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Hey Fam,
Vieje here. It’s good to be back after a few hectic weeks. Conference season came on strong with TechCrunch Disrupt in San Francisco and Money2020 in Las Vegas. It was awesome seeing old friends and partners while also getting the chance to meet some of you all who came to say hi.
At Disrupt, I hosted four roundtable discussions about the changing landscape of equity compensation and I’ll admit, I was surprised by how many people attended and were interested in learning about equity compensation.
Money2020, aka the FinTech Super Bowl, was an absolute blast. I know that FinTech has had a rough year, but if attendance at Money2020 was any indication, it’s definitely on the rise. It felt like 3-4x more people than last year and I couldn’t believe how many founders there were building great products.
On that note, here’s a fun (yet, hopefully still informative) topic for this week.
Taxes aren’t always so black and white
October 15th is the second tax deadline, which is when tax returns on extension are due. Although April 15th gets a lot of press, October 15th is really what drives CPAs nuts as there’s no room for error and you can’t extend past that. In honor of tax season officially being over, I thought I’d write about some of the complexities and oddities of our tax system.
📚 My favorite professor and legend, Bill Resler, used to say that there’s only three truths: life, death, and taxes. It’s hard to disagree, as the government seemingly wants more of our money every year. Nearly everything is taxed, but just how and when the tax applies is much more of a gray area.
The tax code is incredibly long and complex, but it doesn’t cover everything and leaves a lot of room for interpretation (and loopholes).
🏛️ A lot of accepted tax law is actually produced in the courts when taxpayers sue the IRS to get a more favorable ruling. Sometimes, it works in their favor. Sometimes not. But we often see that even judges don’t understand the tax code.
The United States tax system is really just one gigantic, complex mess caused by politics and inefficient past lawmakers.
But it can be interesting. And, sometimes it’s just pretty damn funny. Here are some of my favorites.
⚾ Getting lucky at a baseball game.
No, I’m not talking about that couple in the upper deck of the A’s game.
On October 4th, Aaron Judge of the Yankees hit his 62nd home run of the season, breaking the American League record. A lucky fan at the Ranger’s stadium caught that ball. And it seems to be headed for auction where it could fetch millions of dollars.
This guy’s financial future may look brighter…but his tax situation is a bit murkier.
Tax code regulations, technically, consider prizes or awards as ordinary income. He could have a tax liability for just catching the ball. So, how would you value it if he doesn’t sell it??
If he does decide to sell the ball, the true value (and tax liability) will become much clearer. If it sells for $1 million, and it’s taxed at ordinary income rates, this guy could be looking at a federal tax bill of over $300K — and that’s not even accounting for state taxes.
I’d love to see what would happen if the fan actually decides to keep the ball instead of selling it. No one knows for sure how this plays out, not even the IRS. Back in 1998, the IRS released a statement which ends with:
Commenting on this situation, IRS Commissioner Charles O. Rossotti said, “Sometimes pieces of the tax code can be as hard to understand as the infield fly rule. All I know is that the fan who gives back the home run ball deserves a round of applause, not a big tax bill.”
💃 The breast deduction.
Back in school (in my favorite class), we were all assigned real-life, weird or unique tax situations to either represent the taxpayer or the IRS. Generally, these usually had to do with deductions that taxpayers tried to take which would reduce their tax bills.
Taxpayers can usually deduct business expenses but not personal expenses. There’s usually a clear line between business and personal, though that’s not always the case.
I was assigned to represent Cynthia Hess who also goes by her stage name: Chesty Love. If you hadn’t guessed, Cynthia was an exotic dancer. And, she was looking to improve her business prospects by getting breast implant surgery. These surgeries can be pretty expensive (and aren’t covered by health insurance), so Cynthia was hoping to write it off on her tax return to ease the cost burden.
The IRS argued that these were personal expenses and should not be tax deductible. Cynthia didn’t give up and she decided to sue the IRS.
It eventually went to Tax Court, and guess what? She won. She was allowed to deduct the cost of the surgery as a business expense.
Feel free to read the awesome court case if you’re interested.
🏚️ Gimme (tax) shelter.
So, both of those were pretty fun(ny) examples of how crazy the tax system can be. But the tax nerd in me wouldn’t feel right if I didn’t share a well-known historical story to illustrate the absurdities our tax system can have.
In 1932, Beula Crane inherited an apartment building from her deceased husband. There was debt in the form of unpaid mortgage in the amount of about $262K, of which about $7K was in accrued interest. But, the fair market value of the building was about the same: $262K.
Unable to pay the debt, and in danger of foreclosure, she sold it for $3,000 (which would be about $65K today) and paid an additional $500 during the sale process. So, she reported a $2,500 gain on the property. Why? She argued that her equity in the property (the value minus any property debt) was zero.
Well, the IRS didn’t agree.
But, there was another issue here: the mortgage was non-recourse. With a non-recourse mortgage, the lender assumes the risk in the case of loss. For example, if someone buys a property for $500K with a non-recourse mortgage, and the buyer stops paying, but the value has dropped to $400K, the lender can seize the property but they must sell it for the current value. Which is: $400K. They can’t go after the buyer for the additional $100K they’ve lost.
Of course, a recourse mortgage is the opposite and, in this example, the lender would have been able to go after the buyer for any additional amount not recovered in a sale.
Anyway, the IRS argued that Crane should pay taxes on the true value of the property. Not just the value minus the outstanding mortgage amount. But, they lost the case and the Tax Court sided with Crane.
So, the IRS decided to appeal. The Court of Appeals overturned the prior ruling, and ruled in favor of the IRS. Eventually, it made its way to the Supreme Court in 1947. They also sided with the IRS, in a 6-3 ruling.
But, that’s not where this story ends.
What sounds like a pretty boring case of tax law actually turned out to be one of the most impactful. That’s because, in their ruling, the Supreme Court created one of the biggest tax loopholes in history. They created the tax shelter.
For nearly 40 years — until it was finally fixed in 1986 — “clever” taxpayers would buy property with non-recourse debt and then take depreciation deductions on the property to reduce their tax bill.
If this still sounds a bit confusing, it is and I could go much deeper into specifics, but the point is this: The tax system can be messy and, sometimes, determined by lawmakers and a court system that may not fully understand how taxes work.
But, it also goes to show you that much of our tax system is malleable, and there are always parts that aren’t as cut and dry as you may think.
Let me know what you all thought about this week’s newsletter by hitting me up on Twitter or replying to this email. We’re also looking to send these out more often, as we have a lot of great content lined up. If there’s anything you’re curious about, or questions you have, let us know.
Things we’re digging: