Intelligent Investing #52 - Taxes with Bill Baker

This episode was recorded with Jeff Oravits and has some of the same content from “Intelligent Investing - Taxes - Their origin and misconceptions with Bill Baker of Granite Mountain Accounting”

 
 To start this series off we will look at:

• How Taxes came to be in the United States
• Where the power to tax comes from in the United States
• Who determines tax changes in our country?
• If you want to propose changes our tax laws, who do you need to contact to communicate is a progressive tax system?
• Why is this setup not efficient for maximum economic productivity
• Common Misconceptions about our tax system

Glenn Leest
 Senior Investment Adviser
 WT Wealth Management
 

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Transcript

The following is paid programming brought to you by WT Wealth Management. Nothing we discuss should be considered as investment advice. This conversation is for informational purposes only. Please do your own research and speak to an investment advisor or financial planner before making any investment decisions.

All right. Welcome to Intelligent Investing with Glenn Leest. This week we're going to talk, I don't know if this is the dreaded word, Glenn, uh, taxes. Yeah. Sometimes it's dreaded. Yeah. Um, we're going to talk taxes and, and you've got a guest with us. Uh, From Granite Mountain Accounting. Yep. I got Bill Baker with us.

He's, uh, our resident, uh, tax expert. And, uh, yeah, I want to do a series on taxes. You may ask why, uh, , why don't you do a series on, uh, Pulling teeth cause it's about that much fun. . But no, I think it's important, uh, that we next week root canals, . Yeah. Next week. Root canals. Uh, no. It is important, uh, because something that we all have to, um, make sure we have dialed in our lives.

Because if you don't have it dialed in and you're a company or an individual, Uh, you find out the hard way, uh, when the IRS or an audit happens, that it's no fun. And that's something you never want to have happen. Now with that being said, the more you learn about tax and the more you can educate yourself, the better you're going to be in that in the long run.

So I want to do a quick series on taxes, and it's a whole big ball of wax. But, um, first I want to introduce my guest, Uh, Bill Baker. He's a, a tax professional here in Flagstaff. He also has an office in New Mexico. We've been working together for quite a few years professionally, and uh, I thought it'd be fun to.

Let's start off with the. The, uh, the history of taxes because uh, uh, why do we have taxe? Why do we have taxes? Yeah. In America. So Bill, uh, how are you today? And let's talk about the, the history of taxes in America. Yeah, Good afternoon. Thanks for having me on here. So, a long time ago, once upon a time, we were colonies, right?

Yep. And part of the, uh, uh, event occurred that we, we, uh, had this revolution and the issue there was taxes. We were being taxed without getting fair representation. So taxes in America. Our thing, particularly with Americans, it's a, it's a big issue. So we have this revolution, we get our independence, and we formed a confederacy.

So we didn't go straight into the United States of America. We became a confederacy. Didn't work out so well. But the fed, the confederacy did not, uh, really promote what we were really good at, which is commerce. Americans are great at commerce. So we, uh, uh, the Continental Congress convened and, uh, came up with, uh, the cons.

So I got this, uh, understanding from, uh, oh, a dozen years or, or so ago, there was a, uh, radio personality named Janet Partial may have heard of her. She recommended a book that contrasted these personalities of, uh, James Monroe and James Madison. And, uh, as you know, James Madison, uh, authored the Constitution.

Mm-hmm.  and, uh, uh, uh, the Congress, the Continental Congress ratified this, well, it wasn't, uh, uh, set. I mean, you can't have just, uh, Couple dozen guys decide that, uh, we're going to be a, a nation. So this, this, uh, the, the Constitution was then circulated amongst the 13 colonies and, uh, uh, uh, discussed. Part of the debate was, uh, about taxes.

So in the Constitution, article one right out of the gate, congress has. Power, the authority to tax its citizens directly. And that was part of the, that was a part of the discussion. Do we want that? Do we want the federal government to be able to directly tax its citizens? And so that's where it all begins.

And, uh, over the years, you've. I've heard, uh, right, yeah. I've heard that taxes are unconstitutional. Yeah. It's not, they're not allowed. If you just don't pay your taxes, they can't get you cause it's unconstitutional and you're like, Yeah, that's a terrible idea. It's right there in the, you know, very first part of the con constitution right there that we just mentioned, that the Congress has the authority, the, the power to, to tax its citizens.

It's pretty clear language and yeah, I, I'd encourage everybody just read it yourself. You'll see it right there, right out of the gate. So that's where it all. Okay, so that was actually a misconception. I actually heard, uh, the misconception that taxes maybe weren't constitutional. What about some other misconceptions?

I've heard plenty over the years that, um, you know, the rich people don't pay their fair share or corporations don't pay their fair share. Um, all these different things. I thought it'd be kind of fun to take a look at what are some other common misconceptions. One of them. The wealthy, the, the high income earners don't pay their fair share and Right.

And what is your take on that bill? Yeah, uh, let, let me finish one more thing about the, uh, Congress. Uh, it's common for us to whine about the, uh, uh, president creating these tax, uh, laws. Mm-hmm. , the president does not create a single tax law, uh, Congress. So if you have an issue about the complexity of the tax law, the high tax rates, whatever it is, You would call your congressman.

You don't complain about the president. Uh, you, you call your congressman. So in our area, that's Tom Mohave, uh, Mark Kelly and Kristin Cinema. I saying those words. So you can, you can find those guys and they will, their office will answer the phone. Hm, Interesting. Okay. And you can lodge a tax complaint.

Yeah. Yeah. So that's another misconception that maybe you just hit on too, is that the president has a lot more, uh, input as far as the taxes and, and as you're saying, it's just not the case. It's, it's, it's the, um, it's not decided in that, uh, I mean, things may come across a desk. He maybe has input, but that's not where decided at.

Right. Correct. And obviously the president in all of our lifetimes has been the, uh, uh, the central leadership figure. He and his administration thinks ought to go? Uh, oftentimes does. Yeah. Uh, however, it is Congress, it's your representative who, uh, uh, uh, comes up with the tax law and, uh, they, and those offices are responsive actually.

Uh, anytime if you've ever had an opportunity to interact with them. Tho those offices are responsive to. As a citizen, but when you go back to the Constitution, you didn't have the federal income tax and all that till much later when they brought that in. Right, right, right. So our current tax system seems to have begun somewhere around World War I Victory Tax.

Right. And it's become more and more complicated, more and more convoluted and uh, uh, uh, I it's thousands of pages long. That's a question you could ask your congressman. When was the last time you reviewed the tax code and read it? Uh, he hasn't. So, uh, . Yeah. Yeah. It's, it's terrible. Uh, you, you had asked about the, uh, the incomes and the uh, uh, Misconceptions.

Yeah. So the problem with the tax code, of course it's easy to say, here's the problem. Uh, but the problem is, is it's just too complicated. Yeah. I don't believe that the guy next to me, my neighbor is paying his fair share. He's not paying, he's, he's using, he's, he's abusing the tax code and he's lying. He's cheating.

He gets favoritism, particularly if he makes a lot of money. Right. So that's just not the case though. The, uh, um, folks who have high incomes, uh, pay a disproportionate share of income tax. Um, now there's also other taxes, right? Yeah. There's employment taxes, social security, and Medicare. There's real estate taxes.

There's sales tax, there's excise tax. You buy a truck. Gets low gas mileage, you're going to play a pay a what they call a guzzler tax. And, uh, so, so there's myriad of taxes. Yeah. But, uh, uh, uh, folks who earn more income, higher income, Uh, they will have, they will pay more. Uh, yeah. And that's, is that, that's a progressive tax system, right?

Right. Meaning the more you earn, you get into higher percentage brackets. Uh, so at a certain percentage you pay 12%, a certain percentage you pay 20, and then whatever the next tier is, So you start earning more and they set. Those brackets. Yeah. Um, which is, you may hear 'em call the income tax brackets.

Right. And so as, yeah, as you make more, not only are you paying more on a dollar amount, you're paying more, that's a percentage. So just that alone, unless there's some huge deductions or you know, things that people can do to lower their income as income, you know, high income earners, that tells me that they are going to be paying more.

And in fact, the more. The less you get for some of those deductions for high income earners. So some of those deductions start to phase out where you used to be able to put in money into your IRA and reduce your income or get this credit or that deduction. And so as you start earning more money, those deductions go away.

So it even compounds the on top of the higher percent rate so that that misconception of the high income earners, uh, don't pay. Their fair share, I would say is definitely not true because they pay disproportionately their fair share or more. And I guess the question. Good question is what is fair share? Um, that's something that Bill and I were trying to figure out.

What is fair share? What's that magic number? Yeah, yeah. What's that magic number? Because you, you watch different, uh, colleges or interview college students, they'll say what's, uh, what's fair share? And they go, Oh, well 70%. You know, of every dollar you should pay in taxes if you make over, you know, a couple hundred thousand dollars and they say, Okay, great.

Um, of course that doesn't affect them probably. Yeah. And they say, Okay, so do you want to be the first one to pay seven, you know, 70 cents of every dollar into the tax code? Oh, no, no, no. I want someone else to pay for it. You know, so everyone always wants someone else to front the bill. But if you go back to, Okay, what would be a fair share?

I don't know the answer to that, but it's, you know, it needs to be across the board where, hey, everyone pays x. Percentage. Um, and we're not going to progressively penalize more people for making more money. Cause that actually has a negative impact on the economic growth if you think about it. Because if you're deed to keep earning more money, because you have to keep paying more and more in taxes.

It's kinda like, well yeah, there's a disincentive to, to make that extra $5,000, $10,000 because you might hit that next tax bracket. Yeah. Was that wrong? Ronald Reagan had that issue, wasn't it? When he was an actor, that tax rates were so obscene that he was like, you know, you get to the 80, 90% tax rate, and you're like, Why?

Why even work? It's just, you know, working to, you know, I as well stay home and watch TV instead of making tv. Have you seen a lot of tax advantages taken away over your years of accounting? Uh, because you, you've been doing this for a while, so, uh, the advantages that individuals can have over time. Have you seen that kind of eroded?

So what we've seen in 2018 was a, was a substantial change, uh, where, uh, you really get what we call a standard deduction. And that's about it. If you're a, a wage earning, And, uh, uh, uh, as your income went up, you phased out of, of as, as Glenn had said, different, uh, deductions, different kinds of credits. And so if you make a lot of, there's a lot of disincentive to make a more money, uh, that.

That, uh, tax rate of, uh, of, of 40% does seem to be a, a, a stopping point with, with politicians. Uh, it seems that you can't go above that and get reelected. So I, I have noticed that, uh, the, the tax system. Uh, uh, is unfair to high per income. Folks, folks who generate lots of income, that's what it's unfair to, if you want to say unfair.

Uh, they, they do pay a disproportionately larger amount, uh, as a percentage of their income and as the dollar amount. Uh, um, let's see. How do I want to say. That prohibits new folks from entering into the wealthy class. So wealth is really how much you have, not how much you earn. If I had a billion dollars in cash in the bank, I wouldn't have to earn a dime.

I could just spend that the rest of my life and I'd never spend it. That's wealth. Income is I'm going to make a million dollars a year and save it up. Well, I'm prohibited from gaining. Because half my income is going to go back in tax. Tax men's there first. Right? Right. Yeah. And if you hear some hammering noises, that's the tax man that's have a little bit of roof work going on.

Yeah. And so Bill makes a good point. There's a difference between earned income, which is I go out work a job, W two, you know, wage earners, that sort of thing, and that income tax earner, um, their income tax brackets go up as they earn more and more. Now it's very different for those that. Business owners or have already made money and they're making interest on that, which we'll cover next.

But definitely the tax code for the individual going out and working a job and making a lot of money, it's, it's, you know, it's you, you end up paying quite a bit more, um, than maybe some of the other routes. Yeah. Let's hit on all that and I want to remind people because we jumped right into it because we heard taxes and got excited.

Uh, but if you want to talk with Glenn anytime, uh, you can call 9 2 8 2 2 5 24 74. That's 9 2 8 2 2 5 24 74. Come back more, uh, talk more taxes and, uh, we're going to get pretty deep into this, so hang tight. We'll be back in a few minutes.

You're listening to Intelligent Investing with Glenn. Least give Glenn a call right now at nine two eight two two. 24 74. That's 9 2 8 2 2 5 24 74. More intelligent investing with Glenn Leestd when we come back.

All right. Welcome back to Intelligent Investing with Glenn Lace and Glenn's. Always willing to take your phone calls at (928) 225-2474 and we're talking the exciting word. Taxes. Taxes, yeah. As we get towards the end. Yeah, I guess where you got to prepare and there's a lot of preparation to do. Yeah. Yeah. Um, do you want to hit on corporations?

Because you, you were talking about how the, there's this misconception about, oh, the wealthier don't pay their, or the high income earners don't pay their fair share. Um, but then there's also, oh, just tax, the corporations more . Um, how does that work? Uh, okay. So the more you dive into economics, the more you realize that raising corporate taxes, corporations are just people, right?

So if you raise. Taxes on corporations are really just taxing the people more. So, um, even that whole notion of all, like you hear a lot in the campaign trail, we'll just make Amazon Pay or Apple Pay, you know, more money in corporate taxes. But how does that really work? So let's think about that for a second.

If you say you're a corporate tax raise 25% and now you're going to bump it up to say, 50%. Um, now what does that do to the business? Because they don't, you know, they're not going to just make less money as far as bottom line profits. So either they need to rise their, uh, costs for what they're charging the consumer, or they lay off people or they reduce their economic output.

So there's all these different things that I believe that when you raise corporate tax rates, it just gets passed along. Consumer, if you raise corporate tax rates by five or 10%, Apple or Amazon might just raise their prices by five or 10%. So it's really you and I that probably end up paying the, the brunt of some of those tax.

Now, if you could force a corporation to pay that extra amount and not raise their prices, that's a different story. But then, then you don't even have a free market. So there's, so I, I, you know, it comes to corporations. I think there's a lot to unpack there, but just the basics of how corporation is even tax is very different from the individual, so corporation or small business.

Um, and, and on the show with. Bill Baker with US Tax Professional. Him and I have known each other for years. He really specializes in small businesses and helping them dial on that part of it. But Bill, what are the differences of even just how a corporation or business is taxed compared to just, you know, the everyday average person, you know, working a nine to five job?

Right. So when you're a regular employee and you get your paycheck, you'll notice that, uh, a bunch of taxes have been confiscated straight outta your check. Yep. And something, somehow it went somewhere. But who this fi a guy or whatever. Yeah. Who is fi, right? Yeah. So, so that's gone and, uh, uh, at the end of the year you get your W two and that's kind of it.

Yeah. Uh, uh, you file your tax return and you get your standard deduct. Maybe itemized deductions, but uh, that's it. And you pay your tax. Mm-hmm. , so a business owner has a other options available. First off, uh, the business owner gets to operate his business, how he decides to operate in his business. Yeah.

And he has some choices he can make. Generally speaking. Well, not generally. Always business owners, whether they're a corporation or they're a partnership, or they're just an individual, they're always going to maximize their profit. That's just what they do. It's, it's human nature. Uh, the, the, the tax code assumes that you're going to maximize your profit.

As a matter of fact, if you lose money a whole bunch of very much, very often, uh, IRS would might come in and say, You know, you, you've been losing money. Are you sure this is a business? Or is this a hobby? Yeah. And, uh, stop taking those losses that that can happen if you, if you lose money. So the, the idea is that, uh, you're always going to maximize your profits.

So a business owner though, there. Zillions of businesses out there, and every guy has his idea of how his business is going to be special and how he's going to maximize his profits. So, so there's a lot, uh, available to a, to a business owner how he does that. , uh, small businesses, which we mostly work with, uh, uh, can, can be structured in different ways.

You have your sole proprietors. Mm-hmm. , you have partnerships, You have, uh, what's called an S corporation or a C corporation. And those are all taxed in different ways. Uh, how you are structured and operate is very individual to the business owners. Yeah, so, so, uh, uh, I, I will say, uh, folks who are organized as sole proprietors, uh, they have, they pay the most in taxes.

It's the, uh, and, uh, uh, it's the most selected for being audited by the irs, uh, as a sole proprietor. It's just part of your individual tax return and, uh, You, you, it, it just, we don't like that structure. Why is it, is it, do they assume the IRS that maybe that's less sophistication there or maybe higher chance of problems or potentially, uh, cheats?

I don't know. What, what, why is there a higher rate? Well, in, in the, uh, the way the taxes are set up is there's what we call a matching system. You get your W two, well, the Iris gets a copy of your W two. . So they match it when they see your tax return and they get this warm, fuzzy feeling, and they're all happy with this person.

When you're a sole proprietor on your, uh, uh, tax return is this giant number of your sales and plus all these costs, and the IRS is unable to to match any of that or very little of it. And so consequently, they like to take a look and, and have an audit and see if everything's been. Reported appropriately so.

So the other structures with the way those work, so you have a c COR or S corp. Basically, the way I understand it, the business, you know, through its normal course of operations, provides a gooder service. And in order to provide the gooder services, there's costs associated, there's, we need to have an office space, we need to have maybe work vehicles, we need to have employees.

In order to retain the employees, maybe we need to offer them benefits, like a retirement plan or healthcare or time off. There's, uh, what about the actual office supplies? There is all these different things that go into, you know, making sure that business can function, because let's be realistic, not every business can just operate outta their house.

That is really unrealistic. And even in for professionals, you know, you don't want to be meeting your CPA at a tax, uh, your tax professional. At a coffee shop or something like that, and him just saying All, you need an office. And those are all expenses. So you say you have a hundred thousand dollars of, uh, gross revenue, but then you have maybe 70 or $80,000 of expenses so that the way a business would be, uh, taxes, they have their gross profits minus their tax or minus their tax deductions or expenses.

Mm-hmm. , now they only show $20,000. Profit. And so that's much different than an individual who maybe makes a hundred thousand dollars and is taxed on all hundred thousand dollars of income. Um, and the, and a lot of times what ends up happening, you correct me if I'm wrong, is there's things that a small business owner and an individual would do the same, but one of 'em is necessary for doing the course of business, and the other one is just necessary to live.

So like a cell phone, you know, internet, right? You know, those sorts of laptop, Those are now business costs or expenses right there. There's many. When you're a a business man, there's.  things that you have that become business tools. Mm-hmm. , you had mentioned the cell phone. Your vehicle, uh, uh, an office in your house is legitimately an office in your house.

Uh, that, that's actually, that, that's quite common these days. Mm-hmm. . Yeah. Uh, maybe for all or part of your business. Uh, uh, so those, those things, uh, are legitimate business deductions as a, as a business owner and you're going to have a cell phone, whether, whether. You're in business. Yep. I think kids have cell phones these days, but as a business you have a business cell phone, and that's written off as an individual.

Mm-hmm. , Right? You're. Able to take that. Correct? Correct. Yeah. So all things being equal, you will have less taxable income, right? Yeah, yeah. So it's very different with the way they're taxed. So individual earns their income, pays all the taxes, and there's very little deductions, whereas a business owner, you know, makes the income, takes all the deductions, all the expenses, and then they pay the taxes on the net profit that that end.

A another area which, uh, uh, Glenn will like me to, to mention is that, uh, uh, so a business owner has, uh, uh, uh, has to save for his own retirement. Mm-hmm. , uh, when you're an employee, you hope. Your employer might, uh, help you out with that. But it, when you're the business owner, it's up to you. So you, the tax code allows for you to, uh, defer some of your income into a, a, a 401k, simple IRA pension plan, these type of things.

And you, uh, give it to your guy to invest and he invested. But you get to keep the money basically, but you get a business deductions. Yep. And it lowers your taxable income. So as a small business owner, you. Really valuable tool available. Uh, it's a, it's a powerful tool actually. There's a lot more options I guess, But then most people aren't small business owners.

Right? They're right. Yeah. Yeah. So it, it, it comes with a lot more responsibility. Cause at the end of the day, if the business failed, it's only you to blame. Um, but in order to make it more feasible, the government has given us, you know, these abilities within tax code to, um, You know, higher chances of being successful as a business.

Cause if we didn't get all those tax deductions and business expenses, business would be a lot harder to conduct. I mean, it'd be very challenging. Mm-hmm. I think that has been, uh, something, like you said, America's really good at commerce and so the tax code is incentivizing Incentivize. Yeah. Incentivize business es people to employ people.

Yeah, yeah, yeah. And, and, and produce goods and services. Cause you do, you want that in your economy. If you dis-incentivize people to go out and make money, make a profit. If you said, As a government, we're no longer allowing anyone to have rental properties. Well, guess what? People's quality of life for where they can choose to live is going to go down dramatically because there's a lot of people that are incentivized by the profit motive to go out, buy that house, do that renovation, do that flip, rent it out, and have it be a nice place if we're relying on the government to do that all for us.

And that's why the government, the government knows that too. They're like, We don't want to. Business because that's a, a lot of comp countries have tried that and it's never worked out quite well. Never that good. Yeah. Yeah, exactly. So there has to be that incentive. Yeah. I think you guys want to get a lot more into the irs Yeah.

And, um, the incentives and all of that. And, um, uh, there's a lot more to cover. So I think we're going to have to do that next week. Yeah. Because we're tight on time. And, and Glenn, remind everybody about the podcast and, uh, get how to get in touch with you because this all ties. Planning as well. Yeah. As far as, um, uh, uh, planning with your finances and investing and there's all kinds of avenues there.

Yeah. So all of our episodes are available online Intelligent Investing with Glenn Leest. Uh, you can go on iTune, Spotify, wherever we get your, uh, podcasts. Uh, and we've got. I think like 60 episodes on there. So not only just what we have here on the show that Jeff and I record, I also do bonus segments throughout the week or extra content, even market updates, what's going on in the market.

So make sure to tune in, subscribe. It's got a lot of great content there. Yeah. All right. That sounds good. Let's, and we'll continue this next week with, uh, Bill Baker. Talk more about taxes, IRS, maybe those 87,000. Iris agents. That sounds like a movie title, Jeff. 87,000. 87,000 Iris Agents Next week, uh, tune in again, folks.

Have a great day. Take care.

The following has been paid programming brought to you by WT Wealth Management. Nothing we've discussed should be considered as investment advice. This conversation was for informational purposes only. PLeest do your own. And speak to an investment advisor, financial planner before making any investment decisions.