Sometimes people talk when they shouldn’t. I’d long been in the advice business: I got paid primarily for giving advice, the right advice, and advice that was right. I didn’t get paid for guessing, for making things up, and I certainly didn’t get paid to give the wrong answer. Not all “experts,” credentialed, licensed, or self-appointed, have this mindset. Not all areas of advice have right and wrong answers. But mine does. Here’s a recent example of where someone went down the wrong path with a little bit of inapplicable knowledge.
This LinkedIn question (it’ll be dead now because LinkedIn killed that product) was pretty straightforward: when should you form separate businesses for different activities? And I’ve answered that question here, including perspectives on business factors, risk/legal issues, and governance/management/leadership reasons.
The “best answer” to the question starts out plainly enough, with decent correct advice, even if it’s a little duplicative (business risks & liability are the same issues as personal risks & liability, and personal risks have to do with entity formation rather than entity separation).
But then the “expert,” apparently a CPA, goes horribly awry. He sets forth a tax savings calculation on why using a corporation would be better than having personal income (of course, this isn’t the question being asked). So far so good, but he then says that the corporate model is “better” because less tax is paid.
That’s sort of right in the sense that $13k in taxes paid is less than $17k in taxes; other than that, it’s all but completely wrong. The missing piece, which concerns me greatly, is that the two examples aren’t parallel at all!
Leaving money in the corporation as income means that *it’s not available as salary or resources* to the shareholder! This dumb idea is the same as saying how much better off you are if you give away lots of money to charity. If you give away $3000, then you have $3000 less in cash but save $1000 on taxes (the 33% bracket makes math easy), so you really have net $2000 less. The alternative model has you keeping the $3k as income, paying $1k in taxes, with $1k less than you had to start with. Now I don’t have a Ph.D. in mathematics, but I don’t need to open Excel to figure out that -$1k leaves me with more money in my pocket than -$2k. That’s on a cash basis and there’s money in the corporation, true, but when that money comes out, you’ll pay tax then. That’s what “double taxation” on corporations means.
The right comparison is that deducting expenses vs. not deducting them is a good idea. Spending money unnecessarily to get deductions is among the dumbest ideas that exist in the world of corporate finance (a close second to reverse mergers [[link]] and outrageous fees on 1031 TIC deals that count deferral of taxes as actual tax savings). Two similar examples: first, there’s a great Seinfeld (yes, that’s redundant for emphasis) where Kramer talks about big companies just “writing it off” and Jerry asks whether Kramer has any idea what a write-off is. It’s relevant because the “expert” who answered this post seems confused.
Okay, so that’s a funny example. This next one could have been tragic. We had an UHNW family client in California. The matriarch was exceptionally thrifty and had, over years of saving and investing combined with some dramatic business building by her husband, managed to amass a net worth in the low 9-digits (and yes, that’s kind of an oxymoron; we’re grading on a curve here). She knew that estate taxes would be high, and so she sought advice from her well-paid (i.e., three times the market rate) financial advisor at a large firm to come up with an estate plan to save on taxes. Boy, he did his job well. He managed to find a plan that would slash her estate taxes basically to zero. Great work, genius-level, right? No, you know that’s not how this story is going to turn out. The “plan” was for her to give the money away and effectively disinherit her children.
almost never what people actually want: what they want is to give as much money as possible to whomever they want to get it and reduce taxes *in light of* that goal.
I managed to figure this out and set in motion plans to correct this atrocious mindset of the advisors and eventually save the family an expected $55 million while allowing the children to receive the remaining assets.
So, being blind to money and the real cash flow consequences isn’t just a corporate finance problem; it can be a personal problem too.
C’mon — if it were that easy wouldn’t we all just give all our money to our favorite charities and be done with it? But the last donation I wrote still came out of my checking account, deduction or not.