“Financial Managers Trust,” a Massachusetts business trust, was a relatively new concept in Massachusetts corporate law when I hung out my shingle 22 years ago. The corporate trust provided the state equivalent of a federal S Corporation, with taxes at the personal rate of 5% rather than the usual Mass.corporate rate of almost twice that amount.
More importantly, according to my attorney, it put me in the same tax league as corporate chieftains in terms of my ability to deduct business-related expenses. No more Schedule C, Form 1040 and standard deductions for me. Not only would I legitimately avoid taxes, but I’d pick up a little cache’ with “trust” in my trade name – not a bad connotation for a financial management business.
I became a free agent, at least as far as my relationship with the tax people was concerned. Whatever happened between me and the IRS and me and the DOR was totally my responsibility, and inevitably there was a learning process involved:
- The head in the sand – As an independent contractor, Financial Managers (FM) billed my clients a fixed monthly retainer fee, and their payments went into the FM bank account. But the President (and sole employee) of FM(me) needed to feed five kids, so the account tended to get drawn down quickly in those early days. Most of the time, but not always, funds got set aside for the IRS and DOR. It took a couple of painful Aprils, with consequent underpayment penalties, for me to realize that there had to be a better way.
- The feet on the ground – A couple of years later, after I had expanded my payroll by hiring my first associates, I realized that I needed more discipline in the tax deposit area. Small as FM was (and was ever to be), it was worth it to retain a payroll service to handle all of the filing minutia and to deposit my taxes twice a month. They never missed and – though I had to scramble to cover those deposit checks on occasion -neither did I.No more tax penalties.
- The logbook in hand – If you are a corporation, the IRS encourages you to deduct all of the expenses that legitimately relate to your doing business. Just keep track and they begin to add up – the car (used almost 100% for visiting clients); the home office (10% of our living space was dedicated to the business; with the kids gone it’s up to 15%); health and dental insurance (100% coverage for my employees as part of their total compensation package justified100%deduction for our coverage); the computer (hardware and software); telecom (the second/fax line, high- speed Internet, the cell phone, bulk long distance, voicemail); office furnishings, equipment, and supplies (net of what the kids managed to pirate); the safe deposit box. All of the receipts got tossed in a file folder, and when I tallied them each year, it saved a bunch of taxes.
- Beyond the home office box – So, if these are all justifiable, I thought, what about those breakfasts and lunches? Sure, a lot of them are with friends, but every interaction is another chance to promote what I do, and leads can (and do!) come from anywhere. So those count, and so do all those organizational dues, and the professional journals, including the Boston Business Journal and The Globe. I have to keep track of the names and numbers of the local players, right?And Business Week and Fortune, as well- but probably not Newsweek, and probably not Sports Illustrated, even though sports has informed a lot of conversations in New England during the past six months.
- But keeping the lid on – I thought about expensing some of my clothing and dry cleaning costs until I read the IRS’ definition of a (tax-deductible)uniform. I also considered inviting Annie (my wife and nominal VP of FM) to dinner regularly and having the Company pick up the tab ’til I realized there’s no way that our dinner agenda could approach200 % business. The Internet and computer expenses at our second home in Maine are 100% business initiated and thus tax-deductible, but I can’t justify writing off the travel expense on I-95 until I have a few clients up there.
As a result of my operating this way since 1983, tax avoidance has become just another element of personal and professional autonomy. It helped that I really didn’t know what I was doing in giving up a full-time job and hanging out the FM shingle when Annie and I had just had our fifth child and purchased a new home with a 17¾%mortgage. And I took a perverse satisfaction in legitimately paying no taxes in one of those early years because my total deductions exceeded my income – I refused to acknowledge that I had anything more than a cash flow problem at the time.
So, the question is – knowing the downsides as I do now, would I recommend this route to any of my kids? Or should they just take their tax lumps with their 1040incomes for the next forty years?
“Of course,” I say, “you should go the route of independent business. Just make sure that you have a wealthy father- in-law. ”
Alligator Bites
From the New York Times, March 6, 2005
“…For most taxpayers, there is little opportunity to cheat significantly without detection, because their wages and salaries, interest and dividends are reported independently to the I.R.S. by their employers, banks and brokers, making it possible for the agency’s computers to spot discrepancies. So, too, with their biggest deduction, home mortgage interest.
“But Mr. Rossotti [former IRS Commissioner] notes that business owners like Mr. Anderson [the biggest known tax cheat in history] are largely in control of what the I.R.S. knows about their finances. Congress has not imposed an independent reporting regime on them, as it has on wage earners, in part because of concerns about burdening businesses with paperwork and compliance costs…”
– by David Cay Johnston
On an affordable retainer basis, FM serves as the part-time controller and senior financial manager for multiple clients, leading them to profitability and positivecash flow.
The goal is for the organization to outgrow Financial Manager’s services, at which time FM will take the lead in identifying and hiring the right full-time financial person for the firm, and effect a smooth transition to his or her management.
Draining the Swamp
Federal Corporate Income Tax Rates for 2004*:
| Rate | Bracket | ||
|---|---|---|---|
| 15% | $0 – | $50,000 | |
| 25% | $50,000 – | $75,000 | |
| 34% | $75,000 – | $100,000 | |
| 39% | $100,000 – | $335,000 | |
| 34% | $335,000 – | $10,000,000 | |
| 35% | over$10,000,000 | ||
*Personal service corporations pay a flat 35%
Federal Personal Tax Rates for 2004:
| Rate | Bracket (Single) | ||
|---|---|---|---|
| 10% | $0 – | $7,150 | |
| 15% | $7,151 – | $29,050 | |
| 25% | $29,051 – | $70,350 | |
| 28% | $70,352 – | $146,750 | |
| 33% | $146,751 – | $319,100 | |
| 35% | over$319,100 | ||
| Rate | Bracket (Married, Filing Jointly) | ||
|---|---|---|---|
| 10% | $0 – | $14,300 | |
| 15% | $14,301 – | $58,100 | |
| 25% | $58,101 – | $117,250 | |
| 28% | $117,251 – | $178,650 | |
| 33% | $178,651 – | $319,100 | |
| 35% | over$319,100 | ||