The revelation that Donald Trump declared a nearly $1 billion loss on his 1995 tax return has led to taxes being in the news a lot the past week. The biased reporting and false outrage associated with Trump’s declared loss has been something to behold. The fact that The New York Times (who broke the story) The Clinton Foundation, and numerous liberal business icons such as Warren Buffett and George Sorros have all used the same or similar provisions of the tax law to limit what they pay in taxes has been completely ignored by most commentators.
I am not a Trump fan but from all appearances he followed the law and didn’t do anything different than any smart business or individual would do under similar circumstances. The provision of the tax code he used to take the deduction is not some obscure loophole but is at the heart of business tax law. For anyone interested in understanding the tax law and how Trump used it here is a link to an article by Meagan McArdle of Bloomberg View that is one of the few fair and unbiased articles about the controversy I have seen.
With the topic of taxes in the news and on everyone’s mind I thought it would be a great time to review the 10 smartest things ever said about taxes:
(1) Taxes are inevitable: “In this world nothing can said to be certain, except for death and taxes.” – Benjamin Franklin
If this was true in Franklin’s time, when taxes were few and rates were low, it is truer today when taxes proliferate and rates are rising.
(2) Worse than paying taxes: “The only thing worse than having to pay taxes is not having to pay them.” – Larry Swedroe
Almost half of all US households do not make enough to pay any federal income taxes, so if you owe taxes next April be grateful. You must be doing something right!
(3) Price of civilization: “Taxes are the price we pay for a civilized society.” – Oliver Wendell Holmes
Almost everyone agrees with this statement in principle, but the devil is in the details. What services the government should provide, how much these services should cost, and what services could be more efficiently or effectively provided by the private sector is at the heart of the battle between left and right. So while there is a near consensus that taxes are the price we pay for a civilized society, what that price should be is very much in contention.
(4) Nobody owes more than the law demands: “Anyone may 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. Over and over again the Courts have said there is nothing sinister in so arranging affairs to keep taxes as low as possible. Everyone does it, rich and poor alike, and all do right, for nobody owes any public duty to pay more than the law demands.” – Judge Learned Hand
In my 15 years’ experience as a CPA I have yet to have anyone tell me they want to pay more taxes than required by law. Apparently everyone agrees that it is permissible to use the law to limit their own taxes, but as the controversy over Trump’s 1995 return shows many are quick to abandon this position when it comes to other people. Unless you can show that you have voluntarily paid more taxes than the law demands yourself it would probably be wise not to expect others to do so.
(5) The mysterious case of 7 million missing children: “Consider what happened one spring evening at midnight in 1987: seven million American children suddenly disappeared. The worst kidnapping wave in history? Hardly. It was the night of April 15, and the Internal Revenue Service had just changed a rule. Instead of merely listing the name of each child, tax filers were now required to provide a Social Security number. Suddenly, seven million children – children who had existed only as phantom exemptions on the previous year’s 1040 forms – vanished, representing about one in ten of all dependent children in the United States.” – Steven D. Levitt and Stephen J. Dubner from the book Freakonomics
Using the tax law to your advantage is smart. Tax fraud, on the other hand, is dishonest, harms our country, and should rightly be condemned.
As the case of the 7 million missing children shows, tax fraud is a big problem. But how big? In 2001 the IRS conducted an in depth study of 46,000 randomly selected tax returns and estimated that taxes were underpaid by about 20 percent. This is not acceptable. We all have an obligation to pay the taxes we lawfully owe and to encourage others to do the same.
(6) Why do you have to go and make things so complicated? “The hardest thing in the world to understand is the income tax.” – Albert Einstein
US congressman David Camp added, “The tax code is 10 times longer than the Bible, without the good news.” Finally, former Treasury Secretary Paul O’Neill said, “Our tax code proves that we are not intelligent people because no intelligent people would have invented the thing.”
While everyone agrees that the tax code is a complicated, unintelligible mess no one can agree on how to fix it. Instead of starting over and coming up with something that makes sense we tinker with different parts of it, making the whole thing even more complicated than before.
What this means for you is that if you aren’t confident you understand the parts of the tax code applicable to your situation you are probably better off paying a professional to prepare your taxes. We should be able to come up with a tax code everyone can understand but don’t hold your breath. I don’t see it happening any time soon.
(7) Don’t let the tax tail wag the financial dog: “You don’t get rich spending a dollar to save 30 cents.” – Patrick Killilea, real estate expert
Managing your finances to minimize taxes is not always the right move. If buying a house makes sense for you, do it. If you own a house, take the mortgage interest deduction. However, don’t buy a house just for the mortgage interest deduction. Paying $1 of mortgage interest solely to save 25 or 30 cents on taxes is not a prudent plan.
The same holds with other tax deductions. It is rarely a good idea to do something only for tax planning purposes. Tax planning can be an important part of financial planning but it should never be your only consideration.
(8) First filer wins: “You’ve got to beat them to the punch…They know the first filer wins.” – Troy Lewis, CPA as quoted in the March 2015 edition of Money magazine
Scammers filing a tax return in your name to collect the refund is a growing problem. One way to minimize this problem is to file as early as possible, as the IRS gives precedence to the first return filed.
Another common scam is for someone to call impersonating the IRS and threatening severe punishment if you don’t pay them immediately by giving them your credit card number. If this happens to you simply hang up. The IRS will communicate problems with your tax return by mail, not phone, and will never threaten you or ask for your credit card number over the phone.
(9) A million dollar middle-class tax deduction: “Let’s start with the simplest form of retirement plan, a straightforward Individual Retirement Account (IRA). You can take $3,000 per year [current law allows contributions of $5,500] and invest it in some investment vehicle such as a mutual fund and, for people with moderate income, deduct the entire $3,000 from taxes…If you are in the 28 percent tax bracket, the contribution really costs you only $2,160, since the tax deduction saves you $840 in tax. You can think of it as having the government subsidize your savings account. Now suppose your investment earns 8 percent per year and you continue to put $3,000 per year into the account for forty-five years. No taxes whatsoever are paid on the earnings from the funds deposited in an IRA. The investor who saves through an IRA has a final value of over $1.25 million, whereas the same contributions without the benefit of an IRA (where all earnings are taxed at 28 percent each year) total only just over $450,000. Even after paying taxes at 28 percent on what you withdraw from the IRA… you end up with close to $1 million.” – Burton G. Malkiel
The result of saving through an IRA instead of a taxable account in the example above is an increase in retirement savings of over half-a-million dollars. With IRA limits today almost double what Malkiel used in his example the benefit of saving through an IRA currently would approach a million dollars. Better yet, use a 401k through your employer, which has the same tax benefits, a much higher limit, and often an employer match, and the benefits would be well over a million dollars. In spite of these benefits an alarming number of people fail to take advantage of this incredible tax-saving, wealth-building opportunity.
(10) “Although ‘death and taxes’ may be certain, how much tax you are required to pay is anything but certain.” – Scott Ford
Both Benjamin Franklin and Scott Ford are correct. Taxes are certain but the amount you pay is decidedly uncertain. The IRA illustration above is just one example. Tax planning is beyond the scope of this article but learning how to use the tax law to your advantage, or hiring someone to do it for you, is vital in building wealth.
George Kinder, founder of the Kinder Institute of Life Planning, summed things up by stating, “It’s not ‘corrupt’ to take tax deductions. It is foolish not to. Tax deductions are there as part of the law of the land. They’re there for your benefit. You should take advantage of every one you can…Take every deduction you are entitled to, and put the savings to work toward your life plan.”
In the end, the goal of personal finance is to help you wisely use your resources to create the kind of life you want to live. Smart tax planning is a vital tool to help you do this and it should be considered in all your financial planning.