Problem:  How are companies like Sherwin-Williams able to lower their taxes by “renting” or “licensing” their own brands to themselves?

Analysis:

1. What is a “name or brand” in tax law?
   • A brand or name in tax law is essentially “intellectual property” (“IP”) or an intangible asset that could be amortized or expensed as a royalty or interest expense.  Thus, companies will often transfer trademarks, copyrights, patents and other forms of intangible assets into holding companies or other legal structures.
2. How does intellectual property or intangible assets lower your taxes?
   • Major companies will transfer the IP to holding companies incorporated in different states.  Usually, the most popular state is Delaware due to their royalty income exception for holding companies or Nevada.
   • Transferring the IP allows the company to create an expense to itself and shift income to a lower tax bracket.  Example:  ABC, Inc. pays 35% in taxes, but DEF, Inc. pays 15% in taxes because it has a less income.  Thus, the company would save 20% in taxes by transferring the income to the IP holding company.
   • The expense that is created is generally royalty income for using a trademark or patent by the parent or original company.  Thus, the company is able to deduct an expense equal to the royalty.
3. How is this legal?
   • Related transactions are viewed with a strict eye to whether or not it has a “valid business purpose.”  But, the federal and local governments cannot deem related transactions invalid wholesale because it was be unconstitutional.  Thus, related party transactions are valid and binding as long as the taxpayer can prove that it has a “business purpose” according to the black letter of the law.
   • A landmark case in New York State by Sherwin-Williams established precedence that this type of tax planning is both legal and valid if you’re able to meet the burden of proof to justify a “business purpose.”
   • Sherwin-Williams justified its business purpose by allowing the public to license their trademarks at market rates.  Although, the company comprises more than 90% of the subsidiary’s income the facts still illustrate a business purpose.  The public is allowed to purchase the license at will and the price the company paid was “at-arms-length” because they paid the same rates as the public.
4. Is it dangerous?
   • When the Sherwin-Williams case was decided, New York State quickly passed anti-passive investment company legislation that attempted to close this loophole.
   • The law adds additional scrutiny to the transaction, but it fails to close the loophole.  The legislation could be viewed as a warning and less as a deterrent to companies.
5. Are there alternatives?
   • Yes, the alternative is to incorporate a legal entity offshore or at a foreign country and utilize the same theory to entirely remove the income from the country.  This would allow a reduction in both federal and state taxes.

Conclusion:

We often complain that names don’t mean anything, but they should be respected because it could lead to a variety of tax advantages that you never thought of with the right knowledge.

Problem:  I sold my company and I have a million dollars of income this year, but I won’t have a source of income for the next three years because of the “non-compete clause” in the sale contract.  Is there anything I can do to pay less tax?

Analysis:

1. You could break the income into pieces, so that you only pay taxes on portions of it in separate years.
   • Installment agreements allow you to break the income into smaller chunks, so that you can defer the taxes until a later period of time.  The purpose of this is to delay the tax liability because of the time value of money concept.  Money is always worth less in the future; you should always pay it in the future if possible because it is inherently cheaper.
   • You could make a like-kind exchange.  A way to avoid paying taxes on a sale of a company entirely is to make an IRC Section 1031 Like-Kind Exchange.  You could potentially avoid paying taxes entirely, if you chose to forgo a monetary transaction.  Instead of exchange cash or your asset, an exchange between to assets could be made and taxes would be avoided.
2. What if I need access to the funds?
   • Installment agreements and like-kind exchanges both limit the liquidity of an exit, but there are creative solutions to this problem.  Debt is probably going to be the easiest and most common method to obtain access to you funds.
   • An installment agreement is essentially a long-term “account receivable” or money someone owes you.  You could go to the bank and obtain a loan for the same amount of money with the installment agreement as the collateral.  This is similar to the concept of “factoring” your account receivables.  It makes available cash that you need today from the future.
   • This transaction avoids taxation because debt is not income and would not be subject to income tax.  This allows you to control the timing when income is recognized, so that you could properly plan.
3. Is there an alternative method?
   • Defaulting on a debt secured by the installment agreement or account receivable could possibly allow you to avoid taxation.  This would require a detailed amount of investigation into the company’s specific circumstances, but it could be a definite option.
   • Relief of debt is generally considered income under the purview of the IRS.  The theory to income derived from debt relief is best understood in the follow example.  When you spend $1,000 dollars on your credit card, it is borrowed money that would be repaid in the future.  In contrast, if you spent a $1,000 dollars, but weren’t required to repay the debt.  There would be no difference between debt and income.
   • In our circumstance, the debt is relieved because an asset of equal value is reclaimed by the lender.  Thus, we didn’t technically obtain a gain or benefit in the transaction.

Conclusion:

Debt is often a power tool that may be used to leverage a business in a variety of methods, if you’re creative and understand their proper application.  Henry Kravis of KKR is known as the “King of Debt” for good reason.  He came from a humble background and was able to purchase JRJ Nabisco.

Problem:  Why can’t I get my lap dances tax free in New York anymore?

Court Case:  http://decisions.courts.state.ny.us/ad3/Decisions/2011/509464.pdf

Analysis:

1. Why are lap dances taxable?
   • New York’s Department of Taxation and Finance audited a strip juice bar called “Nite Moves” in 2005 and charged them $124,921.94 in sales taxes because the state deemed lap dances taxable.
   • Generally, stripping and lap dances have fallen under the sales tax exception provided by the umbrella of “dramatic or musical art performances.”  Thus, it wasn’t necessary for “patrons” to slip a dollar bill along with 8 pennies into G-strings and thongs.
2. How did New York get around the “dramatic or musical arts performances” exception for lap dances and stripping?
   • It always comes down to record keeping.  NYS caselaw states that “statutes creating tax exemptions must be construed against the taxpayer.”  Thus, when you’re asking for a deduction the law states that it’s your problem to prove it.  So, if it’s impossible to prove, then you’re screwed…
   • The strip club wasn’t able to prove that their dancers had performed “choreographed performances” as defined in the tax code.  They supplied the court with video tapes dubbed the “Nite Moves DVD” in order to illustrate the “art of stripping and lap dancing” and had an “expert witness” trained in anthropology to regurgitate the legal definition of a choreographed performance in the context of lap dancing.  (It must’ve been interesting to watch women at various “stages of undress” in court.  This is the judge’s term for stripping.)
   • The court slammed the strip club for its lack of substantial evidence and proceeded charge them sales tax.  The court deemed the DVD inconsequential because it was not recorded during the period in question or depict the specific private dances that were being audited.  The expert witness was disregarded because of the same logic.  The expert based their entire opinion on “experiences in other clubs” and did not view the dancers in “Nite Moves” specficially.  (This is probably the greatest excuse I’ve ever heard of to be a perv…)
3. What does this mean for strippers?  Does everyone need to start charging sales tax on lap dances?
   • This case establishes precedence, so that the next time a strip club gets audited it is possible that they’ll have to pay sales tax.
   • Strip clubs are going to have to keep “records” of their performances in order to prove their “choreographed performances” in order to substantiate their exemption from sales tax.

Conclusion:

Is it just me or did NYS just legally justify strip club owners to film strippers for perverts?

Problem:  How do you lower your taxes without “planning or strategizing?”  You blackmail the government like Twitter!

Analysis:

1. What are state and local “Credits and Incentives?”
   • Credits and incentives are essentially bribes to specific industries or specific companies that local governments provide businesses because companies threaten to take jobs away from the local government.
   • They’ve been marketed as economic growth initiatives, but in reality they boil down to corporations blackmailing local governments.  Politicians fear that the loss of jobs in their constituency’s districts during their watch would lead to poor voter turnout for their re-elections.
   • State and local governments are all fighting for their piece of the tax pie because it’s a zero-sum game.  The Supreme Court in Complete Auto Transit, Inc. v. Brady states that local governments must apportion their fair share of the income and the tax derived.  The court stands on the constitutional legal concepts of the commerce clause as well as the due process clause.
   • Thus, companies such as Twitter, Zynga and Yelp blackmail local governments because they can transfer jobs and tax revenues to other local state jurisdictions and bargain for preferential tax treatment (“bribes known as credits and incentives”).
2. Is the practice of state and local “Credits and Incentives” prevalent?
   • There are four major accounting firms in the global economy.  Each of the “Big 4 Accounting Firms” has their own division specifically tailored to state and local credits and incentives.  These professionals are generally ex-local governmental employees or ex-public servants who’ve moved into public practice.
   • PwC’s Credit and Incentives Department
   • KPMG’s Credit and Incentives Department
   • Deloitte’s Credit and Incentives Department
   • Ernst & Young’s Credit and Incentives Department
3. Isn’t this good for American companies in the global market?
   • Walmart is the worst state and local “Credit and Incentive” offender.  Walmart has created an entire business model based upon the exploitation of federal, state and local social benefit programs.  Walmart’s initial orientation and training includes counseling to public assistance programs.
   • Walmart systematically underpays their employees at sub-poverty levels and directs their employees to their local food-stamp offices as a supplement to their income and their concept of medical coverage is Medicaid for low-income families that earn less than $14,000 dollars for a single family.  All of the above are federally funded programs administered through the state and local governments.
   • Walmart habitually strong-arms local governments to provide multi-year tax abatements and provide credits or grants to build their Walmart Supercenters within town limits.  Tax abatements are exemptions from paying taxes.  The most common tax abatement local governments provide are real estate tax abatements for minimum periods of 5 to 10 years.
   • At the culmination of the tax abatement period, the company would either demand a renewal of its preferential tax treatment or they would move to a location just out of the town’s border to avoid taxation.
   • Credits and incentives are at heart legalized corporate bribery.

Conclusion:

Maybe it’s time that we received a few incentives for choosing to live in the states we’re in? lol.

Problem:  Walmart is having its cake and eating it too!  How does Walmart own its stores and deduct rent they pay to itself?

Walmart Captive REIT Chart

Analysis:

1. It’s called a “Captive REIT” tax structure.
   • A Real Estate Investment Trust (“REIT”) is an investment vehicle or entity that people use to gather large amounts of capital to invest into real estate and generate profit that is distributed as dividends to their shareholders.  A REIT is generally incorporated as a corporation, but can be a trust.
   • A Captive REIT is a REIT that is a corporation that is generally owned by a single shareholder or a small group of shareholders used to avoid taxes.
2. How does a Captive REIT help a company?
   • A Captive REIT’s goal is to change the character of income that a company receives in order to capitalize on the Dividend Received Deduction (“DRD”) provided by the law to corporations.
   • The Captive REIT would take rental income it receives and distribute it as dividends.  The DRD corporate tax rules allow corporations to deduct 100% of its dividend income received from a subsidiary that you own (Qualification: 80% or more ownership).
   • The Captive REIT tax plan allows you to pay rent to yourself and then deduct it as an expense.  You’d effectively get double the deductions because the corporation would expense its mortgage costs as well as the rent expense that the company pays itself.
   • The rental income is usually sent to a company incorporated in Delaware or Nevada.  Delaware and Nevada won’t tax the rental income.  Delaware Holding Companies are exempt from paying taxes on royalties and Nevada has no corporate level income tax.  Thus, any rental income the company receives is not taxed in of the 50 states, but deducted in all 50 states.
   • How many companies use this tax plan?  Walmart is the most famous proponent of this tax model, but Toys R’ Us, Home Depot and every major American retailer has used this tax plan for decades.
3. Does this still work?
   • Federal corporate tax law has closed this loophole, so this tax model is no longer useful for federal level taxation.
   • But, not all states have yet to follow the federal government in closing this tax loophole.  In 2007, there was a huge flood of states that suddenly woke up and started to close this tax model.  Examples of states that did this are North Carolina, New York, Connecticut, Massachusetts, Hawaii, Louisiana, Illinois, Kentucky and etc.

Conclusion:

Creative tax planning can make common sense go out the window and down the rabbit-hole into Alice’s Wonderland.  Lol.

Problem:  Why is IKEA a non-profit tax-exempt entity with an effective tax rate of 3.5% and how are they saving BILLIONS?

IKEA Org Chart

HN Member: Henrik

HN Question:

Hey Cam,

I saw your post for some free advice.  =D  (Thanks, btw!)  I’ve read that IKEA is a charity and I was wondering if this was true?  I don’t understand how a charity works into “tax planning?”  I thought that income from a charity had to be used for a charity?

My business has a lot of income coming from Euro, so I figured maybe I could learn a thing or two from the big guys.  I have about 2 mil in sales in total and 1.4 mil is from Euro.  I keep about 1 mil after my expenses.  Is there anyone you could recommend to help set this up or discuss something similar?

Best,

Henrik

DISCLOSURE:  I am a huge fan of IKEA and the desk that I’m typing on as well as the desk lamp that is allowing me to see my keyboard are all products of IKEA.  I have no ill will towards IKEA and I think that their products provide a great value proposition!

Analysis:

1. Who is Ingvar Kamprad?
   • He is the founder of IKEA and its related companies.
   • He is the 11^th wealthiest individual in the world, but “listed” #162 in Forbes.  More than 50% of his net worth is held in a nonprofit tax entity in the Netherlands, thus nontaxable.  (His charity is worth $12 billion and has given $60 million to charity, since it’s inception.  This is 0.5% of the “charity’s assets.”
2. What is IKEA?
   • IKEA is a private unlisted company that is not required to issue annual or quarterly financial statements because it is not registered with the SEC (“Securities Exchange Commission”).
   • IKEA is made of a multi-national corporate conglomerate that is based in the Netherlands.
3. What is the Stichting INGKA Foundation?
   • It is the world’s largest charitable foundation with $36 billion in assets.  In comparison, the Bill & Melinda Gates Foundation has $33.5 billion in assets.  (Stichting means Foundation)
   • The Stichting INGKA Foundation has yet to expend more than 0.2% of its assets per year on charitable purposes.  In contrast, the Bill and Melinda Gates Foundation is required by it’s endowment to expend all of its assets on charitable purposes within 50 years of Bill & Melinda’s deaths.
   • The Stichting INGKA Foundation’s charitable purpose is to “encourage design” and their single greatest line item is “other operating and administrative expenses.”  The Bill and Melinda Gates Foundation’s charitable purpose is to save lives and their greatest single item expense is “vaccinations and prescription medications”.  Enough said.
   • The IKEA stores that we all know and shop at are owned by INGKA Holding BV a wholly-owned subsidiary of the “nontaxable charitable foundation” called Stichting INGKA Foundation in the Netherlands.
   • All IKEA operations from administration, manufacturing, transportation and etc are held within the charitable foundation’s subsidiaries.  Thus, income from IKEA operations is nontaxable.
   • The Stichting INGKA Foundation is managed by a committee headed by Ingvar Kamprad and four other committee members designated by Ingvar Kamprad.
   • The assets of the “nontaxable charitable foundation” or Stichting INGKA Foundation can only be transferred to another foundation with the same charitable purpose and approval by Ingvar Kamprad’s committee.   Thus, IKEA is effectively protected against all forms of corporate takeovers.
4. What benefits do charitable or tax-exempt non-profit entities get?
   • Charities don’t pay income, sales or property taxes.  They generally only pay employment taxes.
   • Charities can buy property on behalf of for-profit companies to help them avoid property taxes.
   • Many countries allow non-profits to avoid having to even file taxes.
   • Charities make great money laundering storefronts.
5. How does Ingvar Kamprad get paid?
   • Kamprad has created a holding company separate from its charitable foundation called Inter Ikea Holding in the Netherlands Antilles a noted tax haven conduit.
   • The Netherlands has an extensive network of countries, which they are allowed to deal with through tax treaties without extensive tax withholdings and etc.  Thus, companies would utilize the Netherlands as a conduit or “tax truck-stop” to funnel their income to traditional tax havens such as the Cayman Islands.  Google uses the Netherlands’ tax treaties with a similar purpose to obtain their 2.4% effective foreign tax rate.
   • Inter IKEA Holding owns the “IKEA Concept” and the IKEA trademark.  The holding company would franchise the intellectual property to the operating arm of the IKEA family.
   • Kamprad’s holding company, Inter Ikea Holding has franchise agreements with all of the operating subsidiaries in the Stichting INGKA Foundation.  Inter IKEA Holding charges 3% royalties on all sales from IKEA operations.  IKEA operations has a profit marge of 8%, after paying the holding company it’s royalty, that is used to pay for IKEA’s day-to-day operations or kept as non-taxable income.
   • The 3% royalty fee on all sales is transferred through Inter IKEA Holding subsidiaries into a series of tax havens before Ingvar Kamprad receives his income.  Kamprad’s effective tax rate is unknown due to the lack of disclosure or financial statements in IKEA – a privately owned company.
   • In comparison, Google is able reduce their effective tax rate to 2.4% on it’s foreign income.
6. Interesting and notable facts:
   • Ingvar Kamprad’s net worth is estimated to be 33 billion by Forbes and 50 to 90 billion by a Swedish business magazine similar to Forbes.
   • Ingvar Kamprad created this tax structure during the 1980s.
   • IKEA warehouse superstores are usually subsidized by state and local governments to the tune of $2 million dollars or more through tax credits or incentives (“Big Checks”).
   • IKEA can cater any event for you with their delicious and affordable meatballs.
   • IKEA sells $20 Christmas trees in Canada every year.
   • IKEA is the world’s most distributed free annual publication.
   • Lastly, Ingvar Kamprad was a Swedish-Nazi – go figure.

Conclusion:

IKEA had a very intelligent tax professional or a team of professionals working for them because this is an awesome tax plan.  Many people have complained about IKEA, since they started in Sweden, but moved to the Netherlands.  Swedes often complain about IKEA or call Kamprad a crook, but they none-the-less credit him as the single greatest private employer and contributor to Sweden.

What are your thoughts on using a charity as a “tax saving vehicle?”  Would you use this loophole to save potentially millions or would you refuse because it is wrong ethically? 

Problem:  Which states are start-up friendly to incorporate in?

HN Member:  kmfrk

HN Question:

Hey Cam,

1) Which states are preferable in terms of tax in a start-up? If there is any states of particular preference at all.

2) My impression seems to be that registering your company in Delaware is more of a priority “down the line”, even though it seems to be the go-to place for many companies. Is Delaware the place to go, or what is the current wisdom?

3) If I move from a European country to the US, should I expect to be taxed by the country where I spend more than six months a year, or are there things to look out for such as the risk of double taxation?

Best,

kmfrk

Analysis:

1. Should you incorporate at all?
   • Incorporation is the first thing everyone thinks about when they consider starting a startup.  This should be pushed down the list as far as possible because it may be an unnecessary cost.
   • There are very few reasons or occasions where incorporation is imperative to the success or continuance of a startup.  (1) If there is a huge risk of liability, then you’d need to incorporate in order to limit your exposure.  (2) If there is a state requirement to obtain some form of approval.  (3) You are required to incorporate in order to obtain funding.
2. What are the usual suspects in the Incorporation game?
   • The state you live in;
   • Delaware;
   • Nevada;
   • Washington;
   • Texas;
   • California; and,
   • New York.
3. Why should you incorporate in the state you live and reside in?
   • You’ll always be required to file and pay taxes to any state that you’re company has “nexus” with.  Nexus is the minimum connection required to a state in order for it to legally tax you.  Nexus is created most commonly through the existence of property owned or rented and employees within the state.
   • If you incorporate in a state outside your resident state, then you’ll be required to file a tax return in the state of incorporation as well as your state of residence.  This can be expensive and it is definitely very annoying.
   • The potential savings from state tax planning isn’t possible without the proper knowledge or the proper help.  But, even the greatest tax plan won’t save you anything, if you haven’t generated income.
4. Why is Delaware so popular?
   • Delaware is the home to the Chancery Court House.  Delaware’s Chancery Court only takes cases related to business law, thus it has a long history and precedence is clear.  This is important because you want certainty, when it comes to the law.  If you’re successful, a law suit in your future is guaranteed.  But, this comes at a price from hefty incorporation costs as well as annual fees.
   • Delaware has numerous tax loopholes that are available to businesses.  One of the popular loopholes involves Delaware’s Holding Companies and IP (“Intellectual Property”).  Delaware does not tax royalties in holding companies, thus income from IP is not taxed at the state level.
   • Why does Delaware want everyone to incorporate in their state?  Delaware has the largest number of domiciled companies of all the 50 states and these domiciled companies help Delaware generate billions in an unheard-of remote area of law called “Unclaimed Property.”  Gift card you’ve forgotten with pennies are common in all companies, but the companies are not allowed to keep the unused funds.  Escheat is a function of law, where unclaimed property is reclaimed by the state of domicile or state of incidence.  But, usually the funds are deferred to the state of domicile due to the structure of the law.
5. Why is Nevada popular?
   • Nevada is a relative newcomer to the world of incorporation or “US Domestic Tax Havens.”  Delaware has been the long-standing king that has held the title, but Nevada has become a stronger and stronger candidate for incorporation.  Nevada is pro-business and the filing fees are very affordable.
   • Nevada has no state income tax on the personal or corporate levels.  Thus, it’s a huge tax savings for anyone that is able to incorporate in the state.  Nevada relies on the gaming industry, sales tax and property taxes to fund the state’s coffers.
   • Nevada also has very aggressive corporate laws that protect the owners of the company.  Generally, Nevada will give the majority shareholders a confirm control over the company with limited requirements to satisfy the minority shareholders.
   • Lastly, Nevada is the only state that has refused to share information with the IRS.  Thus, your tax information within the state is unknown to the federal government.
6. Why are Washington and Texas known as friendly start-up states?
   • These are two states that don’t have personal income taxes.  But, they both have corporate level taxes.  Washington and Texas don’t have their taxes based on income because their taxes are based upon gross receipts.  They tax companies at lower rates but on a larger base.  They made the gambit that this would be a fairer determination of tax and it would generate greater revenues.  Their logic was that a company should pay for the privilege of availing itself to their residents and that best measure of that is the gross receipts generated from the state.
   • Also, they have growing startup communities that have begun to attract talent.  But, the reason why a startup community has developed in these areas is because a large number of Fortune 500 technology companies are based in these states.  Thus, their employees at one point or another wish to strike for gold – themselves.
7. California is Terrible!
   • It has incredibly high tax rates and one of the most aggressive tax codes within the 50 states.  Generally, I have nothing positive to say about this state legally and tax wise.
   • California’s minimum tax is $800 dollars regardless of income or loss.
   • But… it has Silicon Valley…
8. New York?
   • Again, it has horribly expensive tax rates and is the most complicated tax system in the United States by any measure.  The state is aggressive with their audits and it has a number of taxes unheard-of anywhere else.  For example, New York City has the CRT (“Commercial Rent Tax”).  The CRT is a tax on the rent you paid.  If your rent is over a certain threshold, then you’re required to pay taxes on the expense/rent paid.
   • New York’s minimum tax is $25 dollars for NYS and NYC each for $50 dollars total.  But, this is based upon the gross receipts or sales.  It could be as high as $5,000 dollars for NYS and NYC each.
   • Silicon Alley…is a joke.
   • But, it’s New York.  No one can ever deny the shear potential of the city and its residents.

Conclusion:

Don’t incorporate unless absolutely necessary, but if you have to bite the bullet then choose wisely.  The best state to incorporate in is the state you’re residing in because it simplifies your tax compliance or tax filings.  Also, you won’t be able to obtain the benefits of the state tax planning unless you’re knowledgeable and have operations of sufficient scale.  The rule of thumb is generate revenues first and worry about the rest later!