Using The Tax Code To Create Abundance
Anyone may
so arrange his affairs so that his taxes shall be as
low as possible. He is not bound to choose that pattern
which best pays the treasury. There is not even a patriotic
duty to increase one's taxes.
Learned Hand
1872 – 1961
U.S. Federal Court judge |
You know that old riddle. “Which
came first, the chicken or the egg?” I have my own version
of the riddle. “Which comes first? Taxes or expenses?”
Unlike the chicken or egg conundrum,
this riddle has a clear answer. And the answer is, “It
depends on whether you are paying taxes as an individual or
as a corporation.”
We hear a lot of talk these days about
the inherent unfairness of the tax system. The claim is that
“the rich” get tax breaks while middle and lower
class taxpayers pay far more than their fair share.
What gets lost in these comments is
an even more fundamental imbalance in the tax system. The
tax system favors corporations vastly more than it favors
individuals.
The crucial difference between corporate
taxes and personal taxes is the point at which taxes are calculated.
If you are taxed as an individual, your taxes come off the
top of your income. If you are taxed as a corporation, your
taxes are calculated after expenses.
You don't
pay taxes - they take taxes.
Chris Rock
|
Consider how the taxation system works.
If you are an employee, you collect a paycheck. Before you
ever get your paycheck, there will be deductions. Federal
tax, FICA, maybe state tax, maybe medical insurance. You will
be left with your “take home pay.” Interesting
concept, isn’t it? What you “take home”
will be less than what you earned.
In other words, you get to use whatever
is left over of your salary or wages after taxes. Food, housing,
clothing, transportation, medical, dental, recreation. You
need to pay for all of these expenses with your “after
tax” money.
Our new Constitution
is now established, and has an appearance that promises
permanency; but in this world nothing can be said to
be certain, except death and taxes.
Benjamin Franklin
|
As one example, let’s consider
medical costs. Who pays your medical expenses if you are an
employee? Medical insurance in the United States is an unwieldy
and expensive mess. Maybe you are covered by your employer,
maybe not. What we do know is that medical costs are rising
exponentially, and most striking unions cite increasing medical
costs to employees as their primary grievance. Even if you
have medical insurance, you will have to pay deductibles.
And you will pay these expenses with after tax dollars.
And when you finally come to calculate
your taxes on your 1040 form, you will find that you cannot
claim medical costs as deductions on your tax return unless
medical expenses exceed 3% of your income.
The avoidance
of taxes is the only intellectual pursuit that still
carries any reward.
John Maynard Keynes
|
What happens if you set up a corporation?
You are the founder of a corporation and hire yourself as
the employee of the corporation. As the founder of the corporation,
you are able to set up a health insurance plan with pretax
dollars. If there are insurance deductibles, you, as the founder,
can write a resolution and put it in your corporate book.
Your generous corporation will cover all of the costs of medical
care for its employees (that means you,) including deductibles,
and any medical costs that most insurance policies will not
cover.
After all, as the founder of the corporation,
you are free to set up any medical reimbursement plan you
wish, as long as you put it in writing in your corporate resolutions.
And before you figure out how much tax the corporation owes,
you first calculate all of the medical expenses paid by your
corporation and then calculate the tax after expenses.
That means, instead of filling out a
1040 form for personal taxes, with your non-deductible medical
expenses, you file an 1120 corporate form. If you are an employee
of your own corporation, your corporation can pay for your
medical insurance. And if there are deductibles, your corporation
can file a resolution to cover all uninsured medical costs.
Do you grasp how significant this distinction is for your
economic well-being?
This distinction is particularly meaningful
for me. I have a chronic health condition that my former medical
insurance company considers “high risk.” The insurance
company agreed to continue to insure me, but at a cost that
was exorbitantly high, and would have come out of my personal
after-tax income. For me, this was not only a matter of money.
It was a matter of being able to get any kind of medical insurance.
Many people with chronic health problems become “uninsurable”
at any price.
However, since I am the CEO of the corporation
I founded, I was able to set up a health insurance program
through the corporation, at a significantly lower rate than
the one offered by my prior insurance company. The corporation
now pays the health insurance premiums with pre-tax dollars.
And as the founder of the corporation, I have written a resolution
that the corporation will pay any deductible costs, and any
other costs related to my medical care. Only after all of
my medical costs are paid, the corporation will calculate
the taxes it owes.
I could give other examples. Your corporation
can provide generous pensions, annuities, life insurance policies,
and other benefits to you as an employee. It can even donate
generously to nonprofit corporations, schools, and churches,
if it chooses. And after it has paid all of these expenses,
and made all of these charitable donations, it can then calculate
tax on the wee bit of profit left over. Or maybe the corporation
will not have any profit at all, and then it will not pay
taxes at all.
I feel compelled to point out that it
has not always been this way. Corporate America used to pay
a much higher portion of taxes than it pays now. This is the
real unfairness of the tax system. The discrepancy between
tax rules for corporations and tax rules for individuals means
that the tax burden has shifted from corporations to individuals.
We don't pay
taxes. Only the little people pay taxes.
Leona Helmsley
|
Why are “the rich” getting
richer? At the heart of the matter, “the rich”
understand the tax system and know how to set up corporate
entities to make the most of the favorable tax laws available.
Is it fair? Is it just? Can you or I
change the system? For myself, this is a bigger challenge
than I am willing undertake. It is the way it is.
Unless you want to play David against
Goliath, or Don Quixote tilting at windmills, you would do
well to understand the inherent imbalance in the system, so
that you can use the system for your own benefit. This means
that the fastest route to keeping more of your own money and
creating wealth is to set up a corporation and pay taxes as
a corporation rather than an individual.
You know,
gentlemen, that I do not owe any personal income tax.
But nevertheless, I send a small check, now and then,
to the Internal Revenue Service out of the kindness
of my heart.
David Rockefeller
|
My point is that setting up a corporation
allows you to use your income to provide benefits you cannot
afford with your after-tax dollars. The corporate tax code
allows you to create wealth in ways that you will never be
able to accomplish as long as your taxes come off the top
of your income. In addition, corporate tax rates are lower
than personal tax rates.
If you have not set up a corporation,
I encourage you to consider doing so. People are afraid that
incorporating means a lot of extra work and trouble. Yes,
incorporating involves time, effort, and expense. And keeping
your corporate records up to date also takes time, effort,
and expense. You will also need to have increased knowledge
of taxes and accounting. The reward for this extra work and
effort is that you will be able to use corporate tax rules
for your own benefit, and the benefit of those you choose
to support with your money.
We contend
that for a nation to try to tax itself into prosperity
is like a man standing in a bucket and trying to lift
himself up by the handle.
Winston Churchill
|
To answer my own riddle, “Which
comes first? Taxes or expenses?” If you are paying taxes
as an individual, the taxes come first. If you are paying
as a corporation, the expenses come first.
This difference is enormous. When you
understand this distinction, you have one of the most
powerful means to transform your economic life from
struggle to abundance.
Knowing how to use the corporate tax code legally and ethically
will allow you to create an abundant life far beyond anything
you will be able to create with the personal tax code.
For Your Abundance,
Kalinda Rose Stevenson
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