Increasingly, businesses don’t generate profits – they generate capital gains | Hacker News Reader

Increasingly, businesses don’t generate profits – they generate capital gains

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82 pointsdeafcalculus78 comments

Unrealized capital gains aren't income because I can't pay my rent and buy groceries with Amazon stock. Even if I could once I did it would be realized same as if I sold it for cash, and I'd owe tax.

You could argue that capital gains rates are too low, but that's a different argument than saying stock owners are getting "invisible income".

I was under the impression that loans can be secured by stock. Then you don't pay the gains but get the money to spend on rent or whatever.

You are correct sir. I own $10,00 in stock. per reg T, I can borrow $5,000 against it. Now the stock goes on an Apple/Amazon like tear and it's worth $1,000,000. Now I can borrow up to $500,000 against it--that's a lot of rent groceries.

The above assumes you control the shares and they are pledgeable as collateral. It is not easy, but doable, to borrow against RSU's. i.e. you probably need a high net worth/private banker relationship.

I was under the impression that per reg T, you can borrow 100% of the equity value of your stock. So if you own $10,000 worth of stock, you can borrow $10,000 against it (but you will get margin called if there's a decline, so don't do that).

You're right however, if you want to acquire more shares using margin, then your equity needs to be at least 50% of the stock value, i.e. with $10k you can purchase (up to) $20k worth of stock.

Shorthand: You can borrow 50%.

You can't put $10K into the account, buy $10K in shares, and borrow $10K in cash (leaving 0 net equity in the account).

Your scenario where you can borrow 100% of the value applies only if you apply that 100% to further shares (meaning you buy 2x as many shares and have a margin balance of 100% of your original equity but 50% of the shares' value).

That means you can buy $20K worth of stock using $10K of cash.

Interesting. I don't usually use margin since I live in a country without capital gains tax, but if I transfer $10k worth of shares and I want to use it as a line of credit, then I can at most take out $5k (in cash) before getting margin called?

Yes and no (mostly yes). The 50% level is the "initial margin" limit (hence the "yes" part) for initiating a loan.

There is a separate, lower limit called the "maintenance margin" limit, which is the equity percentage that you need to hold to avoid a margin call on a held position.

So, if you deposit $10K in shares, they appreciate to $12K, you borrow $6K and then the share price falls back to the original amount, you have $10K in shares, $4K in net equity (40%), but are probably not going to receive a margin call.

Or, if they are worth $10K, you borrow the limit of $5K and the share price falls by 1%, you won't get a margin call there either (on most securities).

What happens when you pay up the loan? Can the bank get your shares without you paying tax?

Otherwise its just a collateral.

Yes. It's even better than actually selling your shares. If using portfolio margin you can even use more leverage, i.e. you can basically defer taxes in many (not all) cases pretty much indefinitely.

Why not just sell shares? You may avoid taxes, but you take risk and interest expenses.

You might not be allowed to sell the shares per an insider trading policy or per a disclosure policy ("CEO of XYZ dumped 50% of their shares" looks way worse than "CEO of XYZ borrowed $25MM to build a luxury house.")

You might not want to sell shares that you've held 306 days, preferring to hold them an additional 2 months to get long-term capital gains treatment on them.

You might not want to take capital gains (even if long-term) on this year's income tax. Maybe you want to defer it to January; maybe you want to defer it to a later year when you expect to have a lower capital gains bracket or when you expect to be able to avoid the Obamacare surtax on investment income (via repeal or via lower AGI)

You might not want to sell shares if the margin loan rate is lower than your expectation for growth of the shares.

The first one is likely still illegal under SEC rule 144 - they don't enforce it often, so it isn't very well known, and it's also a little vague, so hard to say whether it applies in this case - but it Might.

Never been to US but everytime i read anything like this it sounds like US has the most complicated Tax system in the world.

And you have to do it yourself!

Well, yes, and a loan can be secured by a house too, using a mortgage. In fact, millions of people do that to buy their houses. Do you consider the loans people get to buy houses "income"? Of course not, because it's not. Loans are not income.

Loans are technically debt but can easily be income de-facto i.e. it can be used as if they are income.

When a bank borrow you money they don't actually take it from somewhere they fundamentally can create it because of quantitative easing pushed by central banks.

The digital monetary system today is a far cry from the gold based system and the ability to use money as if they are income are very real. Money is more a concept today.

Banks creating money is not quantitative easing. This is a misconception you probably got from a vast oversimplification of what QE is. Banks can create money even without QE (and have done so for a very long time now).

https://en.wikipedia.org/wiki/Quantitative_easing

I can see how my writing would have been misunderstood so let me rephrase.

They can't do it without the Central Bank and it's the same mechanism as allows for QE. It's only possible in a FIAT based system.

When banks do it it's called fractional reserve banking but the mechanism is fundamentally the same, the ability to "create money".

Fractional reserve banking doesn't require central banking either. It only requires that people accept more abstract forms of money such as bank notes, and that not too many people try to withdraw their money at the same time.

There's no mandate that bank notes need to be issued by a central bank. See the article: https://en.wikipedia.org/wiki/Banknote

"National banknotes are generally legal tender, meaning that medium of payment is allowed by law or recognized by a legal system to be valid for meeting a financial obligation."

So yes it requires a central bank as it's through them the recognition happens. Philosophically all money requires is trust no matter what not even a legal entity as long as people trust it, but practically to claim that central banks aren't needed for FRB is wrong to the best of my knowledge.

It links to another article on the same site that basically explains that US macroeconomic measures of Income and Savings ignore capital gains. By transforming the income from profit and dividends into capital gains, the income becomes invisible to economists, politicians, etc who rely upon those measures.

Surely that's a problem with the measurement...? This could probably be fixed relatively rapidly these days, since all money is electronically tracked somewhere. It would certainly be easier than trying to persuade (or compel) every player to file this or that income in a different way "so that we can run statistics".

Not to mention that anyone who can save money in a savings account is also perfectly able to buy some shares or funds and get capital gains themselves.

This article gets two big things wrong:

1) Amazon's lack of profits appears to be due to reinvestment back into the business, not because the margins are non-existent. If the margins weren't there, there would be no money to invest in R&D.

2) The author never comments on the issue of double taxing corporate profits. Is it really the spirit of the tax code that $1 in profits earned by a business should really yield $0.48 to the federal government? The best way to address the author's concern is to put the effective corporate tax rate (35% corp income + 20% dividend) more in line with capital gains rates.

Isn't your first complaint exactly described in the article?

>3. You build a bigger and bigger business.

Is it really the spirit of the tax code that $1 in profits earned by a business should really yield $0.48 to the federal government?

In my view, the answer is yes. At least at the macro level, there are no unintended consequences in the tax code. Double taxation has been widely known to anybody who has influenced the development of our tax code, for decades.

With that said, is there potentially a better way to collect $0.48 on every $1 earned in profits? Should it be $0.18, or $0.88 instead? Those questions are certainly worthy of debate.

> In my view, the answer is yes. At least at the macro level, there are no unintended consequences in the tax code. Double taxation has been widely known to anybody who has influenced the development of our tax code, for decades.

He's not really asking if that tax rate is intentional. His real question is doesn't it seem unfair that a business is taxes for 48 cents on every dollar?

In that case, I think the answer depends on whether you favor lower taxes, or higher. I also wonder if it would make sense for business taxes to be progressive, like income taxes.

Amazon's retail business is very low-margin. Most of the profit they do make now is coming from AWS. Their valuation right now comes from investor expectations that they will eventually run every other retailer out of business and then change monopoly rent with much fatter margins, rather than on the margins they have now.

Interesting proposition. Anything I can read on this further?

There's gross margins to fund R&D, but if all that money is spent, isn't net margin zero?

> Is it really the spirit of the tax code that $1 in profits earned by a business should really yield $0.48 to the federal government?

But it's profits and not revenues. It's the government that defines what those profits are with their tax deductions, etc. So I think it's pretty fair.

A big hint is up North in Canada where the corporate tax rate is lower: corporations aren't magically more profitable. Canadian dividend recipients even get a 50% deduction on dividend income to account for the corporate income tax already paid. Yet you don't see American dividend investors flocking to Canadian equities do you?

A principle well known to economists is that if you tax some activity, you are going to see less of that activity. This applies to business profits. Heck when I started my first business our newly engaged accountant told us "whatever you do don't make a profit" (meaning pay any money mad to employees/managers). Hardly a new or specific to Amazon concept.

So the idea is we want someone to get rich but not let some others to have basic income.

That indeed sounds like the human intention, despite universally people claim the opposite.

I have truly no idea what you are talking about. The idea is that if a government is going to tax money at X% when left to accrue as corporate profit, but at Y%, where Y<<X, if extracted in some other way from the business, then any rational human will do the obvious thing.

> "money mad to employees"

"mad"? What does that mean?

It was likely a typo for "money made."

Oh right, the accountant advised that all leftover money be paid to employees or managers.

Yes.

Typo. "Made"

I'm all for raising taxation, but I've always felt Amazon is often the wrong target to pick on. They are a rare example of an old-school business in the digital age - they pinch every penny and then reinvest all revenues in the business itself or send them out as personal compensation. They don't stash billions in Bermuda accounts, they don't give them to Wall Street players with the right connections, they don't leverage their might to spike property prices, and so on. Amazon is what every big business could be if people at the top were a bit more concerned with actual efficiency and growth, and less with pure greed.

But: in their actual business practices, Amazon often squeeze the little guy - both their workers and their small-retail competitors - so they are easy to hate. They clearly display all the problems with cyberspace (who should be taxed where, when bits go up and down some fiber? Where is my data "in the cloud"? Etc etc), so they are at the nexus of a number of critiques, and rightly so. I personally don't think, though, that their overall investment/growth strategy should be attacked, because it's actually very good from a social perspective.

What makes you think Amazon is doing everything in it's power to avoid paying taxes just like every other multi-national?

http://www.newsweek.com/2016/07/22/amazon-jeff-bezos-taxes-4...

The point is not tax minimization (which every company does), it's what you do with the money thereafter. Amazon historically didn't hoard cash like, say, Apple, preferring to put most of the money back in the business, which is what I was talking about; however, looking at recent data, it seems like they've started significant accumulation of cash in 2014, and they're now sitting on $20bn+. I wonder what triggered this change.

"I'm all for raising taxation, but I've always felt Amazon is often the wrong target to pick on."

Agreed.

Amazon is the embodiment of our new winner takes all economy. The natural result of the combination of power law distribution of attention and market unification.

If society chooses to mitigate, the two available strategies are pro-competition (anti-monopoly style breakups, artificial top-down market segmentation) or radical cashectomies (wealth redistribution thru higher tax rates and universal basic income).

Avoiding double taxation? Evil!

How about removing the corporate income tax? https://www.nytimes.com/2014/01/06/opinion/abolish-the-corpo...

I've never understood the whole "double taxation" complaint. Money is taxed whenever it changes hands. Why is it that only the taxing of dividends is considered "double taxation" [1]?

1: http://www.thepatriotaxe.com/blog/wp-content/uploads/dividen...

Because companies can't deduct the dividend payment on their taxes. If $100 is paid in dividends then both the individual and the company pay income taxes on that same $100.

If I use $100 to pay for groceries, I had to pay income tax, sales tax, then the company has to pay any profits on it, and then when the employee gets paid they have to pay income tax on their part.

Perhaps the issue is we tax money way too much as it flows through our economy.

Its definitely about how the compounding of two taxes is a lot.

If you live in a country that doesnt have a tax treaty with the us for example, for every 100 dollars, you could potentially have to pay 35 in the US, and then of the 65 left, 22.75 more to the home country, for a whooping total of 57.75% tax rate.

There's even more [and more unjustifiable] whinging about "double taxation" over inheritance tax, despite inheritances comprising assets that bought with income that in many jurisdictions hasn't been taxed for decades, often with enormous untaxed asset price appreciation in the mean time.

Many of the people making arguments against "double taxes" also favour balancing the books with higher sales taxes - sales taxes not deductible from our income taxes - presumably in the expectation that the incidence of that "double tax" will fall more upon other (usually poorer) people...

"Simple: don’t show any profits" is a concept that's been used forever to avoid paying taxes from the local handyman all the way to Amazon.

It isn't evil, but just try and convince some people that.

Especially that handyman, who's trying to avoid those estimated payments in a slow business part of the year.

Exactly, anyone that wants proof of this just needs to do business with a tradeperson outside of the big cities.

Family has had a cabin home about an hour outside of Minneapolis, whenever I need something (plumbing, woodwork, etc) I always ask for the cash price. You can get huge discounts because the business simply doesn't have to report it (they DO but no way to track it).

I personally don't think it should be frowned upon.

You don't think felony tax evasion should be frowned upon? That goes far beyond tax avoidance.

If you think this behavior is bad in the US, come have a look in Europe. You'll be amazed. And I'm from Northwest Europe, I 'm told I would not believe what common practice is in Greece.

Do you think it's OK for Amazon and other companies to do this in a more "corporate" sense?

Why is it OK for the big guy but not the little guy just because they have good legal/financial resources? For some small businesses in this country, it's the only way to stay competitive to big enterprise. See: Little pizza shop versus large franchise.

I'm talking about the spirit of the whole thing, not the law.

To be completely honest, most business will tell you this revolves around the criminal amount the card processors take from them in processing fees.

What Amazon does is completely different!

The laws by which they retain their cash are different yes, but is the result? Not to mention the order of magnitude is larger.

Yes, because the money is going directly back into things that benefit the company and returns cashflow which will (presumably) be taxed at a later date.

Credit card rates with your own merchant account are 3% - 8%, depending on your industry and chargeback history.

Federal Marginal tax rates are 10% - 38%, plus maybe 5% in MN.

If they are giving you a 5% - 10% discount for cash, sure, it's probably because they appreciate skipping the credit card. If they give you a larger discount for paying in cash, they probably aren't reporting the income.

CC rates can be negotiated down below 3%.

Depends on the business.

For card-present goods and services it's likely lower, but for card-not-present online software sales from a small company, rates with your own merchant account can be even higher than 8%. This is a big advantage of using Stripe and the like.

Yes that's for sure, I'm just stating all the causes of the proliferation of this problem.

It also means that sales tax is being avoided with a cash transaction. Although, I guess Amazon also avoids the sales tax...

No, they don't avoid it. I pay sales tax on every purchase I make on Amazon. It is required based on the laws of certain states. I recall there being some law passed a while ago regarding this.

The question of whether or not the rules are equitable is complicated.

The problem with your position is that it reduces us to "nobody should have to pay taxes, ever". That's most definitely not going to work.

That's not true, in my opinion it goes back to the equity conversation. Per another comment what Amazon and the little guy are doing are different in process/principle, however the resulting impact to the government is orders of magnitude larger from Amazon, no?

I guess there is no way to estimate the total $ missing from small business to compare.

"I'm talking about the spirit of the whole thing, not the law."

Well, that's the problem. You asked a question about why one is acceptable and another is not and the reason is legality.

What it sounds like is that you want tax reform or to do away with loopholes, which is fine. There's a lot of shady/questionable/unethical things that the law allows and corporations take advantage of them whenever they can. And let's be serious - you would, too, if you had the resources become a multinational conglomerate and have the best accountants and tax attorneys that money could buy. We all would, especially if we were CEO/CFO of one of these firms with a responsibility to look out for shareholders. If you can deliver more money to them and you don't, you're probably going to be out on your ass real fast. The solution is to change the law because you are never going to convince people to not use it to their advantage. If I had a company and people told me I could make an extra 200k a year just by restructuring the company and making a few adjustments that would be frowned upon by society but would not land me in jail, the odds of me not doing it are slim to none.

Yes, again, I'm talking the spirit vs the letter of the law.

Of course everyone who learns the can "legally" circumvent the law, will. That's clear with every large company in the US.

If you ignore scale, sure. A handyman pocketing $100 in cash here and there is a good deal different from a company whose whims could affect the trajectory of the economy.

I wasn't insinuating pocketing cash.

I was insinuating tax avoidance methods. Which are completely legal and how every small business stays afloat. (Write offs, SEP IRA, Depreciation, company car, office space, etc.)

It's not the act that is evil, is the person doing it, am i rite. We must take the veil off Lady Justice.

Please. Corporate taxes make no sense as they are, companies don't pay taxes, people pay taxes. And corporate taxes more often than not fall on the consumer.

Almost six years ago, before I took to taxi driving, I spent almost two months as a "seasonal associate" at an Amazon warehouse in Phoenix. It was such a relief to get laid off... In the warehouses, people are servants to the machine, and are entirely replaceable.

"Humanity's Second-Best Hope" was based on my experiences at Amazon: http://www.taxiwars.org/p/humanitys-second-best-hope.html

Seasonal. Warehouse. Job.

This experience sounds like a typical warehouse job. I'll ignore the outdated political symbolism.

Amazon's net profits increased to $1.17b in 2016 and are likely to stay healthy. So the article is already a bit obsolete. It's not like it isn't onto something, but the ingenious scheme used by evil megacorporations isn't just not posting a profit, but moving that profit to some tax haven to avoid taxation.

This seemed to be the case but after the recent earnings report Bezos & Co. hinted that they are likely to go back to losing money now.

https://techcrunch.com/2017/07/27/it-looks-like-amazon-would...

Am i the only one so cynical that i don't see how is this a problem for anyone?

Of course their unrealized gains are not included in income... that's not what income is.

The online reason this works is because the tax code specifically preferences investment & the gains thereon vs interest & wages/Self Employment income.

Wouldn't that be an interesting discussion to see as part of tax reform...not holding my breath.

We get more of what we tax less?

Weird.

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