One of the days, I’ll get around to reading the copy of Sandel’s ‘What Money Can’t Buy; The Moral Limits of Markets’. It’s even made the exquisitely painful cut of being one of only two dozen books brought on our three-month sojourn on the south coast of England. When I do read Sandel, I hope to acquire a greater appreciation for exactly how market thinking has permeated and corrupted so many aspects of human life.
One surprising place a weirdly attenuated and manically zealous form of market thinking has popped up is in the Minnesota tax office. (via BoingBoing) They’re running a quite unhinged vendetta against Lynette Reini-Grandell and Venus DeMars, a married couple who make music, art, poetry and teach English. The taxman running their audit says Reini-Grandell and DeMars’ creative activities don’t make enough money, and haven’t for years, thus proving the artists are mere hobbyists who shouldn’t get a tax break. Either they should turn a consistent profit by now, or have given up already and gone back to being good little consumers.
“The tone of all these proceedings have been completely anti-art. There has been an emphasis on creating a product, advertising it for sale, and then selling it. …
Writers do not write a few lines and then advertise they have a poem for sale, making sure that the poem sells at a break-even point of what it cost monetarily to produce it. But this is what the Minnesota Department of Revenue insists I should be doing. It sickens me to have to participate in this because I know it is deeply wrong.”
More here.
Sometimes, these apparent miscarriages of justice loom large in the headlines and then kind of fall apart when you look at the detail. Not this one. The further you get into the taxman’s narrow view of capitalism – large record company: good. Independent entrepreneur: bad – the more apparent it is that he believes so implicitly in the winner-takes-all model of capitalism that it’s not enough for musicians in the long tail to bump along the bottom indefinitely. No, they must be shamed for failure and fined a six figure amount in back taxes.
It all seems to come down to intent. Does running your own independent record label and ‘failing’ to sign to a major mean you don’t want to make money? At the consistent but modest level of success Venus de Mars has, the majors aren’t interested and the musicians keep more of their profits if they run their own show. Does allowing your music to be played royalty-free on public radio mean you just don’t want success enough? (Tell that to the Ariana Huffington business model of ‘blog for me for free – you’ll get exposure’.) It’s a Kafka-esque nightmare where the artists must try to prove they are innocent of just not wanting it enough.
In fairness, there is a question to ask about how much the state should, through tax relief, subsidise individuals’ artistic endeavours. And one person’s day-job supported creative career is another person’s tax-funded vanity project. But the amount of resources the Minnesota tax office is putting into going after two very modest earners seems odd, and speculation about what is fueling the animus behind it ranges from simple hatred of trans-gender people to a broader programme to discredit state cultural grant-making.
But even if the state looks at creativity purely from a market standpoint, isn’t it worth foregoing a small amount of tax income to keep the talent pool bubbling up winners? After all, that’s what we do with tax breaks for R&D or the UK’s much misused patent box. Even if you don’t believe the state should subsidise, or at least not penalise, art for art’s sake, doesn’t it make financial sense to very cheaply back a lot of creative horses in order to share the takings of the ultimate winner?
It would be foolish, in the age of austerity, to cultivate any idealism about the subjective choices states make on who to go after for tax and who to nod through to the winner’s circle. Overt choices are being made, and they are profoundly political. Just yesterday in the UK it was confirmed that the taxman used government surveillance powers (“We’ll only use it for terrorism or serious crime. Promise!”) to investigate the whistleblower of a secret deal to give Goldman Sachs a £20 million tax break. And today, Margaret Hodge, chair of the parliamentary committee that grilled Google on tax avoidance and shamed Starbucks into paying at least some corporation tax in the UK, had this to say about the latest HMRC sweetheart deals:
“If we got £4.5bn in, how much did we not get? That is what taxpayers will want to know”.
As the Greeks know all too well, once people believe that tax is paid only by the weak and foolish, the state loses an essential part of its credibility and ability to function. Why shouldn’t everyone claim for that unused home office or fiddle their VAT when the builders extend the side return? On a larger scale, why should UK taxpayers subsidise with development aid a state whose ruling class refuse to pay their way?
Just like the Minnesota taxman, the UK HMRC’s version of market capitalism shows a strong bias in favour of the biggest firms. ‘Too big to pay their tax bill’, you might say of the large companies who pay less than they owe and rely on the government to act strenuously to protect their secrecy. Even worse, the market distortions created by governments’ failures to tax and collect on corporate profits mean only the biggest, most multinational firms can win.
When, say, a national champion like Cadburys is taken over by a vast multinational like Kraft, many of Cadbury’s profits generated in the UK are shifted abroad to jurisdictions where almost no tax is paid on them. The result, which I’d not heard about till recently, is a significant loss of tax revenue to the UK. This isn’t just a happy accident for the company doing the buy out. It can be central to the deal. The fact that the acquiring multinational will pay a lower effective rate of corporate tax than any national competitor gives it an unfair advantage over domestic firms at the same time as it strips the government of tax revenue.
The market distortion facilitated by the government’s supine attitude to tax collection is bad for consumers (why compete so hard on product and service when much profit comes simply from a lower tax rate?), bad for competitors, bad for tax-payers and bad for users of public services. It’s not just Kraft, of course. Same for the Boots takeover by Walgreen. Same for the Walkers Crisps takeover by Pepsico.
I wish the unholy zeal of the Minnesota taxman could be grafted onto the UK government’s pursuit of corporate tax revenues. Or even for the government to start caring as much about taxing economic activity in the UK perhaps a quarter as much as it cares about clawing back housing benefit from the disabled. David Cameron waffles about the G8’s need to ‘do something’ about multinational profit-shifting while he refuses to cooperate with EU measures that might actually get somewhere. Unconvincing, to say the least.
Like our tax system, this government seems determined to punish the losers over and over again, while rewarding the winners with ever more prizes. Come 2015, we’ll see who the real loser is.
{ 114 comments }
Rich 04.30.13 at 12:19 pm
Would you feel the same if the activity were not art? Assume a taxpayer really enjoys collecting baseball cards. Should he be able to deduct the cost of acquiring the cards on the theory that he might one day decide to open a business selling the cards? What if he has a “business†that he runs out of his house and almost never sells a card? Should a football fan be able to deduct the cost of tickets and cable because she claims that she might one day write a story about the game/match? What if she plans to open a shop reselling the old ticket stubs and the shop just happens to lose money. It is inherently difficult to separate hobbies (consumption) from investment (business) because some of us are lucky enough to make money doing what we love to do. The tax authorities have a difficult job drawing the line, and any line will produce bad results some of the time.
SamChevre 04.30.13 at 12:45 pm
I can’t speak to Minnesota law, or to the instant case.
However, having run a small business (which was a failure from a making-money perspective), and knowing farming (which is one place where the business/hobby rules are aggressively enforced, particularly if horses are involved), I doubt that there is any anti-art animus.
In the US tax code, an activity is presumptively for-profit if it makes money three years out of five. If it doesn’t make money three years out of five, there’s a list of tests that mean it may still be a business. If it isn’t a business, you can deduct the costs against earnings from the activity, but not against other income.
I’m inclined to think this is in general a sensible rule. Otherwise, there would be a vast temptation to have a “business” reviewing restaurants, or collecting baseball cards, or sportswriting–that was solely a way of not paying tax on most of your actual income.
prasad 04.30.13 at 12:50 pm
Re Sandel, I think it’s worth remembering his particular objection to markets isn’t primarily something to do with economic outcomes like inequality. It’s moral, moral here meaning analytically continued from Sandel’s other bioconservative moral approach on bioethics invoking corruption, defilement and sanctity. He is troubled by carbon taxes (decacralizing environmental purity) or compensating people participating in drug trials (incentivizing the taking of health risks) in basically the same way he’s troubled by prostitution, surrogacy, euthanasia or genetic engineering. There are proper and naturally despectful ways of dealing with things, and undignified ways likewise. Steven Pinker took on this numinous reasoning quite ably.
Marc 04.30.13 at 1:05 pm
@1: In principle, yes. In practice, if you go to the article they’re pretty clearly hounding someone who they don’t like. Claiming that you have to be signed by a major label to be a musician is pretty specious. Going on tours, selling recordings (but not enough of them!) and so on are very different from taping a game and claiming that you’ll write a book someday.
salacious 04.30.13 at 1:16 pm
“In practice, if you go to the article they’re pretty clearly hounding someone who they don’t like.”
Not necessarily. All the article gives us is their highly subjective account of their interactions with the tax office and speculations about motives. Of course, those speculations could be true, but unless I missed some evidence in the article, this audit could very likely just be the product of some bureaucratic drudge in their office applying some obscure regulation or guidance document. Distasteful perhaps, but thin gruel on which to mount Maria’s surprisingly libertarian assault on the taxing power.
MPAVictoria 04.30.13 at 1:17 pm
This is a really difficult issue and I don’t have much to add on whether the couple from Minnesota is being treated unfairly or not. I can however sign on wholeheartedly with Maria that the current British Government, and indeed the current governments in most developed countries, currently seem intent on punishing the weak and rewarding the strong.
MPAVictoria 04.30.13 at 1:18 pm
” Distasteful perhaps, but thin gruel on which to mount Maria’s surprisingly libertarian assault on the taxing power.”
Hmmm. I did not read her post that way at all. In fact she spends a good chunk of the piece complaining about government inaction against large scale tax cheats. Hardly a libertarian position.
Sebastian H 04.30.13 at 2:43 pm
The hobbyist line is a tough one, because if not well enforced it could easily become a hole big enough to suck up most of the tax code. I tend to interpret the article as much less a ‘markets rule’ issue and much more a class issue. Government officials generally prefer to spend time attacking the lower class because they don’t fight back as hard as te upper class, and won’t be embarrassing you to your boss nearly as often.
PGD 04.30.13 at 2:43 pm
As a couple of people have said above, opening the business expenses deduction up to any costs people incurred in a serious hobby would make it even easier to evade taxes than it is now.
Donald A. Coffin 04.30.13 at 2:52 pm
“As a couple of people have said above, opening the business expenses deduction up to any costs people incurred in a serious hobby would make it even easier to evade taxes than it is now.”
Why does the name “Romney” come to mind here?
Chris Bertram 04.30.13 at 2:59 pm
This kind of thinking is also part of the UK Coalition government’s plans for “welfare reform”. Here’s Lord Freud:
http://www.guardian.co.uk/society/2013/jan/21/universal-credit-benefits-work-longer
engels 04.30.13 at 3:11 pm
It’s even made the exquisitely painful cut of being one of only two dozen books brought on our three-month sojourn
How quaint.
Jon D 04.30.13 at 3:31 pm
Part of this derives from the inconsistent way that we see ‘income’. A business has ‘income’ that is revenue minus expenses. An individual’s ‘income’ is merely revenue. So if a business buys food for its employees or pays to transport them then it deducts that from its taxes. But an individual buying food for themselves or filling up their gas tank does not.
This distorts the market, pushing people to spend more of their lives under the aegis of formal organizations that can take advantage of this regulatory arbitrage. It also results in these treacherous marshes between ‘hobby’ and ‘business’. If my hobby happens to make money I must treat it as a business and can then deduct some of the expenses. But if it doesn’t make money then I can no longer deduct those expenses. What if it makes money sometimes but not often?
Perhaps it would be better to switch to a pure revenue tax for both businesses and individuals. Both get taxed on the money coming in rather than allowing for myriad complicated deductions. Or just tax money spent via VAT. We have ended up with the worst of both worlds with a rats nest of rules and weird incentives.
Maria 04.30.13 at 3:43 pm
Salacious – first time I’ve been accused of libertarianism. I thought I was pretty clear that the taxing power should be both stronger and more equitably applied. Generally, that makes me a leftie, and one typically arguing against my own financial self-interest, no less.
Rich and Samchevre, yes indeed, I agree there’s a discussion to have on where to draw the line on hobbyists versus creators. (Otherwise, why blog about it?) And I do think that art is more of a social good than collecting baseball cards, and inherently worth subsidising. But perhaps more pertinently, the minute I sell anything I make on, say, Etsy, I’m liable for tax. So when it comes to sales, there is a pretty bright line, but not on expenses or investment. That’s a bit ‘having your cake and eating it’ from the tax collector’s point of view. Hey ho, that’s just life, but in the broader scheme of mass tax evasion/avoidance, it’s more than a little irritating.
To give a pertinent example, the various writers on Crooked Timber pay for the hosting ourselves. Why? Largely because if we installed a tip jar or similar, at least one of us – and probably all of us – would have a new tax liability we’d rather do without. If any of us could say we make any income from blogging, even indirectly, then maybe we could claim against a sixteenth of the expenses (or divide by however many of us there currently are). But it’s messy and self-defeating. I guess what I’m saying is that even hobbyists are clearly liable for tax on our hobby activities, but for offsetting our expenses, it’s a mess.
(Actually, I don’t know if that’s even pertinent. It’s sunny outside and I’m thinking of ice pops.)
I’m inclined to agree with samchevre that the rules may not be unreasonable, so the Minnesota case may just be an egregious example of an individual tax collector abusing what are mostly commonsense rules. If so, the disinfectant of sunlight may help to clean up that case. Like MPAVictoria says, it’s complicated.
But I think what a couple of commenters seem to think of as a clear distinction between hobbyists and not-terribly-successful professionals is becoming increasingly blurred. Look at those ‘portfolio careers’ that redundant middle class professionals are encouraged to embrace. Or the fact that a tiny percentage of writers make their living from writing, but do teaching, editing and other parallel activities, too. Or the fact that any ‘creative’, from photographers to composers to copywriters, is now obliged to spend time and money on self-promotion in order to achieve minimal success. You might break even, or make a loss, and maybe you should just give it up and embrace dilbertism and light beers. But really, in the scale of things, is it so expensive to cut creators a little slack?
What I’m really annoyed about is not the existence of tax rules that may or may not be responsive enough to cultural and economic change at this moment. It’s the clearly intentional failure of governments to enforce rules against large companies and wealthy individuals, while going after the little people for chump change.
L2P 04.30.13 at 3:49 pm
” I can however sign on wholeheartedly with Maria that the current British Government, and indeed the current governments in most developed countries, currently seem intent on punishing the weak and rewarding the strong.”
The US, too.
The IRS audits a huge percentage of EITC claimants – people making less than $30,000 and getting a refund of $2-$3k. The IRS rarely audits the rich. Part of it is that the rich fight back, but most of it is suspicion of the poor unfairly buying the latest Iphone on the government’s dime.
Metatone 04.30.13 at 4:03 pm
Ironic that the UK government is mooting clamping down on “hobbyists” since there’s plenty of evidence that it encouraged a surge of hobbyists in an attempt to game the unemployment and benefits figures.
Phil 04.30.13 at 4:08 pm
Chris, quoting David Freud: He said new demands could also be placed on the self-employed, pointing out that the tax credit system as it stands allowed people to pursue hobbies, earn nothing and subsidise their income through state support “without any expectation that they will increase their earnings and move towards self-sufficiency. This flies in the face of a principled welfare systemâ€
Does he not imagine that people would want to increase their earnings and move towards self-sufficiency? If there is anyone who would be happy to bump along on the odd sale and fairly minimal government support, does he really think the numbers are big enough to be worth worrying about? Does he really think this is a significant problem for British society at the moment? If it’s a matter of ‘principle’, what principle does he have in mind?
Nasty, penny-pinching, hate-mongering, ignorant bigotry. Not surprised he’s from Croydon.
Tim Worstall 04.30.13 at 4:35 pm
“The IRS rarely audits the rich. ”
Well, every corporation does get audited. And the IRS/HMRC most certainly doesn’t take their tax accounting as being OK without a very close look indeed.
As to Margaret Hodge’s complaining about corporate taxation. She’s more often than not getting the wrong end of the stick. Google pays little tax in the UK because EU rules say that it doesn’t have to (the whole point of the Single Market is that it is a single market. You don’t need to sell from within each EU country: you can sell from just one to all 27.) Amazon similarly. Vodafone (part of that £4.5 billion) was again about which law prevails, EU or UK. These aren’t distortions of the system they’re the way the EU built them to be.
And I do think that Madame Hodge deserves more stick herself: she’s been shouting that “we’re not saying it’s illegal but that it’s immoral”. An interesting statement from a woman whose family fortune is in a trust to avoid inheritance tax.
ajay 04.30.13 at 4:39 pm
there’s plenty of evidence that it encouraged a surge of hobbyists in an attempt to game the unemployment and benefits figures.
How would that work? Not doubting you, just confused…
Hazel Meade 04.30.13 at 4:48 pm
This isn’t so much and example of “market thinking” infecting the arts as it is an example of how a complex tax code tends to favor large companies and be captured by rent-seeking interests who want to keep out small competitors.
Why should “hobbyists” be taxed differently than for-profit corporations anyway. Indeed, why should business be alowed to deduct rent and individuals not?
The fair and equitable thing to do is to make the tax code as simple and uniform as possible precisely because that way it avoids disctiminating between hobbyists, small-businesses, and large businesses.
Hazel Meade 04.30.13 at 4:58 pm
It could also be that in this case, there isn’t any particular malicious intent but that the couple happens to be raising a lot of tax-evasion red flags.
For the past few years I have claimed consulting income as a self-employed person. Of course as a business you get to deduct all sorts of things you can’t deduct as an individual, including in some cases rent for running a home office, travel, gasoline costs if your business involves a commute. If your goal is to minimize your tax burden, then you might want to deduct as much stuff as possible, so as to make it appear that you are running at a loss (and therfore do not owe any taxes). People cheat on this all the time. This is one reason why self-employed people are heavily flagged for audits by both federal and state governments.
So the state government comes along and sees a couple running a self-employed business and claiming all sorts of deductions so as to claim they aren’t turning a profit. From the state’s perspective, probably from some automated system that flags based on patterns, that looks like a tax cheat.
Matt 04.30.13 at 5:02 pm
I met a man in Alabama once who was a collector of exotic cars. His collection was really amazing, with some of the oldest mint Rolls Royce cars, some Ferraris, a 1932 Cord (see here: http://en.wikipedia.org/wiki/Cord_Automobile ) and so on. He noted, casually, that officially these were his “inventory”, and sometimes he did sell one, though in fact he made essentially no effort to sell them, didn’t advertise, etc. So, the potential for abuse in this area is significant.
The IRS audits a huge percentage of EITC claimants – people making less than $30,000 and getting a refund of $2-$3k.
This is true, but doesn’t always work for the bad. Two times I got the EITC even though I didn’t apply for it because of the fact that the IRS goes over a lot of claim eligible for it. When it was clear I was eligible, I was given it automatically. My understanding is that this isn’t that unusual. My understanding is that what happens here is that tax claims falling in this area are looked at closely (not necessarily “audited” the normal sense) and people are then both added or taken away from the eligible pool as is reasonable.
MPAVictoria 04.30.13 at 5:09 pm
“The IRS audits a huge percentage of EITC claimants – people making less than $30,000 and getting a refund of $2-$3k. The IRS rarely audits the rich. Part of it is that the rich fight back, but most of it is suspicion of the poor unfairly buying the latest Iphone on the government’s dime.”
Disgusting. I wonder if going after EITC claimants even turns a “profit” once all of the expenses are taken into account.
Matt 04.30.13 at 5:38 pm
It’s really hard to tell from a necessarily one-sided article, but it’s entirely possible that the auditor is being a bully/jerk/whatever. If so, that’s clearly bad.
On the other hand, it looks like a lot of this pivots on fairly technical papers that are getting conflated. Your ‘enterprise’ is presumed to be a business if it actually makes money and presumed not to be if you consistently report losses. However, you can rebut that presumption in several ways, as SamChevre (@2)’s link shows, and it’s not super-clear to me that they made any serious attempts to do that.
BoingBoing’s readers seem pretty up-in-arms over the auditor’s question about why they are not signed to a major label. Note that this seems to follow directly from one of the IRS’s tests for determining if an activity is for profit, namely: “Have you changed methods of operation to improve profitability?” Saying something like “As an independent artist, I keep 100% of my sales” isn’t an effective way to address this. They need to add something like “I spoke with Record Company X last year. They can increase our distribution three-fold, but want $0.75 on the dollar, so that deal wasn’t profitable for us.” Even something like “The indie aesthetic is part of what appeals to our audience and joining a label could reduce our fan base” might help convince the auditor that they’re legitimately attempting to operate as a business.
@Maria, I was under the impression that even hobby expenses could be deducted to offset hobby-related income (from the fifth-to-last paragraph of SamChevre’s link):
Coulter 04.30.13 at 5:45 pm
“The IRS audits a huge percentage of EITC claimants – people making less than $30,000 and getting a refund of $2-$3k. The IRS rarely audits the rich. ”
wow that would be horrible if it were true, but it isn’t…
12% of taxpayers who make more than $1 million are audited vs. less than 1% below $100,000.
Jake 04.30.13 at 5:52 pm
And I do think that art is more of a social good than collecting baseball cards, and inherently worth subsidising.
The couple in the article are/ being subsidized – the one year the poet actually made money was when she got a grant from the State Arts Board. The state isn’t even saying that they can’t deduct their costs from the money they make from their art, just they’re “not intending to make a profit on art, that we’re just pretending to be artists so we can indulge in our hobbies and go on vacations.â€
If you put “professional” in front of artists in that sentence, it sounds like a fair charge.
Cranky Observer 04.30.13 at 5:53 pm
So is Amazon a business or a hobby? IIRC they have lost money 58 of the 60 quarters they have been in business, and whenever they get close to turning a profit they announce their intention to lose more money next quarter. Should they lose their business deductions?
SamChevre 04.30.13 at 6:13 pm
So is Amazon a business or a hobby?
C-Corporations (like Amazon) get the tax treatment that a hobby does; they can subtract expenses from revenues, and carry losses forward against future profits, but they can’t deduct the expenses from other sources of income (since they do not have any). The only place the business vs hobby distinction comes with individuals who have income from one source, and losses from a business/hobby; the question then is “can you deduct the losses from the business/hobby from your other income?”
uffy 04.30.13 at 6:23 pm
Wow. This is probably the saddest comment section from a progressive-minded group I have ever seen. A couple of artists hire an accountant to stay in compliance with tax-law, they apparently do an awful lot of work to try to make a profit, but now everyone agrees that since they only sometimes “make” money that they should owe some amount of penalties in excess of their home equity due to deducting business expenses.
Granted the article is obviously one-sided, but no one is citing new information that points to any abuse of the tax system whatsoever – the only case made is that they weren’t profitable enough so their investments are invalid even though their accountant thought otherwise and they will most certainly be taxed on any and all future profits.
SamChevre 04.30.13 at 6:26 pm
they will most certainly be taxed on any and all future profits
No, that’s not how the law on taxation of hobbies works. If there are any future profits from the activity, past losses can be deducted from those profits even if it is a hobby; the only thing that you can’t do with losses from a hobby is deduct the costs from other income.
roger nowosielski 04.30.13 at 6:30 pm
“. . . a progressive-minded group,” uffy? Whatever gave you that idea?
Most are Americans; and as Americans, they still subscribe to the notion of American exceptionalism and statism.
Jonathan 04.30.13 at 6:38 pm
There is really not enough information here to make an informed judgment. We don’t know how much the total income from the art and music of this couple was. We don’t know the total amount of the expenses they claimed each year. If the claim is they owe Minnesota $100,000 for three years, then the total income from art for those years most have been more than that, right? (even including penalties). They can’t be taxed at more than 100%, I’m assuming. I am thinking of a scenario where they make 90 K from art a year and claim 100 in expenses. I’m sure that would raise the attention of the taxman. Then I can imagine the “why aren’t you signed with a major label” conversation, because you can’t both be struggling artist and have that much income from your art. In short, something doesn’t quite add up here and I’m hoping someone can explain it to me.
Dr. Hilarius 04.30.13 at 6:43 pm
Worstall @18: “every corporation does get audited.” What? Not hardly. My one person law office has been incorporated for years and so far no audit, nor does my CPA ever expect one to happen. Not even every corporation with billions of dollars in assets is audited. And audit rates have been declining.
“For instance, in 2012, the IRS audited 10.5 percent of companies with assets of $10 million to $50 million, according to publicly available data. By contrast, it audited 93 percent of the companies with assets of $20 billion or more.”
http://www.pogo.org/blog/2013/04/20130416-risk-of-irs-audit-declines-for-many-businesses.html
Marc 04.30.13 at 6:46 pm
Re audits for the EITC: From the IRS fact book.
What are the chances of being audited? Of the 140,837,499 total individual income tax returns with a filing requirement, 1,564,690 were audited. This works out to roughly 1.1%, the same as the rate for the previous year. Of the total number of individual income tax returns audited in FY 2011, 483,574 (30.9%) were for returns with an earned income tax credit (EITC) claim, a slight increase from the 473,999 (30%) of all audited returns for FY 2010.
For reference, there are about 27 million EITC claims, so people who make EITC claims are significantly more likely to be audited than the average tax return.
Jonathan 04.30.13 at 6:49 pm
I think I get it now: you can’t pour significant money from your day job into your hobby and call that business losses, reducing your overall tax liability that way. There has to be a way of distinguishing business from hobby. If you don’t claim expenses far in excess of your revenues, you probably are safe. You can see the potential for abuse if someone had lucrative day job, expensive hobby, and just a little bit of income from the hobby.
SamChevre 04.30.13 at 6:52 pm
Jonathan @ 32
If the claim is they owe Minnesota $100,000 for three years, then the total income from art for those years most have been more than that, right?
No. Definitely not.
The issue SFAICT is not the earnings from the art–it’s the expenses. Reading between the lines, it looks like they have incurred expenses sufficient to get $100,000 in tax reductions after taking all the art-related income into account. The tax department is saying “that’s not a business–it’s an expensive hobby–so you can’t count the expenses as deductions from your non-art-related income.”
For example, my (entirely hypothetical) business as an independent restaurant reviewer: if I earned $75K annually from my day job, spent $25K a year eating in restaurants, and sold one restaurant review for $100. The tax would be on the $25K that I claimed as “business expenses”, on the grounds that this was not a business–not on the $100 I actually earned.
SamChevre 04.30.13 at 6:54 pm
Yes–#35 is exactly right.
Jonathan 04.30.13 at 7:00 pm
Thanks for comment 36. That clarifies it. It’s even worse than I thought, in fact. Expenses qualifying you for 33,000 less in tax liabilities on state taxes are substantial. We still don’t know what the total art-related total revenue minus expenses is.
OCS 04.30.13 at 7:00 pm
Here’s how I read it — one or both of them has an income from something other than their art. They make some money on their art, but they lose more. They deduct those losses from their total income.
So, just to pull numbers out of a hat — they make $50,000 in their day jobs, and $2,000 in sales of their art. But they spend $10,000 making and promoting that art. They deduct the $8,000 loss on the art from the taxes they owe on the money they make at their day jobs.
AFAIK, you can lose money as a professional artist (or anything else) for as long as you want and the taxman won’t care. It’s when you deduct those losses from another income that they start wondering what’s going on.
I have no doubt that the artists are “real” artists. But that might not necessarily be the same thing as being professional artists, at least for tax purposes.
OCS 04.30.13 at 7:03 pm
Whoops — SamChevre said it better at #36.
Frowner 04.30.13 at 7:07 pm
Isn’t Venus de Mars a trans woman ? When I first saw this, my gut response was “someone wants to hassle the queer folks who are quite visibly gender non-conforming and politically outspoken” before it was “someone wants to hassle the artists”. That’s not to say that the logic of capitalism isn’t terrible, but in this political climate it is difficult not to see that gender and sexual identity could be big factors in who gets selected for harassment.
Matt 04.30.13 at 7:08 pm
Yeah, OCS (@39) and Jon (@35) nailed it. To extend OCS’s example, they cannot deduct $8,000, but they could deducted $2000. If, in a future year, they make another $2000 without spending anything else, I think (subject to some restrictions), that they could deduct another $2000. It’s really not intended to soak hobbyists.
Jonathan 04.30.13 at 7:17 pm
The hobby deduction is designed, as far as I can tell, so that people aren’t taxed at all on smallish amounts of income that don’t actually turn a net profit, as in Sam’s example of the restaurant reviewer who spends more money in restaurants than the total income for the reviews. The problem I see is in mixing categories. Most art, economically speaking, behaves more like a hobby than a business. That doesn’t mean it’s not valuable too, but you can’t have it both ways, poor starving artist yet deducting tens of thousands.
SamChevre 04.30.13 at 7:35 pm
in this political climate it is difficult not to see that gender and sexual identity could be big factors in who gets selected for harassment
That certainly could be; however, every small business owner I’ve ever known “knew” that a Schedule C with a loss was likely to be audited, and a Schedule C with a loss two years in a row made it nearly certain.
Trader Joe 04.30.13 at 8:07 pm
If they are being dunned for $100k, some portion is going to be penalty and interest so the amount by which erred is probably more on the order of $75-80k that they owe due to how they filed.
They indicate that they aren’t sheltering passive income and that they have an accountant who presumably would have been smart enough to prevent them doing that (otherwise he had best get his own insurance policy warmed up).
Most likely there is some fairly substantial class of expenses that have been routinely claimed as an offset against their artist incomes which is being specifically disallowed.
For example if they had 100k of gross income in each of five consecutive years and claimed 100k of expenses such that they owed $0 – it would be a hobby. They can’t get a benefit for tax not paid so its not just a matter of recording a loss – its that they should owe tax on the art earnings (i.e. if you spend $20 to write a restaurant review and earn $100, you are supposed to be taxed on the $80 net, even if it is a hobby).
The article talked about flying around a lot to different events and doing benefits for “free” against which she may have been recognizing cost without any income – that’s a charitable deduction perhaps (on Sch A), but not an offset to income (Sch C).
Instead, the tax man is saying you earned $100, you have legit expenses of $40 so You’ve netted $60k x each of say 5 years for $300k of income against which you’ve never paid any estimates or anything – taxed at 25% you owe 75k of tax and 25k of penalty and interest….that tax rate might be high, but thats the idea. It could be deduction disallowance which then results in tax on real earned income that is running up the bill, not sheltering of other correctly witheld “day job” earnings.
Western Dave 04.30.13 at 8:13 pm
The $100,000 is likely inflated by penalties and interest. Actual bill is probably a third of that. And they disqualified grant income as counting towards art income. For many non-university based artists (especially installation artists) grant income is a huge chunk of their income. Before my wife gave up her art career, it was tough going to break even because all her work decayed over time. Another professional artist I know mixes teaching kids with the actual art career stuff. If the art career stuff is disallowed from the (lucrative) teaching kids stuff as hobby than she’s screwed. She finally got her first big commission recently after 10 or fifteen years of breaking even at best on the art work.
mpowell 04.30.13 at 8:29 pm
It’s actually not that hard to imagine that the state has a very good case. If they are facing a 6-figure bill, that means they’ve taken deductions in excess of $100,000 over their income as artists. If this were a situation where their revenues were $1M and their expenses $1.1M, that might make sense in the process of running a real business, but I doubt that’s the story. What is the statute of limitations on this sort of thing? Does that represent 7 years of tax returns or more? I think there is a very good reason for a statute of limitations here because it would be unfair for someone to think they had a small valid deduction for many years only to get hit with a huge tax bill 20 years down the road.
a_random_guy 04.30.13 at 8:59 pm
“And I do think that art is more of a social good than collecting baseball
cards, and inherently worth subsidising.”
This comment gives away the game. Art is a great hobby: Millions of people play music, write, act in amateur theater, etc. The sense of entitlement in wannabe professional artists is astounding. Usually, the amateur works are as good or better, and come with less crap.
Why the devil should we subsidize people like this? If they cannot make a living with their art, they can pursue it as a hobby like the rest of us.
Jake 04.30.13 at 8:59 pm
The article said this was for three years of tax returns. It sounds like the tax man is saying “You made $80k teaching, $5k selling art, and claimed $20k in business expenses as an artist. Your art business is actually a hobby because it’s not actually making money so you can only deduct art expenses against art income, your income was $80k not $65k, you owe us back taxes and penalties.”
L2P 04.30.13 at 9:01 pm
“Well, every corporation does get audited.”
Really? That’ll be news to the 99% of corporations with assets under $10 M that weren’t audited, or the 80% of larger corporations that also, somehow, missed getting audited.
Over 50% of all EITC filers get audited. Individuals making more than $200k? Not quite so often.
Substance McGravitas 04.30.13 at 9:39 pm
Because we should be subsidizing everyone else too.
Sounds like a scam, relatively speaking, but I just can’t work up the outrage. More subsidies for more people please.
MPAVictoria 04.30.13 at 9:47 pm
“More subsidies for more people please.”
Indeed. At least these people are using the money to buy food, shelter and musical instruments and not on imprisoning minorities and useless fighter jets.
Bernard Yomtov 04.30.13 at 9:51 pm
Maria @14,
But perhaps more pertinently, the minute I sell anything I make on, say, Etsy, I’m liable for tax. So when it comes to sales, there is a pretty bright line, but not on expenses or investment. That’s a bit ‘having your cake and eating it’ from the tax collector’s point of view. Hey ho, that’s just life, but in the broader scheme of mass tax evasion/avoidance, it’s more than a little irritating.
Just to add to what SamChevre and others have said, this is not accurate. At least as far as the IRS is concerned, a hobbyist is entitled to deduct hobby-related expenses up to the amount of hobby-related income. If you sell a photograph for $100 you can deduct $100 of photography expenses. What you cannot do is deduct all the money you spend on photography, on the grounds that it is a business.
I want to know more about the numbers here before I rail at the State of Minnesota.
stubydoo 04.30.13 at 10:56 pm
It’s fun trying to come up with examples, e.g. “the money I spend working on my golf game is all tax deductible because I was trying to win the free car wash voucher in the club’s annual tournament”
(come to think of it, I’m quite sure there’s someone somewhere who actually has tried to deduct a golf club membership on the basis of making essential business contacts, though I doubt it was successful).
The OP (and a few of the commenters) are trying to make a point about the tax authorities being mean to the little people (and/or the arts) whilst being much more accomodating for the rich and powerful. But a case like this doesn’t really indicate anything more than them trying to do their job.
There’s a distinction to be made between the enforcement by the tax dept. bureuacrats and the loopholes that the elected representatives in their infinite wisdom decide to create – an excellent example being the Romney example mentioned way upthread
(for those who don’t know, all of the $70K annual upkeep for Mrs. Romney’s dressage horse is treated as a tax deductible expense. I’m quite sure that the IRS rank-and-filers would have loved to deny it as a just a hobby, but sadly they cannot as congress specifically singled out dressage horses with a special provision. There are of course many other interesting Romney family tax gambits, but this is the one of particular relevance here).
I’ve had dealings with tax authorities in a wide variety of contexts both on my own behalf and for others. The only case I ran into where the taxpayer was truly treated like crap was a small foreign corporation that ended up with some K-1 income from a US partnership and had no other US income.
P.S. Yes EITC claims (some of which I have also been involved with) do have a somewhat higher audit rate than general tax returns, but that’s only because the provision really is a bit of fraud magnet. Similarly (and more dramatically) for Schedule C losses (both large and small). Large corporations always are audited every year, although that’s an accounting audit by private auditors – they’ll get a tax audit every three years or so (still much more often than any low income individual).
SusanC 04.30.13 at 10:57 pm
A lot of high-tech companies have a money-making product plus a lot of speculative projects that make a loss(*). Once you start to think about it, the distinction between an expensive hobby and investment that you hope might eventually be profitable is quite nebulous. e.g. Is the XBox just Steve Balmer’s very, very expensive hobby? (**)
(*) I will swiftly pass over the high-tech companies that have no products that make a profit…
(**) Last I heard, it was running at a net loss. I have no idea if it’s become profitable by now, but I would guess not.
Hazel Meade 04.30.13 at 11:56 pm
I don’t think SamChevre is quite right.
I have filed taxes in which I claimed income from a business. You can deduct expenses up to the income that the busienss brings in. You cannot deduct the “business loss” from your day job earnings. The forms aren’t even set up that way. If the profit or loss from the business turns out to be zero, you enter zero for the amount earned from your business. You do not enter a negative number or deduct the busienss loss from your regular income.
However, what people DO cheat on (which might be the case here) is to exaggerrate their business losses so as to avoid claiming any income from their business.
So it’s possible that this couple was pulling in a lot of money from their music but claiming large exepenses to offset it so their profit would come out to be zero, so they wouldn’t have to pay taxes on the extra income.
SamChevre 05.01.13 at 12:10 am
Hazel Meade @ 56
I’m linking to the forms 1040(PDF) and Schedule C. Losses from Schedule C (business income/loss) go on line 12 of the 1040, and net out against other income. (Note this is Federal taxes–I know nothing about Minnesota.)
I had a loss-making business in 2010, as I scrambled wildly to find some way of earning an income after being laid off–so this one is engraved on my memory.
Hazel Meade 05.01.13 at 12:12 am
Ok, nevermind, he’s right, you can claim a loss from your regular income. I remembered wrong.
Yeah, I would have to agree that if someone is claiming large losses from a “business” against their regular income that would certainly raise a lot of red flags.
You could still make this problem go away by treating individuals and businesses the same. Tax everyone on revenue, or let everyone deduct expenses and only tax “profit” (annual increase in net worth for individuals?) .
In the sky 05.01.13 at 12:13 am
I am glad to see some very good comments on here from the army of fact checkers. I have a couple of more comments.
1) Just about every large (by large, think the biggest few hundred) corporation is effectively audited. They may not be officially audited per se, but they all have dedicated IRS officials to check their books. These officials often work on-site.
2) No, 50% of EITC claimants are not audited. In the region of 1-2% are. A good chunk of these are self-employed under-declaring their income. Another good chunk of these people don’t file at all, albeit probably innocently enough.
3) There’s an awful uproar about the likes of Starbucks not paying tax in the UK. Instead of opening up branches in the UK themselves, imagine if Starbucks had sold the exclusive rights to their brand to a British company. Tesco, say. The royalties for that contract would be massive, and involve hundreds of millions (if not billions) of pounds heading from the UK to the US. And since that would be a real cost to Tesco, it wouldn’t count as profit, and wouldn’t end up in HM Revenue anyway. Absolutely nothing underhanded or illegal here, and no tax to London.
But if Starbucks set it up themselves, and pay equivalent royalties to their HQ in Seattle, there’s outrage.
4) And nobody ever mentions that the foreign profits of US corporations are fully taxable in the US. Earn £100 in the UK and somehow manage to only pay 5% tax on it? The US is expecting tax on the remaining £95. (Subject to not paying more than the US’s corporate rate of 35%, reasonably enough.)
5) Hazel Meade @20 nails it:
But as to
1) Individuals, somewhat ridiculously, may deduct mortgage interest. Subsidizing large homes, baby. Great idea! (But try repealing it.)
6) The assumption of bad faith on the part of Minnesotan tax authorities is unfair. The assumption that they’re all uber-capitalist Kafka-esque drones is unsubstantiated. The further speculation that this is them trying to discriminate against a transexual is also fairly outrageous.
Salient 05.01.13 at 12:27 am
The focus on technical points is hard to follow up on without the numbers and data, but there’s a whole lot to this that doesn’t depend upon quantitative assessment.
Sounds (a) like a reasonable complaint and (b) completely in keeping with Maria’s point about how we go about constructing and enforcing tax law to keep very close tabs on those who occupy marginal roles, and very loose tabs on those entities that could afford to pay and might even be legally obligated to pay substantially more.
Applying for disability and even unemployment benefits can go pretty much the same way. Every statement you make is collected solely for the purpose of using it against you.
I won’t talk about the parallels with the treatment Aaron Swartz received, except to note there’s some resonance there.
Telling a performance artist they tour too much is second in mind-melting paradoxysm only to Pink singing “I’m not here for your entertainment” to entire stadiums of people who had paid and attended specifically in order to be entertained by her.
stubydoo 05.01.13 at 1:18 am
Salient @60 does that “mind-melting paradoxyism” point still apply even if touring expenses have been several times total revenues consistently for many years running?
jpe 05.01.13 at 1:21 am
they’re hobbyists. that’s fine, but we don’t subsidize it through the tax code.
jpe 05.01.13 at 1:27 am
” Telling a performance artist they tour too much…..”
I’d be shocked if that’s actually what the revenue agent said. its fairly clear from the interview that the subject doesn’t know much about tax, and it wouldn’t be surprising if s/he misunderstood.
jpe 05.01.13 at 1:37 am
” A business has ‘income’ that is revenue minus expenses. An individual’s ‘income’ is merely revenue. ”
that’s not true. take the story here: the artists claimed a net loss on their schedule C and tried to deduct it against other income (wages, investment income, whatever). individuals, no less than corps, are taxed on their net business income. its just the case that most individuals don’t have their own businesses but are employees, and the latter typically only have non-deductible personal expenses.
roger nowosielski 05.01.13 at 1:41 am
@51, Gravitas
BTW, responded to your last rather thoughtful comment on the Petraeus thread just as it was closed. (True, the devil is in the details, and I wish you could make your point before things came to a peak. ) The main point was, I wasn’t going to take comfort in the natural propensity for any bureaucracy to be bungling things, because that’s what they’re best at — except of course when we’re talking about Nazi-like efficiency, as when all trains run on time. It’s a good thing we’re not there yet. Which still leaves the question of intent?
Would you be comfortable, for instance, knowing that our Dept of Homeland Security was just as inefficient as the Dept of Education happens to be? And for how long?
In any case, it’s water under the bridge now.
MPAVictoria 05.01.13 at 2:04 am
One thing this thread has accomplished is to remind me how glad I am for an uncle who is a tax accountant. Thank you Uncle Gerry!
Antti Nannimus 05.01.13 at 2:45 am
Hi,
“We’re all dodgin’, dodgin’, dodgin’. We’re all dodging our way through the world.
Dodgin’, dodgin’, yes, dodgin’. Dodging our way through this world.”
Spider John Koerner, “Dodger”, One Foot In The Groove, 1997
Some of us are better at it than others. It’s very difficult to repeatedly achieve tax benefits from a business that never shows a profit, especially as a sole proprietor. To get away with that, they should incorporate, or even better, become a church.
Have a nice day,
Antti
Lemmy Caution 05.01.13 at 4:06 am
“Venus DeMars: “They also really don’t like that I tour. They say I tour way too much and that really, my name is already out there enough, after all this time in the business, there is now no need to do any promotional touring. I have this statement in writing.—
They must be losing money by touring. I guess that is pretty common:
http://www.metalinjection.net/its-just-business/bands-money-touring
Substance McGravitas 05.01.13 at 4:29 am
One of my touring friends used to consume all the food and drink he possibly could in a given hotel room/band room: it was the only tangible benefit he ever got.
Salient 05.01.13 at 4:45 am
Salient @60 does that “mind-melting paradoxyism†point still apply even if touring expenses have been several times total revenues consistently for many years running?
You are seriously going to issue a technical complaint about the setup to a lame joke about a Pink song? (Factoid: all the internal tensions of the song disappear in karaoke.)
—
Trying to assess whether or not the tax goons are onto something is sort of not the point. It’s like saying the people the police officers pick up in the park really are selling drugs in response to someone saying that states devote disproportionately many resources to ensure that every last person in the park’s a drug seller.
But also, it needs to be said: Venus DeMars is a performance artist. The state is basically arguing that some kinds of their performance are hobbies (the ones that in isolation are costly), and their other kinds of their performance (the kind that appear in isolation to be revenue-accruing).
I mean, it’s not like Venus DeMars’ day job is Accounts Payable. And while it’s certainly plausible that an artist that is prominent and making livable money in one artistic medium could intentionally and in bad faith devote energy to other artistic media as a personal hobby with coincidental significant career crossover because in some complicated way it soaks expenses and results in tax breaks or super cheap fast-paced tours of regional clubs, OH LOOK I tricked you into believing this sentence was going to gently bank off that clause as if it’s not crazy instead of leaving it completely unresolved so it sticks out to emphasize how unlikely that is.
Sebastian H 05.01.13 at 6:25 am
“Telling a performance artist they tour too much is second in mind-melting paradoxysm only to Pink singing “I’m not here for your entertainment†to entire stadiums of people who had paid and attended specifically in order to be entertained by her.”
You don’t seem to understand the song. The song is set in a bar, where a woman (Pink) is telling the guy who is hitting on her to buzz off. She is making the point that the presence of a woman in a bar doesn’t imply that they are there purely to entertain any man who thinks she is hot. Those listening to the song aren’t invited to identify with the jerk, they are invited to identify with Pink.
Nick 05.01.13 at 9:09 am
I think the problem comes from trying to tax profits at a relatively high rate rather than simply taxing turnover at a relatively low rate. Profits are an abstract and contestable measure that is easily hid and taxing it distorts behaviour from the big corporations to the small firms.
ajay 05.01.13 at 9:16 am
I wasn’t going to take comfort in the natural propensity for any bureaucracy to be bungling things, because that’s what they’re best at — except of course when we’re talking about Nazi-like efficiency, as when all trains run on time.
Sidenote, but Nazi bureaucracy was actually incredibly inefficient and fractured. The German rail network in particular was horrendously overstretched and unreliable (even allowing a bit of leeway for the effects of the bomber campaign).
It was the Allies who ran terrifyingly efficient, mechanised, centralised military-bureaucratic states, and the Axis who relied on horses, improvisation and muddling through.
Tim Worstall 05.01.13 at 10:05 am
@50. This is what I was referring to:
” Large corporations always are audited every year, although that’s an accounting audit by private auditors”
And this:
” Just about every large (by large, think the biggest few hundred) corporation is effectively audited. They may not be officially audited per se, but they all have dedicated IRS officials to check their books. These officials often work on-site.”
jpe 05.01.13 at 10:34 am
” The state is basically arguing that some kinds of their performance are hobbies”
Under the tax law, if there isn’t profit and there was never a reasonable expectation of profit, then its a hobby. that’s not the state’s argument, it’s the tax law that the revenue agent is tasked with enforcing.
I used to do audit defense, and have no love for tax department auditors, but the woman interviewed sounds absolutely insufferable.
ajay 05.01.13 at 11:29 am
I admit I was a bit startled that the amount of money in question wasn’t some tiny, petty amount, but $100,000. That’s a fair amount – I don’t think I have too much of a problem with the taxman spending his time going after six-figure sums. A hundred grand here, a hundred grand there and pretty soon you’re talking about real money.
Richard J 05.01.13 at 11:53 am
(In lieu of a more detailed comment – broadly, the idea that trading losses are available only where you’re carrying on a genuine trade with a view to a profit is an essential one, as otherwise, you give a green light to every blasted dodgy film partnership financing scheme ever.)
Also, I note that Minnesotan state income tax rates top out at about 8% – even assuming a doubling through interest & penalties, you’re looking at roughly 2/3 of a million dollars of expenses claimed.
(And as someone who actually does advise big corporates on their tax affairs, press coverage is deeply misleading – the oral evidence from the QCs responsible for drafting it from a recent House of Lords hearing on a General Anti-Avoidance Rule should give an indication as to the actual practical complexities of implementing what sounds like a straight-forward idea. http://www.parliament.uk/documents/lords-committees/economic-affairs-finance-bill/Online%20Evidence%20-%20final%202.pdf )
jpe 05.01.13 at 12:06 pm
@ 77: funny you say that, because a UK client of mine got busted for one of those dodgy film financing partnerships. (I’m a US attorney and tax advisor that gets the pleasure of occasionally working with UK citizens working in the states)
ajay 05.01.13 at 12:51 pm
Also, I note that Minnesotan state income tax rates top out at about 8% – even assuming a doubling through interest & penalties, you’re looking at roughly 2/3 of a million dollars of expenses claimed.
Wow. $600,000 in dodgy expenses? They’re wasted on performance art. They should be in Parliament.
OCS 05.01.13 at 2:11 pm
Salient #70
“But also, it needs to be said: Venus DeMars is a performance artist. The state is basically arguing that some kinds of their performance are hobbies (the ones that in isolation are costly), and their other kinds of their performance (the kind that appear in isolation to be revenue-accruing).”
If this is what’s going on, I agree with you, it seems unjust. I re-read the article and it’s pretty hard to figure out the real circumstances based on the information in there.
I do think the career/hobby dichotomy can be tricky. In my past life as a freelance journalist I had an accountant suggest that I write off trips back home, vacations, museum visits — anything at all, really, because I might write a novel some day, and for a novelist everything is grist for the mill. I did not take this advice. Not to sound like a boyscout, but it seemed like a pretty obvious tax dodge, and I’m not interested in cheating on my taxes. If I had taken those deductions, I think the authorities would have been right to disallow them and make the distinction between my journalism and my novel-writing.
On the other hand, my wife is still a freelance journalist. Occasionally she’s invited to a conference to speak, and even more occasionally there’s a small honorarium. The money never covers the cost of travel and lodging, but she goes because the exposure is good for her career and she makes professional contacts. She declares the income and writes off the expenses. If the tax authorities suddenly decided that her “speaking career” was a separate thing from her writing career and tried to disallow all conference-related expenses that exceeded speaker fees, then that would be unfair.
Maybe this case is more like the latter than the former. But it’s still hard to work up much outrage since so many details are missing.
Hazel Meade 05.01.13 at 2:14 pm
@In the sky
Yes, home owners get to deduct interest, but renters can’t deduct rent. Aside from the inherent bias against poorer people this entails, this is interesting because it reveals the practice of “interest-only” mortgages during the run-up to the financial crisis as being a kind of rental arbitrage. By effectively renting your home from the bank, you are permitted to deduct that cost from your income and thus lower your tax burden, whereas a straight out rental you wouldn’t.
@jpe
” its just the case that most individuals don’t have their own businesses but are employees, and the latter typically only have non-deductible personal expenses.”
I think the objection here is WHY individuals can’t deduct “personal” expenses, what is really the difference between an “employee” and a self-employed person in an exclusive contract with a business, and why the tax code should treat them differently. Conceptually, corporations are legal persons, so if a corporation can deduct the rent it pays for it’s headquarters, why should a self-employed human or an “employee” be forbidden from deducting the rent paid for living quarters? The difference between these situations seems to be entirely a linguistic construct.
Bernard Yomtov 05.01.13 at 2:28 pm
Another point worth mentioning, I think, is that Minnesota faces a handicap in responding to this sort of thing. Unless its laws are very unusual, the tax authorities are forbidden from revealing the details of individuals’ tax returns. So what we get is an entirely one-sided, and not very precise, description.
Under other similar circumstances, I think a lot of those expressing outrage here would recognize that, and be more restrained in their reaction. At least I hope so.
ajay 05.01.13 at 2:37 pm
Conceptually, corporations are legal persons, so if a corporation can deduct the rent it pays for it’s headquarters, why should a self-employed human or an “employee†be forbidden from deducting the rent paid for living quarters?
Heh. This reminds me of the guy who tried to drive on his own in the high-occupancy vehicle lane and argued that he wasn’t alone, his corporation was in the car with him, and corporations are people.
I suppose the parallel is that a self-employed human can deduct the rent paid for work space, just like a corporate person can. If a corporation needed a house to live in, then it wouldn’t be allowed to deduct the rent on the house; but it doesn’t.
Zamfir 05.01.13 at 3:03 pm
Hazel Meade wrote: “Conceptually, corporations are legal persons, so if a corporation can deduct the rent it pays for it’s headquarters, why should a self-employed human or an “employee†be forbidden from deducting the rent paid for living quarters ”
The distinction is not so much between a corporations and a person, but between purposes. If you as an individual rent an office for work purposes, you can in most countries deduct this against income from that work. Even if you didn’t organize that work as a legal person, though usually that simplified the matter.
On the other hand, if you (and potentially a group of other people) set up a corporation with the sole purpose to rent a house for you to live in, then you will find it hard to get this deducted from your income.
If you pay rent to this corporation, which in turn pays in the rent to the house owner, then your corporation can deducts its expenses against its income (is, the rent you pay to it). But you will still pay taxes before you pay rent to it, the company’s deduction only prevents double taxation.
Zamfir 05.01.13 at 3:04 pm
Ninjaed
Richard J 05.01.13 at 3:08 pm
On the other hand, if you (and potentially a group of other people) set up a corporation with the sole purpose to rent a house for you to live in, then you will find it hard to get this deducted from your income.
One of the few delights in reading tax case law are cases in which someone seeks to argue that they absolutely need a Ferrari for the purposes of their business and use it solely for business use only.
roger nowosielski 05.01.13 at 3:12 pm
@ 73, ajai
An urban legend, then. So be it.
Coulter 05.01.13 at 3:18 pm
“Aside from the inherent bias against poorer people this entails, this is interesting because it reveals the practice of “interest-only†mortgages during the run-up to the financial crisis as being a kind of rental arbitrage. By effectively renting your home from the bank, you are permitted to deduct that cost from your income and thus lower your tax burden, whereas a straight out rental you wouldn’t. ”
BUT, the person who rents you an apartment does get to deduct their interest expense. Rental units have high leverage and are generally interest-only or low amortization of principal. So the answer to your question is one of distribution, not direction – renters DO get the benefit of interest deductions (in fact these deductions are worth more for landlords than individual tax payers, ), it is just they have to split some portfion of that with the landlord. Makes them about the same, considering a very large % of US homeowners don’t get the benefit of the mortgage interest deduction (either because the standard deduction is better or amt or whatever else).
Kevin Erickson 05.01.13 at 3:28 pm
While I’ve known a number of independent musicians who’ve endured audits, this is certainly the strangest case I’ve ever heard of. In particular, if the account of the taxman’s statement about public radio is accurate, he’s clearly confused about how broadcast royalties work.
In the United States, no terrestrial (AM/FM) radio stations are required to pay performers royalties when their music is broadcast. It doesn’t matter if the station is commercial, public, or non-commercial/educational. This is an odd loophole in US copyright law that persists because of the massive lobbying power of the National Association of Broadcasters. The US is nearly alone among industrialized nations in this regard; other nations that fail to compensate performers include North Korea, Iran, Rwanda, and China. (The songwriter and publisher, on the other hand are compensated through performance rights organizations like ASCAP and BMI, again, regardless of whether a station is commercial or non-commercial.)
djw 05.01.13 at 5:57 pm
Satz>>>>Sandel
Hazel Meade 05.01.13 at 7:23 pm
If you pay rent to this corporation, which in turn pays in the rent to the house owner, then your corporation can deducts its expenses against its income (is, the rent you pay to it). But you will still pay taxes before you pay rent to it, the company’s deduction only prevents double taxation.
I get the logic, but the philosophical rational behind it seems questionable.
Your saying only human beings have to pay taxes on all of their revenue, and abstract entities like corporations don’t, because ultimately all the income to abstract entities accrues to individuals eventually. But then we’re taxing the income people use to satisfy actual human needs, and not taxing the income that goes towards expanding an abstract business enterprise. Isn’t that kind of prioritizing business growth over human need?
Hazel Meade 05.01.13 at 7:25 pm
As in:
Money that you spend on food and shelter for your children = taxable.
Money that you spend on building a factory to make more money = not taxable.
jpe 05.01.13 at 7:39 pm
“Conceptually, corporations are legal persons, so if a corporation can deduct the rent it pays for it’s headquarters, why should a self-employed human or an “employee†be forbidden from deducting the rent paid for living quarters”
We tax net business income. That means income less expenses incurred as part of the business. Needless to say, rent for a residence is a personal expense. Anyone, corporation or individual, that rents office space as part of the trade or business can deduct that cost (provided it’s ordinary and necessary)
jpe 05.01.13 at 7:50 pm
“If you pay rent to this corporation, which in turn pays in the rent to the house owner, then your corporation can deducts its expenses against its income”
I believe your payments to the corporation would be non-taxable capital contributions, and the corporation’s payment of rent would be non-deductible personal expenses.
Jonathan 05.01.13 at 8:45 pm
A tax on gross revenue (rather than on net profit) would make most business impossible to run. The idea is that if one has a restaurant, say, one would have costs: rent, food, utilities, salaries, etc… Then you would have revenue: what people spend in the restaurant. The restaurant only makes money if revenues exceed costs, and the margin might be fairly small.
That’s a different sort of question than asking about “human need” when looking at income tax. The point is not to compare humans and corporations, but to realize that those are two separate kinds of questions, conceptually. We can argue about what status should be given to investment. Say the restaurant owner decides to expand: that’s part of his expenses and sh/e will lose money or narrow the profit margin in the short run, be taxed less. Do we want to encourage or discourage that investment through tax policy?
Metatone 05.01.13 at 8:49 pm
@ajay – If you start up a micro business then there are a few months of incentive payments, tax credits etc. So you’re still getting the equivalent of the dole, but it comes from a different pot (not labeled unemployment) and you’re an entrepreneur, not unemployed. All administered by A4E and other similar contractors.
The numbers aren’t that high in total, but I remember someone blogged that there was a big spike in one month, enough to make a difference to that month’s unemployment reporting.
novakant 05.01.13 at 9:18 pm
Actually, I think the only moral thing would be to collectively STOP paying taxes for a while – until, say, Amazon et al start paying their fair share of taxes and, much more importantly, the government stops using our money to drop bombs on brown people, imprison people forever without trial and undermine our civil liberties like it’s 1984.
Fledermaus 05.02.13 at 4:08 am
Corporate Americans have even more tax advantages than listed in this thread. This is a bugbear of mine. Let’s take the corporation that provides car service for senoir execs to and from work. The exec pays no taxes on the benefit and the corporate person gets to deduct the expense. But the $30k admin assistant isn’t allowed a free ride and must spend money on a car and gas, none of which is deductable. Same benefit, but the high paid exec gets a defacto tax break.
Zamfir 05.02.13 at 9:17 am
Hazel wrote: As in:
Money that you spend on food and shelter for your children = taxable.
Money that you spend on building a factory to make more money = not taxable
Yeah, if the goal is a personal income tax. You can also have a tax on business income, a revenue tax like the VAT in Europe. That’s a different tax that behaves very different. Since their competitors are taxed at the same rate, companies pass on such a tax to their customers, who pass it on to their customers, until the customer is not a business. So in practice, it’s a consumption tax.
Those are useful as well, but they have their weaknesses. In particular, they are difficult to make progressive, since the tax does not necessarily know who will end up paying for it. Unlike a personal income tax, which comes by its nature with some information on how rich its payees are.
Also, richer people consume a smaller portion of their income, so switching from a personal income tax to a revenue tax lowers their tax burden. I am not sure if that’s your intention (it seems to be for certain proponents of revenue taxation), but I get the impression that you are aiming for more progressive taxation, not less?
ajay 05.02.13 at 9:47 am
96: thanks very much. Interesting.
ajay 05.02.13 at 9:55 am
Let’s take the corporation that provides car service for senor execs to and from work. The exec pays no taxes on the benefit and the corporate person gets to deduct the expense.
I am surprised by this – in the UK, at least, most such “benefits in kind” are taxable. The exception would be if the senior executive is disabled – in which case the car service is non-taxable. And the IRS will tax you on “personal use” of a company car, and specifically includes routine commuting to and from work as “personal use”.
(There are exceptions for occasional use – so if you work late, miss your train and the company pays for a taxi home, that’s not taxable.)
Richard J 05.02.13 at 10:16 am
(There are exceptions for occasional use – so if you work late, miss your train and the company pays for a taxi home, that’s not taxable.)
A pet subject of mine, worryingly. The exact wording of the test is along the lines of ‘ no more than 60 times a year and after 9pm where there is not an established pattern of late night working, and it would be unreasonable or dangerous to use public transport).
The London offices of banks, law firms, accountants, etc. with 1000s of employees focussed very much on the 9pm test (for obvious practical reasons when it comes to handling the resultant expense claims) and HMRC found easy pickings a few years back by focussing on the subjective parts of the test (e.g. Does lawyer X who normally works 9-7 but spent two months on a particular deal in the office to 2am every day regularly work late-night? I spent some time negotiating with an inspector to reach a pragmatic view as to exactly how many often a person would have to take a taxi home before it became considered a regular pattern. Even so, we still found ourselves with a six-figure tax bill at the end of it. As an example of how most tax disputes in my experience involve trying to interpret a rather vaguely drafted sentence in statute, it’s a reasonable example of what most of my job is.
Katherine 05.02.13 at 10:37 am
Richard J – the easiest solution – and the one the firms I worked for always went for – is to charge the taxis to the client as disbursements.
Richard J 05.02.13 at 10:43 am
It’s still potentially a taxable benefit for the employee irregardless – it’s just hidden behind the scenes by the employer paying the tax on their behalf via a PAYE Settlement Agreement.
But anyway, this is a bit of a digression for those uninterested in the intricacies of UK personal taxation…
Trader Joe 05.02.13 at 10:53 am
I promise you no one riding in the back of a taxi at 10pm after a 16 hour day is thinking of that ride as a benefit any more than the four cups of their employers coffee they’ll consume the following morning to get themselves back away for what will probably be another 16 hour day….
The tax will come later when presumably that hard work will translate into actual pay which the UK will glad hit for up to 50% and the US somewhere between 25 and 50%+ state.
The guys taking those taxi’s arent the 1%ers. They might be 3 or 4%ers, but the 1% leave well before the taxi rules kick in.
ajay 05.02.13 at 12:12 pm
The guys taking those taxis arent the 1%ers.
105: to qualify for membership of the 1% in Britain, you need to be earning more than £150,000 (single person) or £194,000 (household). I would question the assumption that no one earning more than £150k ever has to work late.
Trader Joe 05.02.13 at 1:30 pm
ajay-
I was only counting the taxi’s called from the office, not the ones called from the pub.
ajay 05.02.13 at 4:14 pm
107- yes, and I’d still say that there are a fair number of people earning £150k who are having to work late from time to time and take taxis home. £150k may put you in the top 1% in the country, but you could easily be in the banking sector, for example, with a £90k salary and a £60k bonus as a fairly low-level employee. (A trader could easily be on twice that by the time he hits 30, but, being a trader, he won’t normally stay late.) A typical junior partner in a London law firm will be on £125-150k, and I can assure you that they often work very long hours.
Richard J 05.02.13 at 4:19 pm
A typical junior partner in a London law firm will be on £125-150k, and I can assure you that they often work very long hours.
QI Klaxon – but if an equity partner (and not an employee with a courtesy title) will be considered self-employed [1] and therefore able to claim for home to work travel, regardless of timing.
[Incidentally, with all the talk of taxing on turnover not profit, I’d note that Brazil effectively has this, which leads to lawyers having an effective tax rate of 10-20% on their drawings.]
[1] subject to forthcoming consultation,
Trader Joe 05.02.13 at 6:53 pm
ajay – point taken…
Perhaps the vernacular 1% doesn’t literally apply throughout London/ the UK.
That said, I think the point I was making – if we can’t use commonly understood shorthand like “1%ers” is that its not the highest of the mighty that find themselves thinking about the taxi deduction – its that first tier of well paid worker bees, the junior partners, not the senior partners in your example, whatever their pay might happen to be – that commonly find themselves in the “taxi deduction = benefit” pool and I doubt any of them see it as much of a benefit.
ajay 05.03.13 at 9:41 am
I doubt any of them see it as much of a benefit.
Better than the alternative, though. Like saying that wearing Osprey isn’t much of a benefit, because it means that you’re living in a sand-covered disaster area getting diarrhoea for your queen and country while being shot at on a regular basis. All true – but it’s still better, ceteris paribus, than not wearing it. When you have late nights, it’s definitely nice to know that at least you won’t have to wrestle with the tube system – you can just step into a taxi, doze off, and wake up at home. I’d call that a benefit.
Katherine 05.03.13 at 7:47 pm
Better that than a night bus, when I was doing it. I must admit, I never thought of it as an employment benefit, but of course it was – I doubt the cleaners working around me were getting cabs home.
Barry 05.03.13 at 8:15 pm
Trader Joe 05.02.13 at 10:53 am
” I promise you no one riding in the back of a taxi at 10pm after a 16 hour day is thinking of that ride as a benefit any more than the four cups of their employers coffee they’ll consume the following morning to get themselves back away for what will probably be another 16 hour day….”
People working two jobs pulling down 16 hours/day and wrestling with dual commuting problems would definitely think that.
Watson Ladd 05.03.13 at 11:20 pm
Jon D: Some business make less then a penny per dollar of revenue, for example oil refineries. Taxing them at the same rate as a bakery with 30% profit margins would dramatically increase the price of gasoline.
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