I was at a friends birthday the other day , and there was someone at the table, a self made entrepreneur, apparently rather successful, the stereotype of someone who is sure about himself, thinks he knows the answers to any problem that he has thought of etc. etc. As it turns out he is rather fascinated about the problem of Retained Earnings tax. Without any further wikipedia search, here is his story:
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"I started my company as a C Corp. because i thought that what real companies are/do. I was always extremely conservative in terms of my tax returns. Every year I get from Amazon all internet sales and report them. The one time that I have been tax-audited they ended up returning me taxes. Still the company was successfull and made good profits, year after year.. I paid the equivalent of 48% (Federal + California ) tax and left most of that taxed profits in the company. My accountant seeing kept on telling me that he should have made the company a S-Corp as opposed to an C corp and that I should take the money (as bigger salary) instead of letting it to become C-Corp profits. But I was always affraid to do that. Never having taking debt or any investment, I was seeing it as my company's weakness that I have to deal with. Having a big cash hoard is what makes a well funded company able to fund growth spurts acquisitions, or just ride the hard times when they come and I wanted my company to be like that.
Until one day my accountant told me that I owe a huge amount of tax, equivalent to a 15% of all my accumulated over the years earnings.. as "retained earnings tax".
He then went on to explain that this is really just one more example of the fight between the old foos the aristocracy and the bourgeois the people that have assets vs the people that produce income, the old money vs the new money.
In his view the following changes should happen to the tax law.
S-Corporations are extensions of one-self and are taxed fine they way they do today.
People should be taxes as today based on a combination of income tax, use tax (like sales tax) AND asset tax (like the property tax). The asset taxes should be applied to all liquid and iliquid assets one might have. Be it land, buildings, shares of C-corps, domestic or foreign, bank accounts, gold diamonds, or commodities... The tax can be 1.25% annually, like the property tax (in his view we should be taxed more..)
C-Corporations should become pass through entities - C-corporations are not people and should not be taxed.
So when a company like Apple becomes huge its profits aren't taxed, neither its cash reserves. However, the shareholders of Apple are taxed and as their equity becomes bigger their taxes become bigger. Ideally unlike property taxes these taxes are like income, a retiree owning a few shares will have to deal with a much lower tax rate than a billionaire.
Ah, and one last thing, Warren Buffet is old money. He is arguing for a bigger income tax rate when he is sitting on a 200B asset on which he doesn't pay taxes for: any large corporation today is creating a (rather expensive for small/medium business legal) scheme that allows it to report consolidated multiational profits even though within US they report no profits or losses. Profits are being report within sub-entities whose country of incorporation is a tax-heaven, ie doesn't cause significant corporate income tax and has no retained earnings tax, The company cannot bring its earnings back.... but is immune from the retained earnings taxation (like Apple who got a loan (using its foreign cash hoard as a collateral) to pay dividends, without having to bring the cash home, hoping for a tax law change in the future...).
One last thing I didn't discuss with him:
In his model, I can have a large company who I control through a small class of high voting power shares. That makes my net-worth small, (all shares are "owning" the future cash flows/profits equally) even though it retains my power. Of course in a correct world, the price for the special shares that the google or facebook founders hold should be much bigger and not the same as the common share... Hm...
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"I started my company as a C Corp. because i thought that what real companies are/do. I was always extremely conservative in terms of my tax returns. Every year I get from Amazon all internet sales and report them. The one time that I have been tax-audited they ended up returning me taxes. Still the company was successfull and made good profits, year after year.. I paid the equivalent of 48% (Federal + California ) tax and left most of that taxed profits in the company. My accountant seeing kept on telling me that he should have made the company a S-Corp as opposed to an C corp and that I should take the money (as bigger salary) instead of letting it to become C-Corp profits. But I was always affraid to do that. Never having taking debt or any investment, I was seeing it as my company's weakness that I have to deal with. Having a big cash hoard is what makes a well funded company able to fund growth spurts acquisitions, or just ride the hard times when they come and I wanted my company to be like that.
Until one day my accountant told me that I owe a huge amount of tax, equivalent to a 15% of all my accumulated over the years earnings.. as "retained earnings tax".
He then went on to explain that this is really just one more example of the fight between the old foos the aristocracy and the bourgeois the people that have assets vs the people that produce income, the old money vs the new money.
In his view the following changes should happen to the tax law.
S-Corporations are extensions of one-self and are taxed fine they way they do today.
People should be taxes as today based on a combination of income tax, use tax (like sales tax) AND asset tax (like the property tax). The asset taxes should be applied to all liquid and iliquid assets one might have. Be it land, buildings, shares of C-corps, domestic or foreign, bank accounts, gold diamonds, or commodities... The tax can be 1.25% annually, like the property tax (in his view we should be taxed more..)
C-Corporations should become pass through entities - C-corporations are not people and should not be taxed.
So when a company like Apple becomes huge its profits aren't taxed, neither its cash reserves. However, the shareholders of Apple are taxed and as their equity becomes bigger their taxes become bigger. Ideally unlike property taxes these taxes are like income, a retiree owning a few shares will have to deal with a much lower tax rate than a billionaire.
Ah, and one last thing, Warren Buffet is old money. He is arguing for a bigger income tax rate when he is sitting on a 200B asset on which he doesn't pay taxes for: any large corporation today is creating a (rather expensive for small/medium business legal) scheme that allows it to report consolidated multiational profits even though within US they report no profits or losses. Profits are being report within sub-entities whose country of incorporation is a tax-heaven, ie doesn't cause significant corporate income tax and has no retained earnings tax, The company cannot bring its earnings back.... but is immune from the retained earnings taxation (like Apple who got a loan (using its foreign cash hoard as a collateral) to pay dividends, without having to bring the cash home, hoping for a tax law change in the future...).
One last thing I didn't discuss with him:
In his model, I can have a large company who I control through a small class of high voting power shares. That makes my net-worth small, (all shares are "owning" the future cash flows/profits equally) even though it retains my power. Of course in a correct world, the price for the special shares that the google or facebook founders hold should be much bigger and not the same as the common share... Hm...
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