_United_Sta...

If these business gains were retaxed at the personal level as ordinary income, that would incent company owners and directors to keep the money in the company's coffers safe from taxation. Then you have corporations sitting on illiquid wealth. Giving personal tax breaks for these business gains creates incentive to distribute money back to the economy to be spent and continue flowing.

I'm surprised to see a reputable publication like GQ repeat the "rich people pay low taxes" fallacy. But it's such an easy way to score pandering points that pretty much every business article and publication spreads the misinformation now.

I've seen this "double taxation" argument in favor of a lower capital gains rate, and it's a flawed one. To see why, consider that your nanny doesn't get taxed at a lower rate just because you pay her with income that was taxed when you received it. The corporation is a distinct legal entity and it is taxed as such.

This taxation scheme isn't gratuitous. The corporate vehicle offers investors the tremendous advantage of limited liability. When it comes to a creditor's suit against the company, the corporation is treated as a distinct entity and the investor is not liable in such suits beyond his investment. The cost of being treated like a separate entity in lawsuits is being treated like a separate entity when it comes to taxation.

Limited liability is not free. When creditors cannot collect because an investor's corporation has insufficient assets, they bear the losses of activity that is attributable to and generates profits for the investor. If investors did not want to be taxed this way, they could reorganize their investments as partnerships. That way they would be taxed as individuals and bear liability for their business activities like individuals.

No, It's not a flawed one

For a nanny, sure, but apparently you missed Accounting 101

Expenses are deducted from income for tax purposes (talking about a corporation)

So this means, for a company, that if let's say, earn (example values) $1000 and pays an employee $400, their taxes are calculated on the $600, not on the $1000

Hence, no double taxation, the taxes on that money are payed 'down the chain'

Under the theory of the tax code, an 'expense' is an expenditure necessary to earn income. A capital gains distribution is not an expenditure, it is a gratuitous transfer. Therefore it is not deductible.

All money is double taxed, triple taxed, etc. The money a business receives from selling a good is 'taxed' money. If you earn a profit (gain) you pay a tax. It's the only way to keep things consistent and fair.

If you want to argue that tax rates should be 11% + 15-35% as the cost of limited liability, go ahead and do it.

But it's dishonest to claim tax rates are only 11%. They aren't.

Tax rates are only [x]%. The corporation is a distinct legal and tax entity from its owners. The corporation may use its income for any purpose without ever paying the income to its owners as dividends.

Most corporate income will not go to its shareholders as dividends (or otherwise). Hence, it is inaccurate to say that the tax cost of limited liability is [x+y]% except in the very limited circumstances where all corporate profits are dividended up to the shareholders. When measuring the true total effective tax rate on a shareholder, you must exclude any corporate income which will not be dividended up from the calculation, so the effective tax rate becomes [x-z+y]%, where z is usually equal to or greater than 95% of x.

If the money that would have been taxed doesn't go to the shareholders as dividends, then it goes to the shareholders as cap gains when they sell their shares.

That's an even stronger argument to taxing dividends the same as ordinary income.

Say 10 people each invest $100 in a business. After 1 year of operation, the business generates $10,000 in profits. The business is taxed as a separate person, and has $6,500 left. With the $1,000 of initial capital, it's worth $7,500. Now, say one investor sells his shares for $7,500 / 10 = $750. How much richer is he? ($750 - $100) = $650. Now, say instead the company pays out all of its profits as a dividend. Each investor receives $6,500 / 10 = $650. The $100 of original investment will of course be recovered when he eventually sells his shares.

In each case, the investor is $650 richer than he was previously. What amount should he be taxed on? $650! His net gain is $650. Why should be he taxed any differently on this net gain of $650 for a passive investment than someone who earns $650 in exchange for services?

I'm all in favor of taxing everything similarly.

If a person makes $1000 pre-tax on a $100 investment, we should tax the $900 in a single chunk. The tax rate should probably be the same as the individual income tax rate, and it should be the same regardless of whether it is long or short term capital gains, dividends, interest or royalties.

My objection is to breaking the tax up into pieces X+Y, and then acting as if the investor only paid Y. That's just a way of complicating the tax system and pretending investors pay less than they really do.

Say you have a corporation C, owned by an investor I. When C makes $100 of income, it's not I's money. It's C's money. When C pays $35 of taxes on that $100, I isn't paying it. If C pays out a dividend to I, and I pays $10 on it, he's not being taxed ($35 + $10 = $45). He's paying $10.

C and I are separate legal persons. Everything is accounted that way. E.g. when the U.S.'s GDP is calculated, C's income ($100) and I's income ($65) are added up and contribute $165 to the U.S. GDP.

Yes, the taxes on C reduce the amount available for C to pay I as dividends. But that's true in any transaction between two people. The taxes on my income reduce the amount available for me to pay my nanny, but you don't add together the taxes I pay and the taxes she pays when computing her tax rate.

EDIT: This is a reply to yummyfajitas, not to myself.

That's not how it works. The only time shareholders will see the corporation's income is if such income is distributed to them. Generally, this happens via: (1) a distribution of the corporation's assets, (2) a dividend, i.e., a distribution of the corporation's earnings and profits but not its assets, (3) a redemption which decreases the shareholder's ownerhsip, or (4) a liquidation which eliminates all shareholder's ownerships.

Capital gains reflects the increase in the market value of the corporation. It is entirely possible, and usually is the case, that the market value of corporate stock is based on the "goodwill" value of the corporation (i.e., brand strength) rather than the corporation's cash earnings. For example...every tech company purchased in the past decade, including but not limited to, such notable non-revenue producing companies as Reddit and Instagram.

The corporation is also distinct from its employees, but they get taxed once.

You're taxed on net income. Net income is gross income, minus expenditures necessary to produce that income. The labor of employees is necessary to produce income, so expenditures on employee salaries are deducted from gross income. Dividend payments are not necessary to produce income. Thus, they are not dedicated from gross income in computing net income.

Your confusion seems to stem from a failure to appreciate the default case, in the absence of corporate form. Without corporate form, a business owner is entitled to, by operation of law, the proceeds of his business, and is liable for, by the operation of law, the debts and other obligations of his business. That is the default scenario.

The corporate form comes along and says "let's treat this business as a separate legal person." The corporation, thus, is entitled to the proceeds of its business, and is liable for its debts and other obligations. The important thing to realize is that under this arrangement, the investor is not automatically entitled to a share of the corporation's profits. It's not his money, it's the corporation's money. The only thing the investor is entitled to is his capital contribution (which is not taxable), voting rights, and certain fiduciary duties from the corporate officers. When the corporation pays out a dividend, it's not giving the investor money he's entitled to by operation of law. It's a gratuitous transfer by one person (the corporation) to another. And it's taxed as such.

So it's not at all "dishonest" to say that the tax on capital gains is only 15%. It's a correct statement of the facts. It's no less correct than saying that your nanny's tax rate is 20% or whatever, even though she is paid with post-tax dollars. The corporate income tax isn't some gratuitous tax as the "cost of limited liability." It's just the natural consequence of structuring a business as a separate legal person in a system that taxes transactions between persons.

The real problem here is that taxation should be progressive. Your marginal income tax rate should increase as a function of your income. It would make a lot of sense to reduce taxation at the level of the corporation, but then treat capital gains etc. the same as any other type of income.

Yes, that may cause corporations to not pay out profits, but there's nothing wrong with that, because if the profits are not paid out, then the shareholders don't have the problematic high income.

If keeping the profit causes share values to rise, then this rise in value should be taxed appropriately according to the same mechanism.

I would suggest actual misconceptions are that:

1. Fungability: companies have similar tax flexibility as individuals and are therefore comparable.

2. Consumption equivalence: that income from capital gains or "personal tax breaks for these business gains" is actually redistributed back into the general economy in the same way as it would be as general (wage) income.

Both are clearly incorrect.

I would go a step further to suggest the US has a relatively high corporation tax compared to other developed countries precisely to compensate for other tax code deficiencies and trends.

Of course, in a sense, all the current arrangements do is capture the "middle" or "poor" class of corporates. Large or sophisticated corporates, especially financial companies, have very extensive means to ensure minimal or even, in some cases, no tax is ever paid.

A preliminary and revealing book on this issue for laymen is Shaxon's "Treasure Islands" (http://www.amazon.com/Treasure-Islands-Uncovering-Offshore-B...).

The US has a relatively low corporate tax rate compared to other developed countries. The U.S. relies significantly more on deductions and credits than any other nation, lowering the effective corporate tax rate below 20%, or even into single digits, for most corporations. Many corporations are able to lower their effective rates to single digits, or even below zero (i.e., GE).

Size is not a factor in this; proper planning is. Paying an expert $10,000 to structure your business flows at the beginning can save millions down the line. You would not skip out on hiring a lawyer to properly incorporate your business and draft your shareholders agreements, so why would you skip out on a tax planner?

The US has a relatively low corporate tax rate compared to other developed countries.

http://en.wikipedia.org/wiki/Tax_rates_around_the_world#List

The capacity to bypass taxes or headline rates is not being compared. In addition, if anything, that only further supports my points.

It would be nice if there was some incentive to share a little of that income with the company's employees rather than only with the owners and directors.

Huh? How do you think places like Microsoft and Google attract top talent? That's the incentive, and it works very well.

Yeah it works great for the lucky people who work at Microsoft and Google. Maybe not so great for most other industries.

Are you implying that the corporate tax + capital gains tax is roughly equal to that of earned income?

I hadn't thought through the numbers, but here goes. The Wiki article in my parent post says that the US federal corporate tax rate once beyond the lowest brackets is 34% or 35%. The personal tax rate on capital gains is 15% of the 65% that remains after the corporate taxation step, so 10% of the original total. The total of 45% is higher than the top personal bracket of 35%. (And it's reasonable that it should be, as the child comment points out, the corporation is buying legally protected limitation of liability. The notion that business owners pay less tax than workaday individuals is a media-created myth.)

Say someone earns a million dollars a year driving a cab. If he negligently hits and kills someone, and gets a $3 million wrongful-death judgment against him, he is personally on the hook for the whole $3 million.

If an individual earns a million dollars a year by owning a fleet of cabs, each organized as a separate corporation with the legally-required $50k or whatever of insurance,[1] and one of the cabs hits and kills someone resulting in a $3 million wrongful death lawsuit, the individual is out at most the assets of that single corporation (say $50k + legal fees).

It would be ridiculous if the individual paid the same %-age of taxes on that million dollars in both cases.

[1] This is actually how many (most?) cab companies are structured.

You are looking at the nominal corporate tax rate. What is relevant in such considerations is the effective tax rate.

Corporations don't care what the base corporate tax rate is. They care about their effective tax rate, which is what they will actually pay in taxes after all deductions, credits, and deferrals are accounted for.

Aside: I knew a guy who relied on wikipedia to give out tax advice. He was sued for malpractice and lost. He now owes his former clients $2 million (the amount of additional taxes they had to pay as a result of his erroneous advice).

It's important to distinguish between a business owner and a passive shareholder. Someone who runs a corporation they own can pay themselves a salary, at market rates, for the work they do, and that money is not taxed when received by the corporation.

The notion that business owners pay less tax than workaday individuals is a media-created myth.

Uh, except that corporations pay taxes on net while individuals pay taxes on gross. It is entirely possible to structure your corporate income such that you would pay less tax than a normal individual.

You simply use your company to pay for all your expenses, take no salary and instead pull in dividends and/or stock that can be sold at long-term capital gains rates in a year.

I'm not sure how you missed all those stories about the selfless CEOs taking $1 salaries (and millions of dollars in stock) in order to do just that.

> The notion that business owners pay less tax than workaday individuals is a media-created myth.

I'm one of those media-created myths. I am a programmer, but I work under a "corporation". And I know I pay way less taxes than friends who work as employees with pure earned income.

I don't see how this would be any different if I, for example, ran a corner store. (Actually, the possibilities increase even more there, as you can use creative accounting on your taxes, PLUS, very easily run a significant portion of your business "off the books".)

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