IRS and the 1%: A report from the front lines…


Been there, done that – have the scars. Being a controller and sometimes a chief financial officer for over three decades, I’ve had plenty of exposure to both the IRS (personally and professionally) and several members of the 1%.

In fact, I suffer under the scrutiny of the IRS BECAUSE of one such member of the 1%.

Not that long ago, after the collapse of the company I was working for (think sub-prime mortgage crisis) I managed to side step into another position. I was grateful for only having been out of work for about a month. Sadly, sometimes a cure can nearly kill you. I went to work for a man who was just finalizing an overseas contract that put well over 8 figures into his foreign bank accounts. He hired me for his New York office as his Chief Financial Officer. This turned out to be the consolidation of five other people (the current CFO, Controller, Bookkeeper, HR Director, and IT Director) at a rate that was tens of thousands of dollars less than I was making in the company that was forced out of business. The contracts that my new companies had in the United States were either failing, stalled, or taken away thanks to the ensuing recession.

I’m a normal human being – I had credit card debt, child and maternal support payments, rent, insurance, a car loan, etc. My new salary was short of what I needed, so I was honest with him, told him my break-even salary, and reminded him that he was now saving over $400,000 a year in other salaries by replacing them all with me. All I wanted was to skirt by until the market improved and then we could re-evaluate the situation. We agreed – it was October. Comes the first of January – he slashes my salary by nearly 50% of what I had been earning just five months earlier. The cut was so deep that even if I stopped paying child support, I still wouldn’t have had enough to pay rent, my car loan, or buy food. On top of this, despite the fact that he had over $30M in his banks, he decided he didn’t feel like continuing his stateside business and let about 40 people go. My debt began to soar.

Now any good business man – you’ll find your pick of the litter amongst the 1% – would have congratulated him for making the right “business decision.” Okay, let’s go with that for the moment.

Prior to this, he had pulled $8M into the country as a loan from his foreign entity. His tax accountants advised him that the IRS would look upon this as a repatriation of foreign earned income and he’d have to pay tax on that. Well, let’s face it, no 1%er every feels it’s incumbent upon them to pay income tax. Thanks to the fact that we used Quickbooks software (an extremely forgiving accounting software with no audit trail) he changed it from being a loan from his foreign entity, had the contracts rewritten overseas, and now re-titled them as “Marketing Fee’s Payable” suggesting that the money was to be returned to the people who had hired him, if at some point the money wasn’t earned. Suddenly, no taxable event; he uses half the money to pay company bills and promptly pockets $4M. He later converts the ownership of the company to a single member LLC, which means that that company no longer files a tax return. For the IRS: out of sight, out of mind. Flash forward, the contracts were fulfilled, the money never went back to client, and no tax was every paid on the money he pocketed.

I wish I could say that was the end of his villainy, but it was just the beginning. At that point he was semi-retired with no business and only three employees (me, a sales agent, and a personal assistant). Oh, and $30,000,000 in a foreign bank. He’s still stuck with the problem of bringing that money here; when he does, it becomes taxable. What to do, what to do? The man likes art, so he goes on a buying binge over the next two years and purchases about $20,000,000 worth in paintings, jewelry, and sculptures. The solution? Have a transport agent package his purchases into containers and ship them back to the United States to his various homes and apartments and the rest into warehouses in the New York metropolitan area. There was no trace of money being transferred from an overseas account to a domestic one and it seems customs doesn’t bother to inform the IRS that art is being imported into the country. No income tax paid.

Now we’re up to about $28,000,000 in taxable income for which not one penny in tax has been paid. Just imagine a member of the 99% messing up their tax return and maybe putting the wrong amount from their W-2 or 1099 on a 1040; the IRS would be all over it within weeks. Why? Because we’re the sheep who faithfully TELL the IRS what we owe them; all they have to do is stick out their hand to collect.

I did try, by the way, to have an attorney prepare a case for the IRS with the facts and backup paperwork to what I’ve mentioned here, but they felt the IRS would shy away from the work it would take to bring this guy to justice. Let’s face it; it’s easier to go after the little people, like us. Actually, the IRS makes it easier for these types to pocket billions with no tax. How you might ask? There is a tax loophole brought to you by the Reagan Administration called ‘non-recourse debt’. Non-recourse debt is a debt that you don’t personally have to pay if there is a default on the loan. Here’s an example of how this works.

First, you have to understand a company owner’s basis in that company. A person starts a company and puts $1,000 in for the expenses of setting up the company. As it starts to make money, that person can withdraw that $1,000 without paying any tax on it – obviously. It’s just like the company paid back a loan. But, if the person takes out $2,000, the second one thousand is taxable because it was more than his basis. Now, let’s up the scale, and this especially goes for real estate developers – people like Donald Trump and the late Leona Helmsley.

Here’s some numbers: The business owner has put $1M into the company as capital. He bought a building for $800,000 with a mortgage of $600,000 that he personally guarantees. Over the next couple of years, the building doubles in value (very common in NYC), it’s now worth $1,600,000. He refinances the building for $1,120,000 (70% of the building’s value) with a mortgage that only the company guarantees because it has a good record of accomplishment – the new loan is now non-recourse debt. The owner is no longer personally libel to the bank if the company defaults on the payments. He pays off the original mortgage of $600,000, which leaves him with $520,000, which he distributes to himself as return of capital – he’s left with $480,000 in basis in his original capital account – no tax due. That’s cool. Another three years go by. The building is now worth $3,000,000. The owner refinances it again with a mortgage of $2,100,000. He pays off the current mortgage of $1,120,000, which leaves him with $980,000 in the bank. He pays himself back the remaining $480,000 in his capital account plus an extra $500,000. Now normally that extra $500K would be taxable, but under the current IRS regulations, since the mortgage is ‘non-recourse’, the IRS considers this as additional basis for the owner in the company, and he takes that $500K without incurring a dime in tax – it is deferred tax. He can buy a fancy car or apartment; he can take a two-month vacation in Europe in the finest hotels, all without losing any sleep over how he’s going to pay Uncle Sam.

Nice, huh? The catch, you might say is that when he ultimately sells the building and pays off that ‘non-recourse’ loan, the deferred tax – because he now has negative basis in the company – would become taxable then. It would, but building owners get fancier, they do 1031 Exchanges for bigger buildings, and wind up deferring the tax forever. Meanwhile the middle and lower classes are footing the majority of the tax burden for the Country.

From Liberty Unyielding

From: Liberty Unyielding

The IRS still has it out for many of us. I make just enough money that the government takes an extra little slice by way of something called the Alternative Minimum Tax – it’s an add-on tax  because it limits the benefits of certain deductions (this was enacted in 1982 and, thankfully, President Obama attempted to lessen the burden some in 2012). I can’t deduct educational costs or the interest on student debt, because I make too much money the government says. For me, the pièce de résistance, are the rules surrounding child support. I am divorced, and I had no issue paying support for my children. The inequity of the situation is that I had to earn far more than I had to pay, because child support is paid with after-tax dollars, so for every dollar I paid out, I had to earn about $1.43. That doesn’t sound like much, but over a decade and $220,000 in support payments meant, I had to earn in excess of $300,000. I’m still okay with that. Here is what I’m NOT okay with: the IRS does NOT allow the payer to deduct a dime. The custodial parent does NOT have to declare a dime. That money goes into the receiver’s bank account tax-free. The payer bears the full burden of the support PLUS the tax on it.

We all know the rich are getting richer and the middle class and poor are getting poorer. There is no question that the Internal Revenue Tax code and the opportunities, which aid the wealthy, are egregious. They must be addressed, reorganized, and curbed. I would love responses to this post describing personal experiences with either the IRS and the 1%, or both.

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