November 1992
Vol 16 No 4
IF ONLY WE COULD KNOW NOW WHAT WE'LL KNOW THEN
Because this letter is being published ahead of the election results, there's no way for us to know precisely what kind of world we're going to face over the next 4 years, but this we do know; it will be exciting for most of us. Regardless who wins, which one of the current crop of candidates is really going to work for you once the final ballot has been counted and the results known? I don't just mean the federal job holders. I mean those elected at every level from top to bottom. Just for fun, take a look at all those platform planks from the 1988 election, those campaign promises, those lofty ideals and sober promises around which the voters rallied. What became of them? Or more to the point, did your personal situation improve or deteriorate during the last 4 years? How much confidence do you have that this election will be different?
It seems to me that the thing that's most vital to the American political process isn't voter apathy so much as the lack of voter memory. Perhaps we just don't recall how things were 4 years ago. We don't realize that trillions of dollars have been added to the tax burden future generations will have to pay. The National Taxpayers Union is an organization that tracks waste and inefficiency in government. Each year they announce what government costs us in terms of the number of days we have to work just to pay our tax bills. In 1992 it was May 8th. But there's more to the story. If you add debt into the equation, Tax Freedom Day isn't in May, it's in late September.
Look around your own town, how's your real estate doing? How many businesses have failed? Bankruptcies? Oh sure, interest rates are down, but who can afford, qualify and/or take a chance on taking on more personal debt? Although the Dow is higher, the broader stock market averages are down. Are people you know more or less optimistic? Does a college education for your kids seem a more remote possibility? Are you more or less able to afford to pay for good health and medical care? Do you feel confident about your old age? Will you be able to maintain your living standards in retirement?
Is there more government regulation and intrusion into your business and personal life? Have terms like EPA, OSHA, FICA, FUTA, FIRTPA, 1099, FED, HIV lowered your expectations? Do you believe the candidates who are running will improve the situation over the next 4 years? For whom? How? What? Where? Why? Will you bet all you've accumulated that you're right? Whether you know it or not, you may be doing just that when you vote or abstain from voting. This is a perilous season for Americans! It's more important than ever that you vote cautiously in 1992. The outcome of this election will affect the rest of your life into the next millennium.
OUR COUNTRY REVIVES DESPITE GOVERNMENT, NOT BECAUSE OF IT!
Radical? Think about it. How many times have you seen any branch of government do anything that was done right, efficiently, and at reasonable cost? How often has the reverse been true? Can you explain what America gained by the Gulf War? Or Viet Nam? Think how well government coped with the L.A. riots, federal deficits, the war on drugs, or farm policy the past 4 years – not to mention the EPA and Post Office?
Neither party seems capable of running the store. They both share blame for starting wars, exploding our deficits – even passing bad checks. The litany of government inefficiency and blundering extends through all levels of government. We've survived as a nation because of the individual efforts of millions upon millions of entrepreneurs who manned our economic bilge pumps keeping the country afloat despite all the attempts to tax and regulate them out of existence. Based on candidates' threats during the campaign, it won't be any easier the next 4 years. We need a whole new deck of cards.
THE MORE THEY MAKE, THE MORE THEY SPEND!
The National Taxpayers Union has completed a study which shows that Congress adds $10 to the debt for each $1 of tax revenue that it collects. Listen to the 'solutions' proposed by all the candidates. Notice that every proposition (That's not the same word as 'proposal'. It usually has a different result when accepted. They make involves increasing taxes as if any surplus would be used to pay down the deficit. It's a cynical system which uses multiple sets of 'books' to dupe the misinformed taxpayer into being willing to pay more.
In spite of our current tax load being the highest in history – almost twice the burden that the serfs had to endure in medieval times – the politicians want more. If you saw the movie 'The Little Shop of Horrors' you'll be able to relate to their constant demands, 'feed me, feed me'. The more government consumes, the more it needs to consume. Only the individual can save the country. Not government with its social programs which are only thinly disguised ways to buy the votes of government dependents.
The first step is to do everything possible to legally avoid unnecessary taxes. That entails learning something about how taxes are levied – on what type of income, property or activity and ways to conduct your affairs so as to take advantage of every 'incentive' in the tax code. (I can't believe that what the media terms 'tax loopholes' are accidental. With all the review and back room bartering required to draft tax legislation, it's my personal persuasion that 'incentives' are placed throughout the IRC to motivate citizens to inform themselves about tax regulations.)
The most logical first step is to limit state and local taxes. Whenever possible try to avoid sales taxes by buying what you need from private citizens. As a landlord, we try to use as much 'pre-owned' property as possible. We install carpets that have been removed from apartments, condos and motels during renovation. We throw away the bad, and hot-seam the good pieces. No sales tax. Ditto for used appliances, tools and equipment, surplus supplies and materials left over on the job and sold by contractors. We haunt garage sales looking for things we can use. This helps recycle things that might have been discarded, it holds down both taxes and operating expenses.
Because of a quirk in mobile home financing, quite often the air conditioning systems are financed separately from the mobile home itself, and thus, are abandoned when a mobile home is repossessed and relocated. We can buy fairly new 22 to 32 package units for about $300 and get independent contractors to install them in our houses for a total cost of about $900 including new ducting, wiring, and control systems. No FICA, FUTA tax on the installation or sales tax on the units. This saves about $2000 on each installation. They've proven to be quite satisfactory over the 4 or 5 years we've been using them. Of course, everything we save in operating costs is taxed as income.
The next thing we might attempt is to find ways to avoid State income taxes. I took the direct approach. I moved from New Jersey to Florida 25 years ago. And in 1989 I moved to Nevada where I spend part of each year. Neither state has an insane tax, while both present above average real estate opportunity with growing populations and rising wage rates. That may seem like a drastic move for many readers, but if you'll take the present value of just $2000 you might save in state income taxes by relocating, and compound those annual savings for 30 years at 10% as an annuity, the total would rise to $328,988. That would provide a decent retiree income. If you can afford to give that sum away because you like where you live, so be it. But there's another factor.
If the voters of your state have approved politicians' passage of state income tax laws, it's just a matter of time until they also approve increased property and sales taxes, business taxes, rent controls, etc., scaring off investment. The 'opportunity' costs of remaining in such an unsavory economic environment will be many times what you might have lost from state taxes alone. Witness Southern California and the Northeastern states from which capital and people are fleeing in growing numbers. It's a tough choice.
IF YOU WON’T REMOVE YOURSELF, AT LEAST REMOVE YOUR TAXABLE INCOME
Our CYA seminar deals with myriad threats to estate building and estate planning, one of which is the taxing power of states and municipalities as well as the federal government. Many people become confused between the uses of trusts versus the uses of corporations in an asset protection program and thus miss out on major tax advantages of being able to move income-generating businesses and assets from a highly taxed environment into a lower taxed environment. The use of C corporations can do this better than any other vehicle for several reasons.
First of all, a corporation is domiciled within the state where it's formed. Currently Massachusetts and California are being joined by other states in pursuing former residents who've left the state, but who have residual income coming in from investments and retirement funds Which were accumulated during their residency there. They are demanding that the individual continue to pay state income tax in their former domicile. Fortunately, Nevada has a specific statute which prevents any other state from levying against property owned in Nevada by their former residents. This has resulted in a flood of retirees moving into Nevada from California. For those that continue to generate income, a corporation domiciled in a low taxed state is about the only solution.
Let's not confuse things. Its a tricky proposition to conduct business in a high taxed state but to avoid paying taxes there. On the other hand, you can live in a high taxed state and do your business from a corporation in a low taxed state, retaining earnings there for expansion, reinvestment, business expenses, etc. You'll only be taxable on the income that you repatriate into your state of domicile. When your corporate retirement plan pays out, you'll also pay state income tax on the proceeds, but it will have been accumulated and compounded much faster without being siphoned off by state (and federal) taxes. If you want to avoid paying state taxes in the state in which you're earning a profit, it's an entirely different kind of a challenge.
Most state courts won't protect the rights of corporations doing business in their state unless it has qualified to do business (and be taxed) in that state. But in a recent U.S. Supreme Court decision, Quill, Corporation of Chicago, IL opened a little crack. It won it's case against the state's having the right to tax mail order sales at point of delivery. You can imagine that catalog sales (and newsletter) business owners breathed a sigh of relief. But with a little bit of legerdemain, it might be possible for you to operate your business through the mails and avoid undesirable state taxes. In other situations, you can 'export' income from a high taxed area and 'import' net income into a low taxed area providing you can justify it with sound business reasons.
Here are the traps. When a corporation in California sells a product at an unreasonably low price to a corporation in Nevada which in turn sells it for a high profit, California will tax the California corporation on the profits earned in Nevada if the owners of both corporations are related parties and if there is no justifiable business reason for such a transaction. The same holds true when mortgages are used as devices for transferring net income between related parties. Or leases. Taxes are a lot more difficult to impose when non-related parties are doing business, and prices or terms are done at fair market values. What are some of the ways to avoid problems?
First of all, corporations owned by allies, in-laws and irrevocable trusts are non-related parties. Furthermore, when non-related corporations use different fiscal years, computer matching of income and outgo between any vendor and vendee becomes extremely difficult if states share information (which Nevada doesn't do). Business reasons are easier to come by than you might expect. It's virtually axiomatic that costs (and resultant prices) in a high taxed state are higher. That's justifies purchases, loans, leasing, etc. from out of state sources. Furthermore, by contriving ways to order supplies and materials by mail order – from your out of state corporation – you'll have the Quill court decision to buttress your position that no state taxes should be levied. Out of state orders might include almost anything – even Mobile Homes and Modular houses.
AT THE FEDERAL LEVEL, IT’S A WHOLE DIFFERENT BALL GAME . . .
When one considers the tax savings at state level, they’re usually a pittance compared to the savings possible at the federal level of taxation both from the standpoint of the magnitude of any particular year's taxes and the compound value of any savings that can be realized. On an annual $50,000 of adjusted gross income, an individual would pay $11,368 in 1992. A corporation would pay $7500 under the same circumstances for a tax savings of $3,868. That would amount to $636,262 if compounded over 30 years, but that's just half the story. Since many states levy their income taxes as a percentage of federal taxes, reduction of federal taxes by use of a corporation would also reduce state taxes for additional savings. And we've already discussed the merits of being incorporated in a state without any corporate or personal income tax.
Admittedly, there are valid reasons why people prefer S corporations to C corporations. If they'd be taxed as Personal Service or Personal Holding corporations, or if they'd be taxed at lower rates. S corporation earnings are taxed at the same marginal rate as their owners while C corporations have their own tax rate schedule. This can be higher than personal tax rates at around $150,000 of adjusted gross income. But closely held C corporations can enjoy considerably more tax shelter opportunities by virtue of being able to deduct myriad fringe benefits that can be received by employee/owners tax free. All this reduces taxable corporate income to the point that a corporation might easily net twice as much before deducting fringe benefits as an individual before calculating the federal tax bite. But there are other real advantages to incorporation when one factors in the benefits of asset protection and privacy.
IT'S NOT WHAT YOU OWN SO MUCH AS WHAT YOU CAN KEEP THAT COUNTS . . .
Asset protection is on everybody's mind these days. Litigation continues to spread as America's favorite pastime. You hear all sorts of stories about how easy it is to pierce the corporate veil but, for properly formed and administered corporations, this is an extreme rarity. When I've tried to legally pierce a corporation in order to attach personal liability to its owners, I've had no success whatsoever. It's been my personal experience that corporations make very good asset protection devices when used properly. Here's an example.
Suppose you intended to buy a hazardous property in a litigious jurisdiction using seller financing. First, take title to it in an out of state corporation. Next, have that corporation sell it to second corporation in another jurisdiction. It would carry back additional financing in the form of a wrap-around blanket lien on the property plus all other corporate assets. Personal property assets that the final corporation has would be liened under the terms of a UCC- 1 (Uniform Commercial Code security instrument) filed with the state. You could master lease the property personally, subleasing it for an income 'spread' or the owner could use a local management firm.
Now, should any litigation ensue against the owner/manager corporation, it will only own encumbered property to satisfy any judgment lien if it should lose the suit. There would be few bidders willing to take on the pre-existing liens against all corporate property. On the other hand, revenues from the property would be paid to the selling corporation in the form of interest and principal payments based upon the purchase price and terms. These could be accrued at the low corporate tax rate as retained earnings, paid out to you in the form of fringe benefits, paid to you as compensation in the form of a low taxable salary and a high non-taxable pension plan contribution, or used to pay the corporation's deductible expenses. You'll like corporate games.
Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com. 
(888) 282-1882
