I go to the bank and tell them I want a $1 million loan. I point to that lump of gold. Great collateral. They give me a loan and very favorable rates.
Then I deduct the interest payments from my taxes and maybe even get a tax refund.
The interest I pay along with the tax deduction is far less than I would pay in taxes.
Why are you able to deduct the interest payments from your taxes?
You setup an LLC or some business entity. Have them own the gold. Deduct interest as a business expense.
Also put other stuff in there like cars and whatnot and start taking depreciation write-offs and the cost of the car as another business expense.
How long can that go on without attracting some scrutiny?
LLCs aren’t required to have income or post profits, but if a business owner is claiming tax deductions through an LCC without reporting income, the IRS is likely to conduct an audit to determine if the LLC is an actual for-profit business.
Surely, when you dug up that gold nugget, you got a lot of income at that moment? I mean, there are people who are professional gold miners, and I presume they pay income taxes, right?
To have wealth, you must have gotten it somehow, and that process of getting is income.
What taxes? I mean, if the loan pays for all of your expenses, and the wealth itself isn’t taxed, why do you need a job?
Let’s not be silly, ‘income’ is a specific monetary transaction where laborers trade their time for money. Wealthy people don’t do that, they encourage other people to trade their time for money and skim some off the top.
Most people are paid by their employer so pay payroll taxes.
Not so for the very wealthy who may only earn a token amount in salary and are paid in stock options which are taxed at a lower rate (and only then when exercised…if you are Musk just go get that loan and leave the stock be).
I recommend reading the ProPublica piece. Tax avoidance schemes are complex and something we are not likely to be able to completely list and define here. The fact remains some of these guys pay no taxes in a given year. Did they earn no money? Did they spend no money? They live lavish lifestyles in huge mansions, great dinners, private jets and so on. Their power bill for such places is probably more than my mortgage. They paid for all of that but somehow they did so while earning no taxable income.
I’m not a tax attorney, but I’m pretty sure that if you dig something out of your backyard, it’s not income until it’s actually realized. There are state level “severance” taxes that are levied on some things like minerals- oil being chief among them. But they’re low, nowhere near on the order of income taxes, and they’re most definitely not income taxes.
Yep- it’s that size differential that makes the difference. You and I could do the exact same thing, if we could fund ourselves on loans of $100, and assuming banks would even lend us such small amounts.
The tax on treasure has to be paid in the first year, but that’s different than minerals. The giant gold nugget analogy isn’t perfect, but the idea stands: you have something of great value, but it is not income.
More realistic, you and some friends start a company, and after 5 years of work, a series of acquisitions, and lots of luck, you find yourself owning $5 billion worth of stock in TheNextGoogleTM. You initially invested $10,000 in your startup, and during that 5 years you never drew a salary over $100,000.
Now you retire and want to start living like a billionaire, so you want $500 million in cash to buy avocado toast and fancy coffee. You could sell $500 million in stock, and pay 15% (or whatever) capital gains tax on it. But, instead you talk to accountants and lawyers who can find legal ways for you to pay much lower than 15-20%, and still get all of the cash and things you need.
The point being, you have billions, even if almost none of it is liquid, and you live like a billionaire, except you pay taxes like somebody earning $200,000 in salary.
Yeah, my first thought was that I have a backyard garden with plenty of stuff I could theoretically sell for real money, but none of it is income until I actually sell it, so why would I be taxed on it before that point?
Ultimately the grousing in the thread is totally about the difference between income and wealth, and/or the taxability of loans secured with that wealth. Or about the difference between liquid and illiquid assets; that billion in the software company isn’t the same thing as billions of dollars of cash in the bank, not by a long shot. You can’t just cash it in all at once, and that goes even more when you really have a lot of it.
When your employer pays you your salary you get taxed on it.
Why should it be any different depending on what they pay you with? Stock options. Gold. Pork bellies. Beanie babies. Dollars. They all have a value.
Get taxed on the value of what was given the moment it was given (heck, even dollars lose value over time).
Why should a stock option be treated any differently than cash?
If you do not want to be paid in Beanie Babies or stock options then do not accept that as compensation.
What people are “grousing about” is finding ways to transfer huge amounts of wealth while never having to pay a tax on it because there are loopholes in the system.
If you receive something of value you pay an income tax on that there and then. Full stop. Heck…even game show winners have to do this when they win a car or whatever. Why should it be different for Elon Musk?
You do realize they are taxed already, right?
When I’ve been given stock options their value was $0. Every single time that’s how they work. A stock option is the ability to buy stock at a give price on a given date or range of dates. So today I’m granted 100 stock options in Amazon in with a purchase price of $3,365 that fully vest in 5 years and then I have 5 years to exercise that option. Today that option is worth zero and if it was worth something it would be a taxable event. Now in five years I hope amazon is worth double or $6,730 at that point in time I would have to pony up $336,500 to own 100 shares valued at $6,730 this is a taxable event and the $336,500 is taxed as ordinary income or I could sell some of my stock to pay for the taxes and to buy the other share so now $0 comes out of pocket and I would own ~4 shares of Amazon this is a taxable event too you just use your proceeded to pay your taxes.
A similar taxable event is one I’m going through we are trying to start a new company with a bunch of theoretical orders in the pipeline. If we start the company today it has no value and its not a taxable event. If we wait until one of the orders shows up then at the end of this year I’ll be liable for half of the value of the company at that point. Just because something may have future value doesn’t mean it has value at the time you were given it.
Thanks for the correction. I was trying to say 1031 exchange although what I was actually referring to was an exchange fund, which I believed (apparently wrongly) also worked under Sec. 1031. Although my long-ago clients used to use exchange funds, I was not in charge of structuring them, so I knew little and remember less about what tax code provisions apply to their operation. The article says that they must invest in at least 20% illiquid investments, usually real estate, but I know from experience that restricted securities with lock-up provisions and restricted legends are also considered illiquid investments. Turning a liquid asset into an illiquid one is as easy as putting liquid assets into an LP that issues restricted units in exchange. This is trivially easy.
This was all my speculation about what Bezos may be doing on a throwaway line above about Bezos deducting interest expense for personal consumption that, in general, shouldn’t be tax deductible. The truth is, I might be very wrong and the strategy I discussed might not work at all. I was hoping @mjmlabs would enlighten us about how the deduction worked.
I’m not that familiar with how the IRS tests the deductibility of the investment interest deduction. We’re getting into GD territory here but it is unquestionable that wealthy people get away with massive tax evasion. Here is just one Bloomberg article on point.
Capital distributions reduce your tax basis in the stock. Using your example, you contribute $900 to a corporation and get 9 shares of stock. You have $900 in tax basis. The company gives back the $900 as a return of capital distribution. The company stays in business (maybe they had retained earnings to fund operations). You still have 9 shares of stock but now you have zero tax basis. If you sell the shares, the whole amount you receive, even if it’s less than $900 is taxable as a capital gain. You don’t get any credit for the original $900 you put in because you already got that money back.
I’ve lost track of the hypothetical but my strategy (which be advised, may or may not actually work) relies on the value of the Amazon stock and the LLC that comes to hold it being worth the same amount. It hasn’t nothing to do with pretending that contributing the stock to the LLC changes its value.
There are, in fact, tax strategies that do rely on contributing property to an LLC in order to reduce its value through illiquidity discounts or occasionally loss of control premiums but that was not a feature of my hypothetical.
You’re right, it’s not that way now. Maybe it never will be. It wouldn’t affect little old ladies with 401(k)s since those are tax deferred. It could also be structured to only affect people who have a certain minimum amount of assets. Like Willie Horton, tax policy should go where the money is.
The intrinsic value was zero but the option value was greater than zero, according to the Black-Scholes model, which is used by professional traders every day to determine what options are actually worth. Asked another way, on the day you received them, would you have traded all your options for $5?
Depends on the company. I gave up a million dollars in options once for nothing since I thought they were worthless and before the vesting date the company was bankrupt and they were worthless. But I agree with your point having the option to buy a stock at less than market price has a value. In my made up scenario we’d be looking at about $15k in value.
Nonsense.
Once you have vested stock options they have a market value at that point in time. If they had no value why would you accept it as compensation?
Stock options are a dodge around taxes.
Pay your taxes on the marked to market valuation of those stocks.
Income tax is a tax on things of value that come into your possession. If you win a car today you pay taxes on the value of that car today…not 10 years from now. Stock options should absolutely be the same. Indeed, ANYTHING of value that you receive should be taxed.
If that makes you not want your stock options fine…demand cash (which is also taxed).
Also, stock should not be taxed at a lower rate (capital gains). It is income like anything else. Pay the same taxes everyone else has to on their income.
Oh boy, stock options! I’ve had to do a lot of research about those for work, as we have a lot of clients who get stock options or other equity awards of various types, and we have to figure out how to report them, or even before that, advise on the tax consequences of selling them if they’re smarter than the average client and think to ask first.
First, there are the normal well-trod stock options. But wait! There are two kinds! Qualified and non-qualified. This is with respect to a certain tax advantage I’ll get to later. With stock options there are 3 ways that you make money: First, the discount of the strike price to the market price at the time the option is granted. This is always ordinary income - the company is basically giving you something for “free” in exchange for your labor. Second, the change in value of the stock between the time you are granted the option. This is capital gain if the option is qualified and you meet the holding period requirements, and not realized until you sell the stock. For non-qualified options this is ordinary income and is realized at the time the option is exercised, even if you don’t sell the stock after exercise.*** Third, the change in value of the stock between when you exercise it and when you sell it. This is always capital gain.
***(However, in the case of qualified options, the income that you would recognize if they were non-qualified must be taken into account for the Alternative Minimum Tax, giving you a potentially massive difference in your AMT tax liability. You might end up owing more AMT then than the stock is worth by the time the lockup period ends if you’re really unlucky. You technically get to take a credit for excess AMT paid in later years when your AMT is less, but it can be very slow to reverse if you don’t have a large gain when you sell the stock and thus have much lower AMT due that year compared to regular tax due to your higher AMT basis in the stock. And because you pay AMT at ordinary income rates, but get the credit back when you’re being taxed on capital gain, you don’t get it all back just when you sell, so for large enough purchases you could be stuck with a large AMT bill that will take forever to reverse.)
But there is also a 83(b) election, which allows you to pay taxes on the value of the options when they are granted instead of when they vest. I have only seen this used in cases where the time value of the options cannot be determined because there is no market for the stock, and the intrinsic value of them is zero, thus you get taxed on zero dollars of income. This is also the case if you are given a profits interest in an LLC/partnership; so long as you aren’t given equity capital but only a profits interest, the IRS says that since you’ll be taxed on the profits when you receive them through the LLC, and you don’t have the ability to get capital out until you accrue profits that are taxed, you don’t need to pay tax right away, and thus don’t pay anything. In these cases it does mean that you’ll pay a lot in capital gains tax if the stock takes off, but you don’t recognize any ordinary income. Since this is mainly only done in the startup phase before other investors come in, it’s done mainly with the first few starting employees as well as the founders. But it does mean those people can get a huge payday from the equity award and have no ordinary income.
Then there are RSUs - restricted stock units. These are grants of stock you don’t have to pay for that you can’t sell for a while. You recognize ordinary income equal to the fair market value of the stock when the RSUs vest, even if you don’t sell them. This usually means that you end up with far less in stock because you need some automatically sold to cover the payroll taxes and federal (and state) withholding.
There’s also Employee Stock Purchase Programs (ESPP) which are kinda like equity awards, but are simply the ability to buy company stock at a discount, as opposed to being given it (RSUs) or being given the option of waiting to buy when you know you’ll pay much less than it’s worth. You have to recognize ordinary income equal to the discount you’re given.
If you find a treasure trove of cash, you must pay taxes on it immediately (if you report it). If you find a treasure trove of goods (like gold), you have zero basis in the goods (or basis equal to whatever in expenses are properly allocable to finding the treasure) and pay taxes on the entire gain when you sell it. If you don’t sell it, it’s the same as finding a pretty (but worthless) sea shell on the beach, and tax law can’t distinguish the two cases.
Basically, you have to track the proceeds of debt to whatever they are used for in order to determine if the interest on the debt is deductible. If you take out a loan to buy publicly traded securities, it’s investment interest and thus deductible to the extent of investment income (including qualified dividends you choose to allow to be taxed as ordinary income). If you use it to buy a business in which you are a passive investor, it’s a business expense, but subject to the passive loss rules and thus can only be offset against income from passive business activities until you dispose of the business. If you use it to buy a business in which you materially participate, then the interest is deductible in full as part of that activity. If you use it to buy a personal residence, it’s deductible as mortgage interest subject to the restrictions on that (at most two homes at once, limited to a certain amount of debt, must be used to purchase the property or make improvements). If you go on vacation with it, it’s not deductible.
These uses of the money might be entirely unrelated to how you obtained the loan proceeds. If you borrowed on margin from your stock portfolio, it will likely be reported to you in the same way that other investment interest is reported, but the broker won’t know whether it’s potentially deductible as investment interest by you unless they know you bought more stock with it. So in general they just report margin interest paid, and leave it to you to decide whether and how to deduct it.
This tracing also applies to loan proceeds distributed as shareholder/partner distributions. Just because the business borrowed it doesn’t mean that the interest is deductible by the people who ultimately end up with the money from the loan proceeds. But of course, that doesn’t stop most people, many of whom may not even be familiar with the rules.
Right so you’re upset because the employee in my example above didn’t pay the $5,000 in taxes on his $336k in stock options. While people will pay to get options they have very little value especially a long way out.
I generally agree with this as long as we account for the purchase price when the stock is sold and we account for inflation over the holding period.