Archive for February 2019

A Non-Political Look at Income Inequality and the Wealth Gap

3 ways you can end income inequality and narrow the wealth gap. Together we can change the world.Frequently we look for political solutions to income inequality and the wealth gap. While the issues can be improved slightly from political action, there are two additional ways to close the wealth gap and level income that are more effective.

Politics is the messiest way to fix these problems and history offers ample warning for those who seek answers from this source. One need not look further than Mao’s China or Stalin’s Russia to see how abysmal political leveling can be. North Korea is a modern example of how not to level the playing field. 

Let’s turn our attention to the second way income inequality can be reduced. Walter Scheidel in his book The Great Leveler explains what he calls the “Four Horsemen” of leveling: war, revolution, collapse and plague. Historically these four horsemen have been the leading cause of leveling of income and wealth throughout history. 

Once again this is not a comforting thought. You can read Scheidel’s work for an in-depth review of his research. The record is clear, however; it takes great dislocation, pain, suffering and death for income and wealth to level naturally.

The first two methods of leveling the playing field are not valid choices if you enjoy freedom and like living a comfortable life. These first two methods of leveling are accomplished by bringing the top down rather than the bottom up. Which leads to an interesting thought experiment on how much we really want income equality and a narrower wealth gap.

 

Defining What We Really Want

Before we continue to the third and most viable way to level income and wealth we need to define what it is we really want and what we are trying to accomplish.

Leveling the playing field is actually very easy if you are willing to destroy massive amounts of wealth. Scheidel’s work and the 20th Century are amply examples of fixing the problem the wrong way.

Political solutions eventually lean toward solutions that are relatively effective which means forcing the top down and violence. The four horsemen do the same thing with the crude hammer of god. 

When most people speak of equality they mean they want to bring the bottom up, otherwise they are no better off than before while the upper classes are rent destitute. Normal people are not so dark in their thinking.

Therefore, we really should not care what other people have as long as we are enjoying affluence. Complaining you have one less apple as you relax in paradise is way too diva for this writer; it also shows a remarkable lack of emotional maturity.

In the Western world affluence is high, but there are still people stuck in poverty. The 1% have taken a larger and larger piece of the pie which means the middle class is getting squeezed with smaller gains and the poor are outright losing ground. (See embedded video.)

 

 

From the middle class on up the Western world enjoys massive affluence the rest of the world aspires to. A nice home with two SUVs in the garage are common. Travel is an affordable luxury. Food and clothing ample.

But there is something that grinds on our conscious when one person is paid less than another for the same exact task at the same exact skill level. This requires effort to fix.

While it is easier to ask someone else to make the change, each of us have within ourselves the ability to force equality. 

As a business owner we can take great measures to ensure employees are treated fairly and equitably. But what about large employers? How can we force change across our society?

And before these actions take hold, what can we personally do to narrow the wealth gap in our own life? Can we narrow income inequality in our own life regardless what business or government does?

This brings us to the third way to level the playing field.

 

 

The Numbers Don’t Lie

In 1995 James M. Poterba of MIT and Andrew A. Samwick of Dartmouth College published a damning report on household wealth in America

The above chart shows the household savings rate in America for the last 60 years. In the 1970s the savings rate began a precipitous decline. At the same time income inequality began to grow. Could there be a correlation?

Poterba and Samwick discuss historical stock ownership in America in their report. Their most interesting comment is telling: All corporate stock is ultimately owned by individuals. They allow for foreign ownership of U.S. equities which was around 5% at the time they published.

Here is what you can do to end income inequality today! 3 ways to narrow the wealth gaps and level income.While stock ownership eventually is owned by individuals, the real question revolves around which individuals own these investments.

According to the report household ownership of stocks was nearly 90% in the 1950s and has declined to less than 50% by the 1990s. Since the report it is fair to say stock ownership has continued declining.

The third way to level income and smooth wealth can only be accomplished on the personal level. If most people refuse to engage the exercise they will suffer greater inequality and there is nothing the government or any politician can do about it!

Traditionally the arguments surrounding income inequality involves wages. There is truth behind the inequality in wages over the last 30 or so years. The richest are getting the largest share.

But this ignores every other source of income! In the 1950s virtually all households held some stock. These households had a fractional share of ownership in these corporations. Dividends went to the household, almost all of them.

Now fewer than half of households own stocks which means these households have zero income from this source. The wealthiest by default ended up owning nearly all America’s wealth. People complained, but refused the one solution nobody could stop them from exercising.

And capital gains and dividends are taxed at a lower rate than ordinary income, like wages. Even with this massive incentive for individuals to own stocks the average person took a pass. And so income inequality grew. 

All the gains in America’s growth hence went to the remaining owners of America’s engine of economic wealth. There was no other possible outcome. The people who held stocks (owned a piece of American businesses) ended up with all the gains and the gains were spread to a narrower and narrower group with each passing year.

 

Get Your Share

At first glance you might think something as simple as having more people own shares in American businesses would not solve the whole problem. That thinking is wrong.

Owning a piece of America’s value creating machine means you get a slice of the profits in the form of dividends. Many middle class taxpayers pay a very low or no taxes on these dividends. 

Something else happens when more people own a piece of corporate America. Your fractional ownership slightly levels the wealth gap because you now own something tangible like the wealthy do. Your share might be small, but there is power in numbers. 

When nearly 90% of households held U.S. stocks, dividends were more widely distributed. It also meant nearly every household had a small say in how companies operated! (Remember, you are a part owner when you hold stock.)

As fewer people held stock there was no one to slow down the enormous gains in CEO salaries. The CEOs rewarded the remaining few shareholders and employees were left out of the discussion because they didn’t own a piece of the enterprise.

Of course, owning a few shares in McDonald’s doesn’t give you the ability to dictate policy at the firm. But if many people owned stock in the company they could gather enough influence to change corporate behavior!

It might sound strange, but what would happen if every employee of McDonald’s owned 100 shares and worked together to change wage policy at the firm? I know, I know. People working at McDonald’s can’t afford to own stock in the firm. Yet I argue you can’t afford not to own a piece of the company if you ever want to change corporate policy!

Income inequality and the wealth gap are the same exact problem! As the wealth gap widens the lower end of the economic scale has less and less say. Of course the people on top want more and they get it because nobody that owns the company says different. 

 

The Gift That Keeps Giving

When my kids were growing up they received a share of stock as a gift for Christmas every year. One year they got a share of Wrigley, another year a share of Disney. 

Part of the gifting process was to examine each company they had stock in along with a few other possibilities.

The family came to the conclusion Wrigley was a winner for a variety of reasons. Wrigley gave every shareholder a case of gum each Christmas which my kids found incredible valuable. Stock ownership had real benefits! 

The financial reports also looked promising. Earning grew and so did dividends. Dividends were reinvested while excess cash was funneled into more shares. The growth was impressive.

Then Warren Buffett came along and funded Mars Corporation’s cash buyout of Wrigley. (Damn you, Warren!) Every member of the Accountant household got a big, fat juicy (Wriggly makes Juicy Fruit gum) check for their ownership in Wriggly. It was a bittersweet moment, however.

Yes, a big, fat juicy check is always welcome, but the regular income of dividends ended! And worse, no more gum in the mailbox in mid-December! It was as close to a crisis as I ever saw it!

While many people use index funds, there is something lost when we give authority to a mutual fund to vote our shares. That is why I still own individual shares in companies.

Your influence is minor when you own a few shares in a company. But even without a majority of ownership a large number of shareholders can make life very unpleasant for management tone deaf to owner/employees. 

Regardless your minor control of the companies you hold stock in, you have an unseverable right to your share of profits. This by default shrinks the wealth gap and income inequality for you.

 

Fixing the Wealth Gap and Income Inequality One Person at a Time

It is tempting to blame government and politicians for the wealth gap and income inequality problems. But as we saw above, the problem is not a political one and politics can’t solve it regardless what politicians promise!

You can change the world; you can make a difference in ending income inequality.Natural levelers are down-right brutal. We don’t need a catastrophe to level the field to an acceptable level. Complete equality is a terrible goal as the 20th Century has shown. However, the current environment is way too lopsided to be good for society in the long run either.

Businesses are the engine of value creation and growth; labor builds the goods and provides the services that make that value creation and growth possible. It is fair to say labor should have a reasonable slice of that pie.

Looking to the government for solutions is only a minor stopgap. Social services (the safety net) can be increased (and improved), but this is unproductive after a point. While more can be done in this area, it will not solve income inequality if individuals refuse to own a piece of the means of production! Nor make even a dent in the wealth gap!

Unexpected plague, war, revolution or collapse can temporarily level the field, it does so by bring the top down, leaving the middle and bottom no better off than before and probably worse. To fix income inequality issues and narrow the wealth gap, we want to focus on improving the most amount of lives as possible, not destroy everything until we are all level digging in the dirt for sustenance.

I know the world preaches index funds; so do I. Before Jack Bogle passed away recently he warned of the issues I brought up above. If mutual funds/index funds/ETFs control all the stocks they will vote the rules in corporate guidance. 

If you respect and value freedom you will demand a voice and your voice is purchased with ownership. It doesn’t take much. A few shares of three good companies can do wonders for your economic status. You can still hold index funds with the bulk of your money. (They pay dividends too, you know.)

Even without direct ownership (ownership through index funds) you still personally shrink the wealth gap. The increasing dividends added to your wage income narrows income inequality ever so slightly.

It took 40 years for the problem to grow this wide; it will take more than a few years to fix, even in your personal life. 

Or we could do what we’ve been doing all along and hope it changes magically all on its own.

Or demand a government bailout. (But then you’re just like corporate America.)

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

Mr. Money Mustache Fired His Accountant

It was late May of 2015 when a wayward accountant from the backwoods of Nowhere, Wisconsin traveled to Cascadia. Tucked away in the Washington State foothills stood the Rainbow Lodge where a nondescript gathering of devoted followers of the emerging Mustachian movement were preparing for Camp Mustache II. This was our hero’s destination.

The goal of our accountant was to meet the Great One, Mr. Money Mustache himself, Pete Adeney, and present him with a business offer. 

The wayward accountant had a game plan. Since Pete had no idea who this crazy guy was he needed to build rapport before springing his devious plan on the unsuspecting celebrity. He had four days to build this rapport, present his offer and seal the deal. The pressure was on!

Since our hero was already attending the event he figured he could volunteer to give a short tax presentation. And wouldn’t you know it, the Big Guy attended the session and sat right in front of him, no more than five feet away!

Oh, well, figured our country boy. He went ahead with his tax strategy presentation. No more than ten minutes into the presentation and Pete interrupted, saying, “You’re my new tax guy.”

Gulp!

Cool as a cucumber, our backwoods accountant never missed a beat as he finished his session. When the session ended Pete introduced himself to the accountant and said, “When I say something I mean it. You are my accountant.”

 

Pressure

You would think the pressure would be off at this point. Mr. Backwoods Accountant had his foot in the door three days early. Not only did he have his coveted rapport, he had a new client; Mr. Money Mustache himself! (Can I squeal like a girl in delight now?)

But there was one problem. Mr. Accountant wasn’t looking for new clients. He had a business proposition to make and he had to figure out how to present it.

Honesty is the only way. Later the same day our hero pulled Pete off to the side and spilled the beans on why he was there.

He admitted to Pete he wanted to offer his DIY online tax software service, using MMM as the platform. Pete didn’t care for the idea. (Disappointment.) But he would be happy to mention the project on the MMM blog without strings attached. (Glee!)

But there was still one overwhelming problem.

 

Honesty

The story to this point is public information. I’ve shared this story in the past and many are aware of it.

What is not publicly known is why I wanted to make the business offer to Pete in the first place.

Sometimes getting fired is the best thing that can happen to you. The loss of a job or client opens the door for new opportunities. You can only grow when you deny the past and embrace the future.

Sometimes getting fired is the best thing that can happen to you.

The reason for the DIY tax software project was because I was ready to take a step back and start living the MMM lifestyle. Now that I ended up with a very visible new tax client that dream fell to dust. 

The DIY tax program is alive and well, thanks to the extra push Pete gave it in February 2016. However, the idea of slowing down and focusing on teaching the next generation of tax professionals had to be put on hold. 

The phone and email server started to smoke the traffic was so heavy. Mr. Money Mustache gets close to 10 million page views per month and his readers are devoted. They all wanted the same taxguy Pete had. This wasn’t going to work.

At its peak I was receiving over 300 emails a day that tax season just from the MMM blog alone. Just saying “No” to each request was a strain on resources. And these weren’t the simple returns either. These fine people took serious advantage of the tax code.

Instead of slowing down I was winding up at a rapid clip and it was wearing my team and me out. It took a few years to adjust to the New World Order. I had to learn to say “No” at a level I never imagined before. 

Employees were crushed by the onslaught. I still don’t understand how I survived the transition. Stress was higher than at any other time in my career. 

Let’s be clear. None of this was Pete’s fault. He had no idea what was about to hit me. Every action Pete took was to help someone he admired and liked. Pete and I became friends. And he empathized with my situation. He offered to break the links on his blog, but I begged him to keep them up. My ego was the only thing enjoying the ride.

 

Hell

My descent into hell was complete. I was adding new clients, but couldn’t keep up with the pace. The first tax season (spring of 2016) was non-stop triage. It wasn’t good at all.

The quality of my work suffered and I was exhausted. And my attitude started to show it.

This was NOT what I had planned. I couldn’t even dream something like this would happen. We’re country folk and live a fairly secluded life. More people contacted my office that year than there are people in the county I live in! Think about that for a moment.

The next tax season (2017) was better, but not my much. I wanted to help all these people and I still fantasized I could. I was saying “No” more, but still held myself open to more clients. It was a round robin at this point. When I said “Yes” to one new client I would lose another. And all the while Pete watched patiently.

Pete knew I was struggling no matter how brave a face I put on. He offered helpful guidance and even mentioned on several occasion I was working too hard. But I kept thinking, “This is Pete! He thinks everyone works too hard. I’m a Wisconsin boy. I can take it.” 

But I couldn’t and I knew it. 

I might be slow, but I ain’t dumb. (No comments from the back row.) Last tax season (the third since that fateful day at the Rainbow Lodge) I was starting to adjust to my new situation. I slowed the pace of client growth (I actually orchestrated a small decline) to a manageable pace.

 

Back on Track

The saving grace of this whole ordeal was automation. I was forced to think in ways I never had to before. 

My team did not fare so well. Every employee I had at the start is now gone. The last one left late last year, burnt out from the experience. My senior employee is now three years with me. It is hard sometimes to see how I could rebuild, but rebuild I did with my original goal back on track.

It could have been worse. You could have kept your job. Sometimes losing your job is the best thing that can happen to you. You now have the freedom to choose the path you want going forward.I’m one ornery backwoods Wisconsin coot that refuses to give up! I had a plan and it got detoured. Nothing more. 

After three plus decades in the tax industry my value wasn’t best utilized serving one client at a time. Yes, this blog does help spread the word and teach others. This blog isn’t enough, however.

With headcount lower and the door closed to virtually all new clients, I was able to focus on the original goals. 

To accomplish these goals I needed to focus on what I was good at: tax. I outsourced all payroll. Except Pete. Pete was my friend. I couldn’t do that to him. 

Bookkeeping—a low margin service—was curtailed to just those clients needing the service as it related to their tax situation. Automation and outsourcing did the rest

Last tax season was at least reasonable. Even my senior employee, Dawn, with me three years, noted the difference. Things were looking up.

Then I made a serious decision. It was time to explain to my friend, Pete, that he needed to have his payroll handled elsewhere and I facilitated the transfer to the service I use in my office. Pete contemplated doing it himself, but decided to take my direction.

Then I got the email.

 

You’re Fired

Pete saw the handwriting on the wall even if I wasn’t totally honest with him. He knew I was under tremendous pressure and was putting on a brave face for the world. I was the only one fooled into thinking nobody knew what was happening behind closed doors.

Pete is one of the smartest. most common sense, guys you’ll meet. His email was titled: Continued Collaboration Plans. Yeah, I can see a pink slip when I see one.

I wasn’t really fired (or is that FIREd) and it wasn’t a surprise. Discussions in our conference room at the office centered several times around the Pete issue: Should we continue doing his taxes? The discussion revolved around how narrow the office demographic had become. We wanted to return to a more traditional tax office. My teams—what was left of them—knew I still wanted to work out of the traditional tax environment and start preparing the next generation of tax professionals.

Pete had no idea. In truth, we never would have turned Pete away: he is too much a friend; I admire him and his work too much. Still, it wasn’t the right thing and apparently Pete knew it too.

Pete made very clear in his email how happy he and Simi were with my work. I responded I wasn’t as thrilled with my performance as he was. I knew where I dropped the ball. Stress and taking on too much are not valid excuses.

Then Pete said he wanted my blessing for a new tax accountant he found, saying,

But at the same time, I’d love to continue collaborating with you on whatever you see fit, whether it is talking about life, blogs, tax strategies, sending folks your way, or whatever.

Pete is all class, as if you guys didn’t know that already.

Pete finished his email with,

So my own taxes are just a footnote – I feel with your firm being so busy already, I’d rather not be a burden myself, and I also don’t feel comfortable sending too many additional customers at you, because you are all so busy already! As stated earlier, I want to be able to bring in more new firms to the fold so we can help more people.

Like I said, all class.

 

Overjoyed

(Don’t bail on me yet, kind readers. The best part is still coming!)

I shouldn’t feel such relief that the ordeal is over, but I do. Serving a very visible client is distracting at best. But the change will serve Pete, his readers, and even you, kind readers, better than ever!

I did something horrible, however. When Pete sent the email I could tell it was hard for him to write it. I waited almost a week to respond, though I saw it the moment it hit my mailbox. My response, you see, was equally difficult to write.

Pete gave some sage advice in his original email:

. . . your teachings through both the Wealthy Accountant blog and the in-person seminars have helped tens of thousands of people – or more. So I want to continue all of this! 

How could I let my friend down. He wanted me to realize my goal from five years back when we first met. You have no idea how humbled I am by his encouragement. 

I finally was able to write back what I wanted to say. Now Pete was overjoyed.

I wrote in my email:

Pete, I can only imagine the apprehension you had writing this to me. Understand I think your proposal is a good one so no worries. 

Rather than just assigning 2018 to his firm, let’s do this as a full transition to the new accountant. If he has difficulties I am available to consult; if he doesn’t live up to your standards I can always step in again.

I made it clear to Pete I was still on his team. His new accountant is close to his home and I am certain will do an awesome job. Because of the new tax law changes I will reach out to the new accountant (name undisclosed at this time for reasons obvious in above writings) to make sure he understands how this will affect Pete. That 199A thing is really important. I can provide guidance (my true value) and he can perform the application.

So you understand how overjoyed Pete was I didn’t take it personally, he started his response:

WOW, thanks so much for that helpful response! You are right that I was nervous that you’d take my request the wrong way. But as I said, it just seems like a win/win for everyone, so why not!?

I agree.

There is one more morsel to share later. You want to stick around.

 

Now for Something You’ll Really Love

While all this was happening, a certain accountant from the boondocks of Wisconsin was still planning and working hard toward his goals of serving his people better than ever before.

Outsourcing and downsizing certainly made a difference in the office environment. With new processes in place working and Pete doing what I should have presented long ago, I have been able to focus on things you, kind readers, have been asking for. And so far this has been the best tax season in well over a decade.

The best boss sees your potential and pushes you to reach for it. The best leaders bring the best out of others.

The best boss sees your potential and pushes you to reach for it.

Camp Accountant is now almost certain to happen. Before it was just too much to fit into an already crowded schedule. The new world order turns this into a real possibility.

Camp Accountant is tentatively planned for late summer this year in beautiful West Bend, Wisconsin. Attorneys, CPAs and enrolled agents will earn continuing professional education (CPE) credits for attending. No other camp has ever done that!

And I have another secret no one reading this will know.

This blog has been growing thanks to training courses I’ve taken. The best course by far is Moolah Marketing. Highly recommended.

The Moolah course, by the way, is remarkable in more than just driving traffic. Rachel Miller, the wonderful woman running the course, hammers first on identifying who your fans are. This is important as I’ll now illustrate.

When I started the Moolah course Rachel kept asking who my fans were and I kept saying the FIRE community. She kept telling me I was wrong. I finally figured out the FIRE community is only a small part of my demographic, but tax professionals scream for more of my work. The tax pros are my people!

What Rachel instilled in me is a new path for this blog, my work and fulfilling my original goal back in May 2015. Several courses in this vein will be produced by this blog or are in the works!

Rachel invited me on a Facebook Live and asked her people if they would like a course from me on 30 Tax Tips for Solopreneures. She said if 50 people were willing to pre-order I was obligated to create the course. It took less than 5 minutes!

So I need to be committed, ah, I’m committed to creating the course. Now I need to set up the order form (a future post will list details and how to order) and create the course. Due date is May. (This year!)

Here are a few more courses in development:

  • 20 Tips to Avoid Taxes When Investing in Real Estate
  • Build a Million Dollar Tax Practice
  • Investing For Dummies (May need to change the name due to copyright.)
  • Bookkeeping for Profit

We are floating more ideas.

This means I will be teaching more than ever. In the past I was locked into serving one client at a time. Now I will serve thousands at a time! If you have a topic you want my team to consider be sure to let me know.

Finally, you may have noticed a new feature here. I started a Find a Local Tax Pro page! (This might be what triggered Pete to email me. A few weeks after I launched I heard from Pete.)

If you need a tax professional, this is the place to look. If you are a tax pro willing to add more clients to your book and follow The Wealthy Accountant tax principles, allow me to add your name to the list. If your tax pro is awesome, be sure to point her to this resource. It is free and you can change or delete your listing anytime your situation changes with no fee. This is for the people of this community. 

 

Did Pete Finally Get Something Wrong?

I’ve known Pete for about 5 years now. The one thing you quickly notice is his clarity of thinking. Anytime I’ve asked for his advice or he just gave it because he saw I was in desperate need, he has always hit the nail on the head.

Pete gave me this final warning:

I’m not sure if I’d post the MMM new accountant thing just yet (and of course you never have to, I can always explain if ever needed that we still work together and collaborate) – but I’ll leave it up to you. In general, I find it’s good not to stoke the gossip engine, because people always get stuff wrong!

I feel this post is about more than Pete using a new tax professional. I covered a lot of material today that will serve your needs, kind reader, for a long time to come. 

I can’t be a mini-Pete forever; I need to strike out on my own in a direction I feel best serves my people, you.

Pete is right. People tend to get it wrong. Many will read the title and no further, building their entire opinion on those few incomplete words meant to drive traffic more than anything else. (Gotta get ya to read it before I can help you.) 

Just this one time can we prove Pete wrong. He is a good man. He’ll be happy to be proven wrong on this. This is a major step forward for this community and desperately needed. We need more qualified tax professionals and this is a serious first step. 

Now if you’ll forgive me, I need to find my handkerchief. I was just FIREd.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

The Coming Collapse of China

Protect your finances if China's debt bubble implodes. Don't let the trade war ruin your retirement plans.

Protect your finances if China’s debt bubble implodes.

When the Western economic world collapsed in 2008 there was only one beacon of light: China.

For decades China has grown at nose-bleed speeds and looked like an unstoppable economic miracle. Now the foundations of that miracle are exposed and the house of cards is in peril. Shadow banks and ghost cities are only the tip of the ice berg.

Speculation over the years of fudged official economic numbers coming out of Beijing is starting to haunt the government there. As 2018 came to a close the government reported the slowest growth in 28 years. This was still a bit north of 6%.

Unfortunately, these slower growth numbers are probably a wildly exaggerated lie. Recently, a former chief economist for the Agricultural Bank of China mentioned a report that two recent studies show China’s economy growing at a mere 1.67% and another showing the economy actually declined.

While there is no doubt China has made massive economic leaps over the past several decades, much of the recent growth is built on a shaky foundation.

In many Western nations an economic crisis can ensue from excessive indebtedness. The difference between Western nations and China is what the debt funding was used for. In the U.S., for example, corporations can over-extend themselves, causing over-production and an inventory hangover. Household debt might be wasted on stuff that has virtually no value. But homes and autos have at least some value and a good amount of utility. Something we will see China wasn’t spending on.

 

Dangerous Foundation

China is mired in a massive amount of debt. Trustworthy numbers are hard to come by, but many reports claim China’s government and municipal debt are several times larger than the annual economic output of the country.

What China spent the money on is a bigger problem than the excessive debt! The growing mountain of debt is difficult to manage. However, if the debt was used to produce something of value it would be possible to work through the financial problems with only modest economic pain.

China did some of that (spending on productive investments) and a whole lot more creating rubble. 

People inside China have captured videos of buildings built in the last decade tipping over and put them on YouTube. Ghost cities in China are well known outside the country. Whole cities with virtually no people living there. 

What is worse is the quality of construction. A large number (based upon information from people living in China a long time) of buildings only a few years old look like they are more than a century old! It is hard to imagine the crumbling facade and disrepair huge parts of these cities can fall into after only two or three years. Again, YouTube videos allow you to glimpse the slow moving disaster in the works.

The layers of debt these unlivable buildings have is equally ill-constructed. Municipalities borrow so they can encourage growth which generates tax revenue. (The tax system in China is untenable as local governments frequently find the greatest source of funds though the crazy financial deals with developers.) 

Builders, which are frequently state-owned and very inefficient, pile on more debt to build the structures.

Then the final layer of debt is added when individuals buy, believing real estate never goes down in value. People in China buy real estate because they consider it a good investment even when they don’t live there or rent it out.

Renting is also far cheaper than buying a property in the populated areas of China. Rents frequently only cover a fraction of the mortgage payment so ownership is even more financially demanding.

 

Inside Information

A year-and-a-half ago this blog was one of the few websites allowed inside China by the government. Today it is officially banned!

My oldest daughter spent time in China last year and was able to pull up this blog. She taught English as a second language and lived with a host family. That is no longer possible.

Are you prepared for the collapse of China and the debt bubble? Protect your finances with these 3 simple steps.Many foreigners teaching English as a second language in China are sheltered from the worst parts of China. My daughter, Heather, sought the real experience and got it. Fortunately she had a host family who considered themselves unconventional and enjoyed Heather’s presence. Her friend stayed with a family that wasn’t unconventional and had a miserable experience.

When Heather returned home she stayed in contact with her host family. She grew a bond with the host mom and their 5 year old daughter. 

In the last few months contact has been more difficult. We actually lost contact for over a month and feared the worst. These are good people and we worry about them because they are friends. 

As we started to give up hope of ever hearing from our extended Chinese family the host mom made contact. The story was grim.

This family had another foreign teacher and they had to send her home early over safety concerns. From the inside China has already started to implode.

The government’s solution to the stagnant economy was to set off another round of debt spending. With state-owned firms extremely inefficient and getting a large portion of the additional spending it is like doubling down on stupid.

 

Reality Test

You can hide fiscal malfeasance for a very long time if the government want the facts hidden. However, the natural laws of economics still apply and eventually assert themselves. 

The growing mountain of debt will eventually cause a crisis. The longer the delay before appropriate remedial action is taken the more pain will be measured out. 

China had started steps to resolve the issues. It would have taken a long time to fix the worst of the financial problems. However, the risk was high China would implode before they resolved the worst of the imbalances. The world community, knowing the approximate depth of the problems, quietly played along. What other choice did they have.

Unfortunately for China, the new American president had no patience for such slow resolutions. The trade spat exposed the underlying weakness of China’s economy quicker than expected and might be the trigger to set off the avalanche. 

The Los Angeles Times recently reported China announced more than $600 billion of economic stimulus. The goal is to fix the problem as fast as possible before catastrophe strikes. More debt seems a poor choice of ointment.

China’s history in not encouraging if the slowdown is too fast and/or a currency or debt crisis occurs before adequate safeguards are in place. 

The debt may be too large for an economy the size of China’s to navigate to calm waters. Many Chinese banks are insolvent because they can hide behind government censors. In a true capitalist economy these banks and other companies would have been shuttered long ago. So the inefficiency of the system trudges on and deepens.

Normally I would have an optimistic option at this point. And while I think this could be the next financial crisis to strike, I don’t think it will be the end of good times forever. All I’m saying is there will be a few moments when people get really scared if China collapses.

 

Preparing for the Storm

Dinny McMahon in his book, China’s Great Wall of Debt, does a better job digging deeper into the debt issues in China. This short post can’t cover the details the way a book can. The issues are deeper than I mention with shadow banks and incredible debt loads even greater than the government in China understands since they also know much of their data is faulty. I recommend reading this book. 

The risks posed by China should not cause undue alarm. Planning for the possibility is wise, but no one knows when, or even if (the miracle could actually be a miracle), the boom will drop. 

Is China's debt bubble about to burst? Learn how to protect your investments before it's too late.Since timing a crisis of this nature is impossible you can’t sell all your investments and hope it is the right move. The investments you sell might benefit from the Chinese crisis or the market could rally for years before the flood of Chinese debt consumes the news feeds.

There are some steps you can take to protect yourself if China implodes and if it doesn’t will bolster your financial situation regardless.

The 2008 financial crisis that started in the U.S. was a debt crisis. Home lending was out of control. Appraisals were based on fantasy and fake documents. Almost sounds like what China is dealing with today. 

Debt crisis are always painful events. Companies fail and jobs are lost. People with money hold it tight for fear things will never improve. 

As we saw in 2008, a financial crisis in a major world economy spreads. Very few parts of the world went unscathed by the 2008 events in the U.S. Even China was affected. 2008 set China on a massive borrowing for growth scheme they can’t seem to get off. Once the lie starts you need bigger and bigger lies to keep the charade going. 

Since debt is the cause of so many financial crisis I suggest you insulate yourself by reducing or eliminating debt. (I prefer the elimination of debt because the seriousness of the China issue is large enough to harm virtually anyone holding debt.)

Reducing debt is an easy (relatively) and simple (relatively, again) way to insure your fiscal soundness if China stumbles. Like all debt, it takes time to pay off. Today is the best day to start the process. When the tsunami is visible on the horizon it’s too late; there will only be time to grab something solid and hold tight.

A second security procedure is to keep some of your finances liquid. Most of your money should probably be invested in broad-based index funds all the time. Market timing just doesn’t work. Having two years of spending in a money market fund might also be a good idea. This is a similar tactic people in or near retirement use so they don’t have to dip into investments when the market is down.

 

Final Planning Tips

I wish I could share more, but I fear if I was totally blunt it might harm my friends in China. 

This is a serious issue China works hard to keep from the press around the world. It is easy to think China is loaded with cash since they hold so many U.S. Treasuries. In a crisis China may have to sell large amounts of these Treasuries to defend their currency causing an interest rate spike in the U.S. This would be economically disruptive even if the Federal Reserve fights to counter the effects of such a liquidation. 

The most serious issue happened when we lost contact with Heather’s host family for over a month. They only contacted us because they were traveling outside China. This is very concerning. When things get really bad (and usually just before), totalitarian governments clamp down hard. Foreigners in China have been learning this. The security alert for Americans traveling in China is elevated and travel there is not recommended. This is not a warning to be disregarded.

If the same thing happened in Russia it would be less an issue since their economy is so much smaller. Even with inflated numbers, China’s economy is still one of the largest on the planet. If China stumbles we will all feel the ground quake, especially since some of the debt is in U.S. denominations.

This post is not about inciting panic, rather the opposite. Risk is high and even the U.S economy looks to be softening. Smaller refund checks this tax season means people were enjoying a slightly higher take-home pay during the previous year. That could lead to a softer U.S. economy for a while.

You can weather almost any economic storm without debt. Even in good times debt can be a burden. 

I worry because a family in China close to my heart is living dead center of where the storm will strike. I wish them and all of China well. 

We are all in this together. So take precautions, reduce debt, increase your financial cushion and be well.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

Final 199A Regulations

The Section 199A deduction requires you to be a trade or business. Follow these rules to take advantage of this generous deduction on your rental properties.

The Section 199A deduction requires you to be a trade or business. Follow these rules to take advantage of this generous deduction on your rental properties.

The IRS released final regulations on 199A. The Kiplinger Tax Letter said it best: “Final regulations provide limited guidance, but IRS gives a safe harbor.”

In this post we will discuss the safe harbor as it relates to “trade or business” with special emphasis on application with rental properties. The safe harbor doesn’t apply to all taxpayers and the trade or business designation is still possible without meeting the safe harbor parameters.

The final regulations run 248 pages. I will follow this post with a detailed post on 199A tiers with several decision trees. Due to the length and complexity of the regulations we are forced to remain focused on one aspect of 199A. Taxpayers with a sole proprietorship, partnership, S corporation or investment property may wish to seek the services of a competent tax professional until more clarification is reached through more regulations or from the Tax Court.

Links are provided at the end of this post to the entire 248 pages of regulations released and Notice 2019-07 (only 10 pages!) dealing with the trade or business safe harbor for real estate issues for your further research.

 

Remaining Problems with the Final Regulations

The final regulations refer to Section 162 (as previous releases have). Section 162 generally governs the deductibility of expenses for a trade or business. But Section 162 is unclear when it comes to rental activities. 

The reason for the vagueness is because the facts and circumstances of each taxpayer differs. Whether the property is commercial or residential, the lease terms, services provided, how many properties owned  and day-to-day involvement in the activity all play a role. We will touch on each of these throughout this post. 

The biggest problem with the final regs is that they were issued after 2018 was in the books. Nobody knew they needed to keep track of time spent in the activity, nor did they know they were required to keep a separate bank account for the rental activity.

The IRS, aware of this, has granted some leeway for the 2018 tax return as it regards contemporaneous records.  However, for tax years beginning after December 31, 2018 you must follow the new regs for record keeping. Ignorance is not an excuse.

Once the IRS laid out the safe harbor for a “rental real estate enterprise” they state: 

Failure to satisfy the requirements of this safe harbor does not preclude a taxpayer from otherwise establishing that a rental real estate enterprise is a trade or business for purposes of
section 199A.

This means the safe harbor isn’t the only way to take advantage of the generous 199A deduction. 

If you use the safe harbor you must include a statement to that effect with the tax return. Qualified pass-through entities (RPEs) can also use the safe harbor and provide the taxpayer with the required statement that application of the safe harbor was used as outlined by regulations. This is attached to your return.

 

Safe Harbor

The new deduction for rental property owners is no game. Get your deduction today.Rental Real Estate Enterprise: For purposes of the safe harbor the IRS uses the term rental real estate enterprise, defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties. 

The individual or pass-through entity relying on this safe harbor must hold the interest directly or through a disregarded entity. This means you can only use the safe harbor if you hold the property personally or as an LLC treated as a disregarded entity. If you hold the property in an LLC electing to be treated as an S corporation (and there is no reason to ever hold real estate in an S corp) you cannot use the safe harbor.

The taxpayer must treat the property (or group of properties) held for the production of rents as a separate enterprise. This means you hold each property or group of properties as a single enterprise. Which means you have a separate bank account and name for the enterprise. Those with multiple LLCs could experience issues with qualifying for the safe harbor. 

Commercial and residential property cannot be part of the same enterprise. Yes, this can cause real confusion when you have mixed property under one LLC and/or business name. As I read this regulation you would need to qualify for the safe harbor for both the residential and commercial property.

Once you establish a treatment for your properties (which properties belong with each enterprise) you must continue with the same treatment unless there has been a significant change to the facts and circumstances (sale or purchase of property, for example).

Safe Harbor Defined: For the Qualified Business Income Deduction only, a rental real estate enterprise will be treated as a trade or business if the following requirements are satisfied during the taxable year with respect to the rental real estate enterprise:

  1. Separate accounting of income and expenses are maintained for the rental real estate enterprise.
  2. 250 or more hours of rental services are performed for taxable years beginning prior to January 1, 2023 with respect to the rental enterprise. 
  3. For taxable years beginning after December 31, 2022, 250 or more hours performed in respect to the rental real estate enterprise in any 3 of the 5 prior consecutive years.
  4. Contemporaneous records are required, including: time reports, logs and similar documents regarding the following:
    1. hours of all services performed
    2. description of all services performed
    3. dates services were performed, and
    4. who performed the services

Of course, contemporaneous records are a bit hard to produce when the rules were not in place until after the tax year concluded, and therefore the records do not need to be contemporaneous for tax year 2018. I recommend going over 2018 ASAP to create a log of all services performed.

 

What Counts for the Safe Harbor

Not all activities count toward the 250 hour requirement for the safe harbor. 

Rental services performed by the taxpayer or by employees, agents, and/or independent contractors of the taxpayer all count toward the 250 hour safe harbor requirement. 

Rental services for the rental real estate safe harbor include:

  1. advertising to rent or lease the property/s
  2. negotiating and executing leases
  3. verifying information from prospective tenants
  4. collection of rents
  5. daily operation, maintenance and repair of the property/s
  6. management of the property/s
  7. purchase of materials
  8. supervision of employees and independent contractors.

Keep in mind the time supervising employees and/or contractors only includes your time supervising. The hours performing services by employees and independent contractors do not count toward your hours.

 

Activities that Don’t Count as Rental Services

Several activities do not count as rental services as applied to the 250 hour requirement:

  1. travel to and from the property/s
  2. financing activities
  3. investment management activities (financial statement review; property search; and procuring and planning, managing or constructing long-term capital improvements)

Generally, things that are easily fudged are disallowed. Saying you spent many hours reviewing the books or driving to the property will not benefit you. Saying you spent x number of hours planning capital improvements to the properties also do not count toward the safe harbor.

 

Other Exclusions

Real estate is better than ever with the new tax laws. Discover the advantages to 199A. Get your tax break today.Several situations are excluded from using the safe harbor. 

Any personal use of the property during the year excludes use of the safe harbor.

Triple-net leases are also excluded from the safe harbor. A triple-net lease is defined as a lease agreement that requires the tenant to pay for all or part of the taxes, fees and insurance, and the tenant is responsible for 

maintenance requirements in addition to rent and utilities. Since most commercial property is leased triple-net, the safe harbor option is unavailable, but may still qualify as a trade or business as shown next.

 

How to Still Claim as a Trade or Business

Since so many tax dollars are riding on the line it is important to determine if you qualify for the 199A deduction. The safe harbor is just that, a safe harbor. Just because you don’t qualify for the safe harbor does not mean you do not have a trade or business.

There are some similarities in this safe harbor with the material participation tests under the passive activity rules. While the numbers between this safe harbor and the material participation tests are different, we can still gather guidance by reviewing the facts and circumstances in determining if the activity is a trade or business.

Earlier last summer while waiting for the IRS to provide guidance on what a “trade or business” is, I decided to build a policy for my office. My conclusion was that investment property (reported on Schedule D when sold) was not a trade or business and property that is treated as a sale of business property when sold (reported on Form 4794) is a trade or business. With the recent IRS guidance I am forced to tighten my definition of a trade or business in situations not covered by the safe harbor.

The IRS actually uses the words “trade or business activities” in their material participation tests. In other words, they say:

You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests:

Whereas the safe harbor for 199A rental services say you need 250 hours, the first material participation test says 500 hours. I think it is safe to say we can use 250 hours when not using the safe harbor as well.

But you can still be a trade or business if you put in fewer than 250 hours if the material participation tests are a valid ancillary. 

Material participation test #3 says if you put in 100 hours, and is more than anyone else in the activity, you pass the test and materially participate.

According to test #2, if you put in substantially all the participation in the activity you pass.

There are additional tests to determine material participation. For trade or business issues I think it is reasonable to use the material participation guidelines, whether it be a small business or rental property. The safe harbor is a bit easier to pass for 199A based on hours, but if you meet the guidelines in any of the material participation tests you have substantial grounds for claiming you are a trade or business since the IRS already recognizes this in another area of tax application.

 

Final Considerations

Section 199A, the Qualified Business Income deduction is one of the most complex pieces of legislation to hit taxpayers in a long while. I dealt with one narrow subsection of the regulations. 

It might be a good idea to hire a tax professional for at least one year if you own a business and or rental property to deal with the litany of tax issues surrounding 199A. Even if an extension is required and your taxes are not filed until later in the year.

Here are a few issues not covered in this post that you will want to discuss with your tax professional:

  • Tier #1, #2 and #3 for small businesses
  • Specified service trades or businesses (SSTB)
  • Form 1099 (If a rental in not a trade or business then Form 1099 reporting can sometimes be avoided. However, you want to be a trade or business for 199A reasons so if you don’t file Form 1099 with contractors the IRS may disallow the deduction because you didn’t act like a trade or business)
  • Contributed property to an entity has special rules
  • Special rules apply to like-kind exchanges and involuntary conversions
  • Special considerations for basis of inherited property
  • Net operating losses affect 199A
  • Capital gains and losses may affect 199A
  • Amended returns are not allowed to initiate aggregation, but aggregation can be used in future years
  • SSBTs are better defined in the final regulations
  • and more. . . 

 

As promised, here are the reports from the IRS. You can read Notice 2019-07 as well as I. It is a short 10 page document and worth a read if you have rental properties. Less readable is the final regulations on 199A, coming in at 248 pages.

If you ever have trouble falling a sleep one evening just pick up the final regs. You’ll be out cold in minutes.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!