Tuesday, February 23, 2016

Demystifying the U.S. Tax Code: How Congress Affects Business Income Taxes

The U.S. tax code forms the backbone of how the IRS operates. Despite calls for reforms during just about every session of Congress, the tax code remains complex and, in some cases, difficult to interpret. Demystifying the code may take years, or even a special degree. Ordinary citizens and business owners may not be able to make heads or tails of the U.S. tax code, but a little knowledge can go a long way.

Sources of Income Tax Law

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The U.S. Constitution gives Congress authority to collect taxes as a means to provide revenue for the federal government. The 13th Amendment, ratified by the states in 1913, gives Congress the ability to assess income taxes on individuals and entities. The income can derive from any source, such as hourly wages, investment income, profits from a business operation, and sales of physical assets. Section 61 of Title 26 within the U.S. Code enumerates exactly what counts as income, although that list does not include every possible source. Laws that start as bills in Congress may alter the tax code periodically.

How Taxes Become Law

Congress passes tax laws, and then the IRS has the authority to enforce those laws. It all starts with the House Ways and Means Committee. Members of this committee agree on which proposals should go up for debate and a vote in the full House and they craft tax legislation. The House then debates the bill and the legislative body may amend it. If the House approves the bill, it goes to the Senate Finance Committee for review, where it undergoes the same process in the House. If the Senate approves a different version of the legislation, a joint committee between both bodies tries to come up with a compromise bill. When both sides of Congress agree and pass the same legislation, the President of the United States either signs the bill into law or vetoes it. The bill becomes a law within the U.S. tax code when the president signs it or Congress overrides a veto.

Intricacies of Tax Laws

Tax legislation, even before it goes into the tax code, is very complicated. The text of the Consolidated Appropriations Act of 2015 is 233 pages, and the behind-the-scenes work that goes into the legislative process is enormous. Congressional staffers and researchers crunch numbers, representatives and senators hear testimony about the effectiveness of tax changes, and members of the legislative body hear hours of debate before voting on a proposal. The tax laws passed and signed into law December 2015 include several provisions that extend tax benefits already on the books. The overall cost of this legislation comes to $622 billion over 10 years, according to estimates from Congress. The bill itself changes verbiage to various sections of the U.S. tax code, using quotes and legal citations.

Delegated Legislation Adopted by the IRS

The IRS takes the changes to the tax code and comes up with procedures, policies, instructions, and tax forms that correlate to provisions within the law. If a law changes the way a business collects an employment tax, the IRS tells businesses how to accomplish this tax collection. This also means the IRS has the authority to penalize businesses for not following the IRS rules. Rules within the IRS turn into instruction booklets and tax forms. Some of these booklets and forms are long, complicated, and hard to read. Owners and investors must differentiate between statutory employees, independent contractors, self-employment income, small businesses, and corporations. Business owners need to know how to implement the Work Opportunity Tax Credit, parts of the Affordable Care Act, and general accounting principles that determine the value of assets, income, and revenue. Businesses that take advantage of deductions and credits can reduce their tax liability, while increases in sales and revenue may increase the taxes a business pays. The process of tax legislation comes full circle when individuals and businesses either pay income taxes each year or receive an income tax refund. Companies usually pay estimated taxes each quarter so the entire burden of paying taxes doesn't occur on April 15 each year. Getting to the point where a company files tax returns may take some effort, depending on the size of a business, the number of employees, and the amount of income brought in by a business.

Help for Taxes

A licensed accountant can help a company by outlining how tax laws affect the bottom line of a business. An experienced business owner knows the intricacies and minutiae of owning a business with the ultimate goal of making money. Likewise, a CPA is an expert on tax laws who can explain how a company can take advantage of tax laws by developing strategies all year long. When tax time rolls around in April, a good CPA gives a client the best way to file the most complete return possible.

Tuesday, February 16, 2016

A Marriage of Equals? The Difference Between Corporate Mergers and Acquisitions

Although both types of restructuring are intended to increase a company's value, profitability, and synergy, the concepts of a merger and acquisition are not interchangeable. The simplest difference is whether the interaction is friendly or hostile. Part of this distinction exists in how it is announced to the public and the target company's employees, shareholders, and board of directors. Friendly purchases are generally called mergers, while hostile ones are almost universally known as acquisitions.

To put it plainly, a merger occurs when two companies consolidate into one new identity, whereas an acquisition involves one company taking over another entirely, establishing itself as the new sole owner. 

What Is a Merger?

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A merger consolidates two companies into a new entity, combining their operations under a new ownership and management structure. Ostensibly, this new management structure includes key members from each firm, building a greater whole from the sum of the two (or more) parts. A merger involves complicated negotiations, rather than one company dictating terms to another. A merger of equals occurs when two CEOs heading companies of approximately the same size decide a marriage between their two companies is in the their best interests. Upon merging, both companies surrender their stocks, issuing new stocks in the name of the newly formed entity. Depending on the relative size of the companies, shareholders of the merged companies often receive new shares at different ratios. The rate of exchange for shares is one of the important details determined by the negotiations. Once the merger is complete, a single new company exists, while the merged companies either cease to exist or become branded sub-entities of the new company.

Why Merge?

Companies may choose to merge for a number of reasons. In a merger, the combined larger entity typically results in increased resources for marketing, finance obligations, or product expansion. Alternatively, the combined entity may merge similar operations to reduce costs, creating a more streamlined company that is smaller than the two independent companies. By downsizing redundant staff and consolidating facilities, the new company often reduces payroll and overhead costs. When the merged companies previously competed directly against each other, they also reduce marketing costs due to the decrease in competition.

What Is an Acquisition?

In an acquisition, one company takes over the operational management decisions of another company. Sometimes called takeovers, acquisitions generally have a more negative connotation than mergers. In some instances, a larger company buys out a smaller one, then compels the purchased company to refer to the acquisition as a merger to avoid negativity. Unlike a merger, the purchased company's stocks are purchased before the sale rather than surrendered afterwards.

Why Acquire?

The strategic reasons for an acquisition mirror those for a merger, such as a decreased market or the desire to reduce competition. Unlike the often expensive and lengthy process of merger negotiation, an acquiring company generally has more freedom to dictate the terms of sale and purchase to the target company in a shorter time-frame. In some instances, companies acquire other entities to acquire rights to a specific product, allowing them to bypass the process of product creation. Similarly, a company may acquire another to gain control over a resource it requires, allowing it to bypass the market. By purchasing another company, a business can increase its size, visibility, and prestige.

Types of Mergers and Acquisitions

There are several kinds of mergers and acquisitions, distinguished primarily by the relationship of the entities involved. In a horizontal merger, the two companies exist within the same business sector. By merging, they increase marketplace visibility, combined value, and cost savings. In a vertical merger, one company buys a supplier or retailer, allowing it to reduce overhead operational costs and to increase its economy of scale. A conglomeration deal involves two businesses whose products or services are unrelated to one another. This allows for diversification of interests and capital investment.


Whether friendly or hostile, horizontal or vertical, or negotiated or purchased, all mergers and acquisitions have one important goal in common: to make the value of the combined companies greater than the sum of the parts combined. Accordingly, a combined company must have more value than either individual company had on paper previous to the restructuring. This is called synergy. Synergy often takes the form of revenue enhancement and cost savings by focusing on staff reduction, economies of scale, improved visibility, greater market reach, and development of new technologies. Success of a venture, whether merger or acquisition, depends on whether this synergy is achieved. Increasingly, the blended Mergers and Acquisitions (or M&A) moniker is used to cover all discussion of mergers and acquisitions, regardless of the nature of the deal in question. The two kinds of corporate marriages, however, remain subtly different, especially to a business in the process of merging and creating a new identity, or being acquired and losing its identity altogether.

Tuesday, February 9, 2016

The Countries With the Highest Taxes in the World

When it comes to the countries with the highest taxes in the world, most people imagine a simple list that can be ordered from highest to lowest. In reality, there are multiple forms of taxation to consider, from the dreaded personal income tax to corporate taxation. As such, while one country may have a surprisingly low income tax, it could still lead the world in terms of corporate taxation. This all makes getting to the bottom of where people pay the highest taxes rarely as simple as it initially may seem. 

Personal Tax Rates

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Coming in at number one on the list of countries around the world with the highest personal tax rates is the nation of Aruba. Aruba is an island country governed by the Netherlands that has a hefty tax rate of 58.95 percent on all personal income over $171,149. Although Aruba has the highest income tax rate in the world, its citizens have the lowest average income compared to the other countries with the top 10 highest income taxes. Because the population of Aruba only earns an average of $23,000 annually, wealthier residents are expected to pay more to make up the difference. Offering some financial relief are Aruba's generous tax policies for married couples, who receive a 3 percent tax break. Workers in Aruba can also rest easy knowing that employers cover their Social Security contributions, leaving more of their paychecks in the bank.

Corporate Tax Rates

The United Arab Emirates has the highest corporate tax rate in the world at 55 percent. Out of 163 nations reviewed by the Organization for Economic Cooperation and Development, this figure is much higher than the nation of Chad, which has a corporate tax rate of 40 percent. The United States is another top contender with a corporate tax rate of 39.1 percent. It's worth noting that the United Arab Emirates — which is actually a federation of seven different Emirates — makes up for its high corporate tax rate by not imposing a federal corporate income tax. Instead, most of the emirates impose more forgiving individual tax decrees that vary up to 55 percent. Corporations that produce oil, gas and other natural resources from the area also face harsher tax penalties.

Overall Tax Rates

When it comes to the highest overall tax rates, Italy ranks at the top with a rate of 50.59 percent. While Italian workers are expected to give the government more than half of their paychecks, this high rate applies after Social Security contributions have been paid. Italian tax rates are even higher than they seem at first glance when you consider how little an Italian citizen has to earn in order to qualify for the highest tax rate. Italy's highest tax rates kick in at $125,000, while the United Kingdom's top rate of 45 percent begins at an income level of approximately $250,000. European countries tend to have higher overall tax rates than others around the world, but these rates vary. Each country has its own set of rules governing Social Security contributions, payroll taxes, and other financial exemptions the country's residents may be entitled to.

Tax Rates in the United States

While the United States doesn't make the top of any list for the highest tax rates, it ranks highly in each of the prior categories. United States workers in the highest tax bracket take home only 60.56 percent of their earnings, according to New York State Tax. Compared to Aruba, the highest American income tax rate is 39.6 percent. The second highest income tax bracket in the United States is still 35 percent. The United States falls behind Italy, India, the United Kingdom, France, Canada, Japan, and Australia for income tax rates. While the United States ranks third in terms of corporate tax rates — at 39.1 percent — the country is also a world leader in corporate tax deductions. These deductions mean that corporations generally pay less to operate their businesses in the United States than they do in most European nations. United States tax law is also unique in that state taxes play such a large role in what each corporation pays. Some states have corporate tax rates that are generous enough to make up for higher federal tax rates, giving businesses more incentive to keep their operations in the country. Tax laws between states can vary as widely as tax laws between countries. Comparing tax rates around the world requires a broad approach that keeps in mind how different various forms of taxation can be. From income brackets to state policy, the amount individuals and corporations actually pay in each country isn't always the figure seen on paper. Understanding the way these dynamics work with each other goes a long way towards understanding the truth about which nations really have the highest taxes in the world.

Tuesday, February 2, 2016

Navigating the Differences Between Corporate and Individual Income Taxes

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Here's a bit of trivia: What type of tax is so often misunderstood that economists label it indefensible and inefficient? The same tax results in notable contortions in economic activity. Although it's supported by the average layperson on the street, very few people even know who bears the burden of such a tax, and many mistakenly attribute the payer as someone it isn't. Unsure? The answer is the corporate income tax.

Just as many consumers (incorrectly) believe corporations pay the corporate income tax, many business owners and managers (incorrectly) assume that the burden is passed along to consumers. Meanwhile, this example of the corporate cat chasing its tail explains why the tax remains popular among politicians. 

There are two significant ways that corporate taxes differ from individual taxes, and recognizing them may save you a lot of time and money. First, the corporate tax is only applicable to organizations identified as corporation's not to partnerships or sole proprietorships. Secondly, the money collected is only assessed on profits, or net income not a corporation's gross income. 

Federal tax rates vary according to different brackets of income, with graduated levels of payment between 15 and 39 percent. Corporations with less than $50,000 of taxable income pay 15 percent, businesses with income between $50,000 and $75,000 pay 25 percent, and rates range from 34 to 39 percent for income above that level. Most corporations face the maximum rate possible.

Tax rates for individuals follows much the same pattern. As of 2016, the top personal rate for a couple filing jointly and single filers is 39.6 percent, identical to that of corporations. Individuals earning less than $37,650 must pay 10 to 15 percent, whereas individuals earning between $37,650 and $91,150 are taxed at 25 percent. Rates vary between 28 and 39.6 percent beyond those figures.

In other words, there is no appreciable difference paid on the lower end of the financial spectrum for corporations versus individuals. As income increases, however, the tax burden becomes increasingly heavy for corporations. If your business is going to pull in substantial profits, consider using the S corporation filing status or having your LLC taxed as a partnership.

States levy additional taxes on corporations, with rates typically ranging from 3 to 12 percent. Most states allow business owners to deduct federal tax expenses, so net rates vary between 1.9 to 4.9 percent. Some local areas impose another tax on corporations. Businesses avoid these costs by relocating out of areas or states with particularly high income tax rates.

Following individual income tax rates and payroll taxes, corporate income taxes garner the largest source of revenue for the federal government. In fiscal year 2015, the total revenues were expected to reach $3.8 trillion. Of this, $1.48 trillion, or 47 percent of all tax revenues, stemmed from individual tax payers. By comparison, $1.07 trillion, or 34 percent of all tax revenues, came from payroll taxes garnered from employers and employees. Corporate income taxes paid by businesses accounted for $341.7 billion, or 11 percent of all tax revenue. Smaller amounts of federal revenue resulted from other taxes, such as excise taxes and customs duties.

Few people would argue that the corporate income tax serves a purpose. Other than filling the government's pockets, it helps restrict individuals from accumulating tax-free income within corporations. It also encourages debt finance comparative to equity finance, since the interest payments of corporations are deductible, whereas dividends are not. Furthermore, the corporate income tax persuades corporations to keep earnings instead of paying dividends.

On the other hand, the imposition of taxes on corporations twice, once when earned by the corporation and again when paid out to shareholders, dissuades business owners from utilizing the corporate form of enterprise relative to non-corporate forms. This dual tax process developed years ago when corporations received state-granted benefits, such as exemption from specific laws, thereby acting as an incentive for owners to pay for such services. Now that states merely serve as registrars and tax collectors, this tax is less justified. 

Since it does exist, however, it is up to business leaders and individuals to understand the notable differences between the types of taxes and what it means to file as a corporation versus as an individual. Deciphering which tax is appropriate to your situation can be complicated. Most small business owners and high-wage individuals benefit from hiring a CPA to understand the nuances between corporate income taxes and individual income taxes. 

As tax laws continue to evolve, CPAs must stay abreast of the changes to keep licensing up to date. This can be invaluable to you, as a business leader or individual, so that you can avoid mistakes apt to lead to auditing errors. Make sure that you can have representation, in case an audit does take place. CPAs provide an in-depth and thorough analysis of, and advise about, tax and financial matters.